Derivatives and Hedging Activities

6 Months Ended

Jun. 30, 2011

Derivatives and Hedging Activities

Derivatives and Hedging Activities

9.             Derivatives and Hedging Activities

The Company is exposed to certain risks arising from both its business operations and economic conditions.  The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and through the use of derivative financial instruments.  Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to certain variable rate loan assets and variable rate borrowings.  The Company does not use derivatives for trading or speculative purposes and currently does not have any derivatives that are not designated in qualifying hedging relationships.

Fair Values of Derivative Instruments on the Balance Sheet

The table below presents the fair value of the Company’s derivative instruments that were liabilities, as well as their classification on the balance sheet, as of June 30, 2011 and December 31, 2010.  The Company did not have any derivative instruments that were assets as of June 30, 2011 and December 31, 2010.

		Fair Value
Derivatives Designated as	Balance Sheet	June 30,		December 31,
Hedging Instruments	Location	2011		2010
Interest rate contracts	Other liabilities	$	1,922	$	1,750
Total hedged derivatives		$	1,922	$	1,750

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy.  For hedges of the Company’s variable-rate loan assets, interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount.  For hedges of the Company’s variable-rate borrowings, interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments. As of June 30, 2011, the Company had two interest rate swaps with an aggregate notional amount of $17.5 million that were designated as cash flow hedges of interest rate risk associated with the Company’s variable-rate borrowings.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income (“AOCI”) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.  No hedge ineffectiveness was recognized during the three and six months ended June 30, 2011 and 2010.

During the three and six months ended June 30, 2011 and 2010, such derivatives were used to hedge the forecasted variable cash outflows associated with subordinated debt related to trust preferred securities. During the three months ended June 30, 2011 and June 30, 2010, the amount of pre-tax gain/(loss) recorded in AOCI due to the effective portion of changes in fair value of derivatives designated as cash flow hedges was $(470,000) and $(778,000), respectively.  During the six months ended June 30, 2011 and June 30, 2010, the amount of pre-tax gain/(loss) recorded in AOCI due to the effective portion of changes in fair value of derivatives designated as cash flow hedges was $(411,000) and $(1.1) million, respectively.

Amounts reported in AOCI related to derivatives will be reclassified to interest income or expense, as applicable, as interest payments are received / made on the Company’s variable-rate assets/liabilities. During the three months ended June 30, 2011 and June 30, 2010, $(120,000) and $(48,000), respectively was reclassified into net interest income related to the effective portion of cash flow hedges.  During the six months ended June 30, 2011 and June 30, 2010, $(234,000) and $8,000, respectively was reclassified into net interest income related to the effective portion of cash flow hedges.  During the next twelve months, the Company estimates that $(697,000) will be reclassified into net interest income as an increase to interest expense.

During the three and six months ended June 30, 2010, the Company accelerated the reclassification of amounts in other comprehensive income to earnings as a result of the hedged forecasted transactions related to certain terminated interest rate swaps becoming probable not to occur.  The accelerated amounts for the three and six months ended June 30, 2010 were a gain of $22,000 and $43,000, respectively.  The Company did not accelerate any amounts during the quarter and six months ended June 30, 2011.

The table below summarizes the impact of the Company’s derivative financial instruments (interest rate contracts) on earnings for the three and six months ended June 30, 2011 and 2010.  All derivative income or expense recognized during these periods was a result of the effective portion of cash flow hedges.  There was no ineffective portion of cash flow hedges during the three and six months ended June 30, 2011 and 2010, respectively, and as such there were no amounts included in derivative income or expense during these periods.

	Amount of gain/(loss) reclassified from AOCI into earnings - effective portion
	Three months ended						Six months ended
	June 30,						June 30,
(dollars in thousands)	2011			2010			2011			2010
Net interest income	$	(120	)	$	(48	)	$	(234	)	$	8
Non-interest income	—			22			—			43
Total derivative income	$	(120	)	$	(26	)	$	(234	)	$	51

Credit Risk Related Contingent Features

The Company has an agreement with one of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.

The Company also has agreements with certain of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well / adequate capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.

As of June 30, 2011 the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $1.9 million.  As of June 30, 2011, the Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $2.4 million against its obligations under these agreements. If the Company had breached any of these provisions at June 30, 2011, it would have been required to settle its obligations under the agreements at the termination value.