Derivatives

Interest rates swaps related to community banking activities

The Company enters into commercial loan interest rate swap agreements with commercial banking customers which are offset with a corresponding swap agreement with a third party financial institution ("counterparty"). The Company has agreements with its counterparties that contain provisions that provide that if the Company fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements. These agreements also require that the Company and the counterparty collateralize any fair value shortfalls that exceed $250,000 with eligible collateral, which includes cash and securities backed with the full faith and credit of the federal government. Similarly, the Company could be required to settle its obligations under the agreement if specific regulatory events occur, such as if the Company were issued a prompt corrective action directive or a cease and desist order, or if certain regulatory ratios fall below specified levels. The Company pledged $300,000 in available for sale securities to collateralize fair value shortfalls on interest rate swap agreements as of both September 30, 2018 and December 31, 2017.

The Company had interest rate swaps related to commercial loans with an aggregate notional amount of $15.2 million and $12.5 million at September 30, 2018 and December 31, 2017, respectively. At September 30, 2018, the notional amount of interest rate swaps is made up of two variable to fixed rate swaps to a commercial loan customer totaling $7.6 million, and two fixed to variable rate swaps with a counterparty totaling $7.6 million. Changes in fair value from these four interest rate swaps offset each other in the first nine months of 2018. The Company recognized $70,000 in fee income related to interest rate swaps in the three and nine-month periods ending September 30, 2018 and recognized $10,000 and $26,000 in fee income in the three and nine-month periods ending September 30, 2017, respectively. Interest rate swap income is recorded in other income on the Consolidated Statements of Income. None of these interest rate swaps are designated as hedging instruments.

The Company entered into an interest rate swap in the third quarter of 2017 to hedge the variability in cash flows arising out of its junior subordinated debentures, which is floating rate debt, by swapping the cash flows with an interest rate swap which receives floating and pays fixed. The Company has designated this interest rate swap as a hedging instrument. The interest rate swap effectively fixes the Company's interest payments on the $10.0 million of junior subordinated debentures held under Northrim Statutory Trust 2 at 3.72% through its maturity date. The floating rate that the dealer pays is equal to the three month LIBOR plus 1.37% which reprices quarterly on the payment date. This rate was 3.70% as of September 30, 2018. The Company pledged $400,000 in cash to collateralize initial margin and fair value exposure of our counterparty on this interest rate swap as of September 30, 2018. Changes in the fair value of this interest rate swap are reported in other comprehensive income. The unrealized gain on this interest rate swap was $1.0 million as of September 30, 2018.

Interest rates swaps related to home mortgage banking activities

The Company also uses derivatives to hedge the risk of changes in the fair values of interest rate lock commitments. The Company enters into commitments to originate residential mortgage loans at specific rates; the value of these commitments are detailed in the table below as "interest rate lock commitments". The Company also hedges the interest rate risk associated with its residential mortgage loan commitments, which are referred to as "retail interest rate contracts" in the table below. Market risk with respect to commitments to originate loans arises from changes in the value of contractual positions due to changes in interest rates. RML had commitments to originate mortgage loans held for sale totaling $69.0 million and $43.6 million at September 30, 2018 and December 31, 2017, respectively. Changes in the value of RML's interest rate derivatives are recorded in mortgage banking income on the Consolidated Statements of Income. None of these derivatives are designated as hedging instruments.

The following table presents the fair value of derivatives not designated as hedging instruments at September 30, 2018 and December 31, 2017:



(In Thousands)	Asset Derivatives
		September 30, 2018		December 31, 2017
	Balance Sheet Location	Fair Value		Fair Value

Interest rate swaps	Other assets		$122		$77
Interest rate lock commitments	Other assets	1,117		873
Total			$1,239		$950



(In Thousands)	Liability Derivatives
		September 30, 2018		December 31, 2017
	Balance Sheet Location	Fair Value		Fair Value

Interest rate swaps	Other liabilities		$122		$77
Total			$122		$77

The following table presents the net gains (losses) of derivatives not designated as hedging instruments for the three and nine-month periods ending September 30, 2018 and 2017:



		Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	Income Statement Location	2018			2017			2018		2017
Interest rate contracts	Mortgage banking income		$138			($370	)		$511		($482	)
Interest rate lock commitments	Mortgage banking income	(281		)	193			203		364
Total			($143	)		($177	)		$714		($118	)

Our derivative transactions with counterparties under International Swaps and Derivative Association master agreements include "right of set-off" provisions. "Right of set-off" provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes.

The following table summarizes the derivatives that have a right of offset as of September 30, 2018 and December 31, 2017:



September 30, 2018					Gross amounts not offset in the Statement of Financial Position
(In Thousands)	Gross amounts of recognized assets and liabilities	Gross amounts offset in the Statement of Financial Position		Net amounts of assets and liabilities presented in the Statement of Financial Position	Financial Instruments		Collateral Posted		Net Amount
Asset Derivatives
Interest rate swaps	$122		$—	$122		$—		$—		$122

Liability Derivatives
Interest rate swaps	$122		$—	$122		$—	$122			$—

December 31, 2017					Gross amounts not offset in the Statement of Financial Position
(In Thousands)	Gross amounts of recognized assets and liabilities	Gross amounts offset in the Statement of Financial Position		Net amounts of assets and liabilities presented in the Statement of Financial Position	Financial Instruments		Collateral Posted		Net Amount
Asset Derivatives
Interest rate swaps	$77		$—	$77		$—		$—		$77

Liability Derivatives
Interest rate swaps	$77		$—	$77		$—	$77			$—