Derivative instruments

12 Months Ended

Dec. 31, 2021

Derivative instruments

Derivative instruments

Note 16. Derivative instruments

The Company is exposed to changing interest rates and market conditions, which affect cash flows associated with borrowings. The Company uses derivative instruments to manage interest rate risk and conditions in the commercial mortgage market and, as such, views them as economic hedges. Interest rate swaps are used to mitigate the exposure to changes in interest rates and involve the receipt of variable-rate interest amounts from a counterparty in exchange for making payments based on a fixed interest rate over the life of the swap contract. CDS are executed in order to mitigate the risk of deterioration in the current credit health of the commercial mortgage market. IRLCs are entered into with customers who have applied for residential mortgage loans and meet certain underwriting criteria. These commitments expose GMFS to market risk if interest rates change and if the loan is not economically hedged or committed to an investor.

For derivative instruments where the Company has not elected hedge accounting, fair value adjustments are recorded in earnings. The fair value adjustments for interest rate swaps and CDS, along with the related interest income, interest expense and gains (losses) on termination of such instruments, are reported as a net realized gain on financial instruments in the consolidated statements of income. The fair value adjustments for IRLCs and TBAs, along with the related interest income, interest expense and gains (losses) on termination of such instruments, are reported in residential mortgage banking activities in the consolidated statements of income.

As described in Note 3, for qualifying cash flow hedges, the change in the fair value of derivatives is recorded in OCI and recognized in the consolidated statements of income. Derivative movements impacting earnings are recognized on a consistent basis with the classification of the hedged item, primarily interest expense. The ineffective portions of the cash flow hedges are immediately recognized in earnings.

The table below presents average notional derivative amounts, as this is the most relevant measure of volume, and derivative assets and liabilities by type.

		As of December 31, 2021						As of December 31, 2020
		Notional		Derivative		Derivative		Notional		Derivative		Derivative
(in thousands)	Primary Underlying Risk	Amount		Asset		Liability		Amount		Asset		Liability
Interest rate lock commitments	Interest rate risk	$	348,348	$	2,340	$	—	$	614,358	$	16,363	$	—
Interest Rate Swaps - not designated as hedges	Interest rate risk		536,548		4,076		—		160,801		—		(952)
Interest Rate Swaps - designated as hedges	Interest rate risk		—		—		—		132,325		—		(5,701)
TBA Agency Securities	Interest rate risk		346,000		—		(410)		565,000		—		(4,004)
Credit Default Swaps	Credit risk		—		—		—		15,000		—		(174)
FX forwards	Foreign exchange rate risk		27,484		606		—		3,866		—		(773)
Total		$	1,258,380	$	7,022	$	(410)	$	1,491,350	$	16,363	$	(11,604)

The table below presents gains and losses on derivatives.

	Year Ended December 31, 2021				Year Ended December 31, 2020
		Net Realized		Net Unrealized		Net Realized		Net Unrealized
(in thousands)		Gain (Loss)		Gain (Loss)		Gain (Loss)		Gain (Loss)
Credit default swaps	$	(287)	$	322	$	-	$	(65)
Interest rate swaps		(8,867)		16,422		(3,981)		(7,297)
TBA Agency Securities		-		3,593		-		(3,527)
Interest rate lock commitments		-		(14,023)		-		13,589
FX forwards		603		1,378		(1,017)		(523)
Total	$	(8,551)	$	7,692	$	(4,998)	$	2,177

In the table above:

● Gains (losses) on credit default swaps, interest rate swaps and FX forwards are recorded in net unrealized gain (loss) on financial instruments or net realized gain (loss) on financial instruments in the consolidated statements of income.

● For qualifying hedges of interest rate risk on interest rate swaps, the effective portion relating to the unrealized gain (loss) on derivatives are recorded in accumulated other comprehensive income (loss).

● Gains (losses) on residential mortgage banking activities TBAs are recorded in residential mortgage banking activities in the consolidated statements of income.

The table below summarizes the gains and losses on derivatives which have qualified for hedge accounting.

(in thousands)	Derivatives - effective portion reclassified from AOCI to income		Hedge ineffectiveness recorded directly in income		Total income statement impact		Derivatives- effective portion recorded in OCI		Total change in OCI for period
Interest rate hedges- forecasted transactions:
Year Ended December 31, 2021	$	(1,133)	$	—	$	(1,133)	$	1,406	$	2,539
Year Ended December 31, 2020	$	(1,359)	$	(1,694)	$	(3,053)	$	(4,579)	$	(1,526)

In the table above:

● Forecasted transactions on interest rates consists of benchmark interest rate hedges of LIBOR-indexed floating-rate liabilities.

● Hedge ineffectiveness is the amount by which the cumulative gain or loss on the designated derivative instrument exceeds the present value of the cumulative expected change in cash flows on the hedged item attributable to the hedged risk.

● Amounts recorded in OCI for the period represents after tax amounts.