Note 14 - Derivative Instruments

As part of its overall interest rate risk management activities, Synovus utilizes derivative instruments to manage its exposure to various types of interest rate risk. These derivative instruments generally consist of interest rate swaps, interest rate lock commitments made to prospective mortgage loan customers, and forward commitments to sell fixed-rate mortgage loans. Interest rate lock commitments represent derivative instruments since it is intended that such loans will be sold. Synovus may also utilize interest rate swaps to manage interest rate risks primarily arising from its core banking activities. As of December 31, 2018 and 2017, Synovus had no outstanding interest rate swap contracts utilized to manage interest rate risk related to core banking activities. Synovus is party to master netting arrangements with its dealer counterparties; however, Synovus does not offset assets and liabilities under these arrangements for financial statement presentation purposes.

Counterparty Credit Risk and Collateral

Entering into derivative contracts potentially exposes Synovus to the risk of counterparties’ failure to fulfill their legal obligations, including, but not limited to, potential amounts due or payable under each derivative contract. Notional principal amounts are often used to express the volume of these transactions, but the amounts potentially subject to credit risk are much smaller. Synovus assesses the credit risk of its dealer counterparties by regularly monitoring publicly available credit rating information, evaluating other market indicators, and periodically reviewing detailed financials. Dealer collateral requirements are determined via risk-based policies and procedures and in accordance with existing agreements. Synovus seeks to minimize dealer credit risk by dealing with highly rated counterparties and by obtaining collateral for exposures above certain predetermined limits. Management closely monitors credit conditions within the customer swap portfolio, which management deems to be of higher risk than dealer counterparties. Collateral is secured at origination and credit related fair value adjustments are recorded against the asset value of the derivative as deemed necessary based upon an analysis, which includes consideration of the current asset value of the swap, customer credit rating, collateral value, and customer standing with regards to its swap contractual obligations and other related matters. Such asset values fluctuate based upon changes in interest rates regardless of changes in notional amounts and changes in customer specific risk.

Customer Related Derivative Positions

Synovus enters into interest rate swap agreements to facilitate the risk management strategies of a small number of commercial banking customers. Synovus mitigates this risk by entering into equal and offsetting interest rate swap agreements with highly rated counterparties. The interest rate swap agreements are free-standing derivatives and are recorded at fair value on Synovus' consolidated balance sheets. Fair value changes are recorded as a component of non-interest income.

Visa Derivative

In conjunction with the sale of Class B shares of common stock issued by Visa to Synovus as a Visa USA member, Synovus entered into a derivative contract with the purchaser, which provides for settlements between the parties based upon a change in the ratio for conversion of Visa Class B shares to Visa Class A shares. The conversion ratio changes when Visa deposits funds to a litigation escrow established by Visa to pay settlements for certain litigation, for which Visa is indemnified by Visa USA members. The litigation escrow is funded by proceeds from Visa’s conversion of Class B shares. The fair value of the derivative contract is determined based on management's estimate of the timing and amount of the Covered Litigation settlement, and the resulting payments due to the counterparty under the terms of the contract. Management believes that the estimate of Synovus' exposure to the Visa indemnification and fees associated with the Visa derivative is adequate based on current information, including Visa's recent announcements and disclosures. However, future developments in the litigation could require changes to Synovus' estimate.

Mortgage Derivatives

Synovus originates first lien residential mortgage loans for sale into the secondary market. Mortgage loans are sold by Synovus for conversion to securities and the servicing of these loans is sold to a third-party servicing aggregator, or Synovus sells the mortgage loans as whole loans to investors either individually or in bulk on a servicing released basis.

Synovus enters into interest rate lock commitments for residential mortgage loans which commits it to lend funds to a potential borrower at a specific interest rate and within a specified period of time. Interest rate lock commitments that relate to the origination of mortgage loans that, if originated, will be held for sale, are considered derivative financial instruments under applicable accounting guidance. Outstanding interest rate lock commitments expose Synovus to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan.

Forward commitments to sell primarily fixed-rate mortgage loans are entered into to reduce the exposure to market risk arising from potential changes in interest rates, which could affect the fair value of mortgage loans held for sale and outstanding rate lock commitments, which guarantee a certain interest rate if the loan is ultimately funded or granted by Synovus as a mortgage loan held for sale. The commitments to sell mortgage loans are at fixed prices and are scheduled to settle at specified dates that generally do not exceed 90 days.

Collateral Requirements

Pursuant to the Dodd-Frank Act, certain derivative transactions have collateral requirements, both at the inception of the trade, and as the value of each derivative position changes. As of December 31, 2018 and 2017, collateral totaling $22.4 million and $43.8 million, respectively, was pledged to the derivative counterparties to comply with collateral requirements. For derivatives cleared through central clearing houses, the variation margin payments made are legally characterized as settlements of the derivatives. As a result, these variation margin payments are netted against the fair value of the respective derivative contracts in the consolidated balance sheets and related disclosures. At December 31, 2018, Synovus had a variation margin of $3.1 million, which reduced the derivative liability, and at December 31, 2017, the variation margin of $1.5 million reduced the derivative asset.

The following table reflects the notional amount and fair value of derivative instruments included on the consolidated balance sheets at December 31, 2018 and 2017.



	December 31, 2018						December 31, 2017
			Fair Value						Fair Value
(in thousands)	Notional Amount		Derivative Assets⁽¹⁾		Derivative Liabilities⁽²⁾		Notional Amount		Derivative Assets⁽¹⁾		Derivative Liabilities⁽²⁾
Derivatives not designated as hedging instruments:
Interest rate contracts ⁽³⁾	$	1,840,288	$	18,388	$	15,716	$	1,466,059	$	10,786	$	12,638
Mortgage derivatives - interest rate lock commitments	52,420		944		—		49,304		936		—
Mortgage derivatives - forward commitments to sell fixed-rate mortgage loans	65,500		—		819		72,500		—		129
Visa derivative	—		—		1,673		—		—		4,330
Total derivatives not designated as hedging instruments			$	19,332	$	18,208			$	11,722	$	17,097


⁽¹⁾	Derivative assets are recorded in other assets on the consolidated balance sheets.


⁽²⁾	Derivative liabilities are recorded in other liabilities on the consolidated balance sheets.


⁽³⁾	Includes interest rate contracts for customer swaps and offsetting positions, net of variation margin payments.

Pre-tax effect of changes in fair value from derivative instruments not designated as hedging instruments on the consolidated statements of income for the years ended December 31, 2018, 2017 and 2016 is presented below.



		Gain (Loss) Recognized in Consolidated Statements of Income
		For The Years Ended December 31,
(in thousands)	Location in Consolidated Statements of Income	2018			2017			2016
Derivatives not designated as hedging instruments:
Interest rate contracts⁽¹⁾	Other non-interest income	$	(29	)	$	20		$	76
Mortgage derivatives - interest rate lock commitments	Mortgage banking income	8			(634		)	182
Mortgage derivatives - forward commitments to sell fixed-rate mortgage loans	Mortgage banking income	(691		)	(2,025		)	1,725
Visa derivative	Other non-interest expense	(2,328		)	—			(5,795		)
Total derivatives not designated as hedging instruments		$	(3,040	)	$	(2,639	)	$	(3,812	)


⁽¹⁾	Gain (loss) represents net fair value adjustments (including credit related adjustments) for customer swaps and offsetting positions.