DERIVATIVES AND HEDGING

3 Months Ended

Mar. 31, 2013

DERIVATIVES AND HEDGING

DERIVATIVES AND HEDGING

NOTE 4 – DERIVATIVES AND HEDGING

Interest Rate Swaps

On November 3, 2006, the Company entered an interest rate swap with a current notional amount of $932,000, which is used to hedge a 15-year fixed rate loan that is earning interest at 7.43%.  The Company is receiving variable rate payments of one-month LIBOR plus 224 basis points and is paying fixed rate payments of 7.43%.  The swap matures in April 2022 and had a fair value loss position of $188,000 and $203,000 at March 31, 2013 and December 31, 2012, respectively.  The interest rate swap is carried at fair value in accordance with FASB ASC 815 “Derivatives and Hedging.”  The loan is carried at fair value under the fair value option as permitted by FASB ASC 825 “Financial Instruments.”

On October 12, 2011, the Company entered an interest rate swap with a current notional amount of $1.6 million, which is used to hedge a 10-year fixed rate loan that is earning interest at 5.83%.  The Company is receiving variable rate payments of one-month LIBOR plus 350 basis points and is paying fixed rate payments of 5.83%.  The Company designated this relationship as a fair value hedge.  The swap matures in October 2021 and had a fair value loss position of $87,000 and $105,000 at March 31, 2013 and December 31, 2012, respectively.  The difference between changes in the fair values of interest rate swap agreement and the hedged loan represents hedge ineffectiveness and is recorded in other non-interest income in the consolidated statements of operations.  Hedge ineffectiveness resulted in income of $4,000 and $6,000 for the three months ended March 31, 2013 and March 31, 2012, respectively.

Credit Derivatives

We have entered into agreements with a third-party financial institution whereby the financial institution enters into interest rate derivative contracts and foreign currency swap contracts with customers referred to them by us.  By the terms of the agreements, the financial institution has recourse to the Company for any exposure created under each swap contract in the event the customer defaults on the swap agreement and the agreement is in a paying position to the third-party financial institution.  These transactions represent credit derivatives and are a customary arrangement that allows financial institutions like us to provide access to interest rate and foreign currency swap transactions for our customers without creating the swap ourselves.  The Company records the fair value of credit derivatives in other liabilities on the consolidated statement of condition.   The Company recognizes changes in the fair value of credit derivatives, net of any fees received, as service charges and other fee income in the consolidated statements of operations.

At March 31, 2013, there were four variable-rate to fixed-rate interest rate swap transactions between the third-party financial institution and our customers with a notional amount of $13.2 million, and remaining maturities ranging from 6 to 10 years.  At December 31, 2012, there were four variable-rate to fixed-rate interest swap transactions between the third-party financial institution and our customers with a notional amount of $13.3 million, and remaining maturities ranging from 7 to 10 years.  The fair value of the swaps to the customers was a liability of $100,000 and $213,000 as of March 31, 2013 and December 31, 2012, respectively, and all swaps were in paying positions to the third-party financial institution.  As of March 31, 2013 and December 31, 2012, the fair value of the Company’s interest rate swap credit derivatives was a liability of $12,000.  During the three months ended March 31, 2013 and 2012, the Company recognized income of $1,000 and $0, respectively, from interest rate swap credit derivatives.

At March 31, 2013, there were two foreign currency swap transactions between the third-party financial institution and our customers with a notional amount aggregating approximately $46,000, and remaining maturity of 1 month.  The aggregate fair value of these swaps to the customers was a liability of $2,000 as of March 31, 2013.  At March 31, 2013, the fair value of the Company’s credit derivatives was $0.  At December 31, 2012, there were no foreign currency swap transactions between the third-party financial institution and our customers.  During the three months ended March 31, 2013 and 2012, the Company recognized income of $2,000 and $24,000, respectively, from foreign currency swap credit derivatives.

The maximum potential payments by the Company to the financial institution under these credit derivatives are not estimable as they are contingent on future interest rates and exchange rates, and the agreement does not provide for a limitation of the maximum potential payment amount.