Derivative Financial Instruments and Hedging Activities

12 Months Ended

Dec. 31, 2011

Derivative Financial Instruments and Hedging Activities [Abstract]

Derivative Financial Instruments and Hedging Activities

Note 15:  Derivative Financial Instruments and Hedging Activities

We have entered into interest rate swap agreements, primarily as an asset/liability management strategy, in order to mitigate the changes in the fair value of specified long-term fixed-rate loans (or firm commitments to enter into long-term fixed-rate loans) caused by changes in interest rates. These hedges allow us to offer long-term fixed rate loans to customers without assuming the interest rate risk of a long-term asset. Converting our fixed-rate interest stream to a floating-rate interest stream, generally benchmarked to the one-month U.S. dollar LIBOR index, protects us against changes in the fair value of our loans otherwise associated with fluctuating interest rates.

The fixed-rate payment features of the interest rate swap agreements are generally structured at inception to mirror substantially all of the provisions of the hedged loan agreements. These interest rate swaps, designated and qualified as fair value hedges, are carried on the balance sheet at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). One of our interest rate swap agreements qualifies for shortcut hedge accounting treatment. The change in fair value of the swap using the shortcut accounting treatment is recorded in other non-interest income, while the change in fair value of swaps using non-shortcut accounting is recorded in interest income. The unrealized gain or loss in fair value of the hedged fixed-rate loan is recorded as an adjustment to the hedged loan and offset in other non-interest income (for shortcut accounting treatment) or interest income (for non-shortcut accounting treatment).

From time to time, we make firm commitments to enter into long-term fixed-rate loans with borrowers backed by yield maintenance agreements and simultaneously enter into forward interest rate swap agreements with correspondent banks to mitigate the change in fair value of the yield maintenance agreement. Prior to loan funding, yield maintenance agreements with net settlement features that meet the definition of a derivative are considered as non-designated hedges and are carried on the balance sheet at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The offsetting changes in the fair value of the forward swap and the yield maintenance agreement are recorded in interest income. In June 2007, August 2010 and June 2011, three previously undesignated forward swaps were designated to offset the change in fair value of a fixed-rate loan originated in each of those periods. Subsequent to the point of the swap designations, the related yield maintenance agreements are no longer considered derivatives. Their fair value at the designation date was recorded in other assets and is amortized using the effective yield method over the life of the respective designated loans.

The net effect of the change in fair value of interest rate swaps, the amortization of the yield maintenance agreement and the change in the fair value of the hedged loans results in an insignificant amount of hedge ineffectiveness recognized in interest income.

Our credit exposure, if any, on interest rate swaps is limited to the net favorable value (net of any collateral pledged to us) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is in a liability position exceeding a certain threshold, we are required to post collateral to the counterparty in an amount determined by the agreements (generally when our derivative liability position is greater than $100 thousand or $1.3 million, depending upon the counterparty). Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. The aggregate fair value of all derivative instruments that are in a liability position and have collateral requirements on December 31, 2011 is $5.1 million, for which we have posted collateral in the form of securities available for sale totaling $4.8 million and cash of $1.3 million.

As of December 31, 2011, we have seven interest rate swap agreements, which are scheduled to mature in September 2018, April 2019, June 2020, August 2020, June 2022, June 2031 and October 2031. All of our derivatives are accounted for as fair value hedges. Our interest rate swaps are settled monthly with counterparties. Accrued interest on the swaps totaled $72 thousand and $64 thousand as of December 31, 2011 and 2010, respectively. Information on our derivatives follows:

	Liability derivatives
(in thousands)	At December 31, 2011		At December 31, 2010
Fair value hedges
Interest rate contracts notional amount	$	34,161	$	23,132
Credit risk amount		---		---
Interest rate contracts fair value (1)		5,052		2,470
Balance sheet location	Other liabilities		Other liabilities

	Year ended December 31,
(in thousands)		2011			2010			2009
(Decrease) increase in value of designated interest rate swaps recognized in interest income	$	(2,582	)	$	(881	)	$	1,866
Payment on interest rate swaps recorded in interest income		(1,076	)		(895	)		(849	)
Increase (decrease) in value of hedged loans recognized in interest income		2,436			575			(1,942	)
(Decrease) increase in value of yield maintenance agreement recognized against interest income		(14	)		254			(19	)
Net loss on derivatives recognized against interest income (2)	$	(1,236	)	$	(947	)	$	(944	)

(1) See Note 10 for valuation methodology.

(2) Ineffectiveness of ($160) thousand, ($52) thousand and ($95) thousand was recorded in interest income during the years ended December 31, 2011, 2010 and 2009, respectively. The full change in value of swaps was included in the assessment of hedge effectiveness.