Derivative Financial Instruments

9 Months Ended

Sep. 30, 2013

Derivative Financial Instruments

Derivative Financial Instruments

15. Derivative Financial Instruments

The Company uses various derivative financial instruments to mitigate interest rate risk. The Bank’s interest rate risk management strategy involves effectively modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin. PrimeLending has interest rate risk relative to interest rate lock commitments (“IRLCs”) and its inventory of mortgage loans held for sale. PrimeLending is exposed to such rate risk from the time an IRLC is made to an applicant to the time the related mortgage loan is sold. To mitigate interest rate risk, PrimeLending executes forward commitments to sell mortgage-backed securities (“MBSs”). FSC uses forward commitments to both purchase and sell MBSs to facilitate customer transactions and as a means to manage risk in certain inventory positions.

Non-Hedging Derivative Instruments and the Fair Value Option

As discussed in Note 3 to the consolidated financial statements, the Company has elected to measure substantially all mortgage loans held for sale at fair value under the provisions of the Fair Value Option. The election provides the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without applying complex hedge accounting provisions. The fair values of PrimeLending’s IRLCs and forward commitments are recorded in other assets or other liabilities, as appropriate, and changes in the fair values of these derivative instruments produced net losses of $48.9 million and $14.9 million for the three and nine months ended September 30, 2013, respectively, which were recorded as a component of net gains from sale of loans and other mortgage production income. The change in fair value during the three months ended September 30, 2013, is attributable to a decrease in the volume of IRLC’s and mortgage loans held for sale, which also conversely affected the value of PrimeLending’s mortgage loans held for sale, which are measured at fair value under the Fair Value Option. The effect of the change in market interest rates on PrimeLending’s loans held for sale is discussed in Note 3 to the consolidated financial statements. The fair values of FSC’s derivative instruments are recorded in other assets or other liabilities, as appropriate, and changes in the fair values of FSC’s derivatives produced net gains of $3.2 million and $8.8 million for the three and nine months ended September 30, 2013, respectively, which were recorded as a component of other noninterest income.

Derivative positions are presented in the following table (in thousands).

	September 30, 2013					December 31, 2012
	Notional		Estimated			Notional		Estimated
	Amount		Fair Value			Amount		Fair Value
Derivative instruments:
IRLCs	$	798,837	$	26,440		$	968,083	$	15,150
Commitments to purchase MBSs	283,437		7,443			165,128		466
Interest rate swaps	—		—			1,969		25
Commitments to sell MBSs	1,826,399		(29,290		)	1,586,930		(1,025		)