Derivative Financial Instruments

6 Months Ended

Jun. 30, 2022

Derivative Financial Instruments

Derivative Financial Instruments

Note 10:  Derivative Financial Instruments

The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position.  Additionally, the Company enters into derivative financial instruments, including interest rate lock commitments issued to residential loan customers for loans that will be held for sale, forward sales commitments to sell residential mortgage loans to investors, and interest rate swaps with customers and other third parties.  See “Note 11: Fair Value Measurements” for further discussion of the fair value measurement of such derivatives.

The Company was holding collateral of $19.8 million to secure its obligation under derivative contracts as of June 30, 2022.  The Company pledged $28.6 million and $27.3 million in cash to secure its obligation under derivative contracts as of June 30, 2022, and December 31, 2021, respectively.

Derivative Instruments Designated as Cash Flow Hedges

The Company entered into derivative instruments designated as cash flow hedges.  For a derivative instrument that is designated and qualifies as a cash flow hedge, the change in fair value of the derivative instrument is reported as a component of OCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.  Changes in fair value of components excluded from the assessment of effectiveness are recognized in current earnings.

Interest Rate Swaps Designated as Cash Flow Hedges

Interest rate swaps with notional amounts totaling $350.0 million as of June 30, 2022, and $50.0 million as of December 31, 2021, were designated as cash flow hedges.  The Company entered into one $50.0 million interest rate swap to hedge the risks of variability in cash flows (future interest payments) attributable to changes in the contractually specified 3-month LIBOR benchmark interest rate on the Company’s junior subordinated debt owed to unconsolidated trusts (Debt Swap).  In addition, the Company entered into one $300.0 million interest rate swap to reduce our balance sheet asset sensitive profile and to lock in earnings in the event future interest rate hikes do not materialize (Loan Swap).  These hedges were determined to be highly effective during the period, and the Company expects its hedges to remain highly effective during the remaining terms of the swaps.  Changes in fair value were recorded net of tax in OCI.

A summary of the interest-rate swaps designated as cash flow hedges is presented below (dollars in thousands):

		As of
		June 30,			December 31,
	Location	2022			2021
Debt Swap
Notional amount		$	50,000		$	50,000
Weighted average fixed pay rates			1.79	%		1.79	%
Weighted average variable 3-month LIBOR receive rates			1.83	%		0.20	%
Weighted average maturity, in years			2.21	yrs		2.71	yrs
Loan Swap
Notional amount		$	300,000		$	—
Weighted average fixed receive rates			4.45	%		—	%
Weighted average variable Prime pay rates			4.81	%		—	%
Weighted average maturity, in years			6.61	yrs		—	yrs
Gross aggregate fair value of the swaps
Gross aggregate fair value of swap assets	Other assets	$	1,412		$	—
Gross aggregate fair value of swap liabilities	Other liabilities	$	19,296		$	958
Balances carried in AOCI
Unrealized gains (losses) on cash flow hedges, net of tax	AOCI	$	(12,844)		$	(685)

The Company expects $0.1 million of unrealized gains to be reclassified from OCI to interest income.  Amounts actually recognized could differ from these expectations due to changes in interest rates, hedge de-designations, and the addition of other hedges subsequent to June 30, 2022.

Interest expense recorded on these swap transactions was as follows for the periods presented (dollars in thousands):

	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Interest income (expense) on swap transactions	$	567	$	(288)	$	1,067	$	(566)

The following table reflects the net gains (losses) relating to cash flow derivative instruments that were recorded in AOCI and the unaudited Consolidated Statements of Income during the periods presented (dollars in thousands):

	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Unrealized gains (losses) on cash flow hedges
Gain (loss) recognized in OCI, net of tax	$	(6,550)	$	(69)	$	(11,395)	$	341
(Gain) loss reclassified from OCI to interest expense, net of tax		(407)		206		(764)		405
Net change in unrealized gains (losses) on cash flow hedges	$	(6,957)	$	137	$	(12,159)	$	746

Derivative Instruments Not Designated as Hedges

Interest Rate Swaps Not Designated as Hedges

The Company may offer derivative contracts to its customers in connection with their risk management needs.  The Company manages the risk associated with these contracts by entering into equal and offsetting derivative agreements with a third-party dealer.  These contracts support variable rate, commercial loan relationships totaling $443.8 million and $491.4 million as of June 30, 2022, and December 31, 2021, respectively.  These derivatives generally worked together as an economic interest rate hedge, but the Company did not designate them for hedge accounting treatment.  Consequently, changes in fair value of the corresponding derivative financial asset or liability were recorded as either a charge or credit to current earnings during the period in which the changes occurred.

Amounts and fair values of derivative assets and liabilities related to customer interest rate swaps recorded in the unaudited Consolidated Balance Sheets are summarized as follows (dollars in thousands):

	As of June 30, 2022
	Derivative Asset				Derivative Liability
	Notional		Fair		Notional		Fair
	Amount		Value		Amount		Value
Derivatives not designated as hedging instruments
Interest rate swaps – pay floating, receive fixed	$	74,892	$	1,798	$	368,937	$	21,761
Interest rate swaps – pay fixed, receive floating		368,937		21,761		74,892		1,798
Total derivatives not designated as hedging instruments	$	443,829	$	23,559	$	443,829	$	23,559

	As of December 31, 2021
	Derivative Asset				Derivative Liability
	Notional		Fair		Notional		Fair
	Amount		Value		Amount		Value
Derivatives not designated as hedging instruments
Interest rate swaps – pay floating, receive fixed	$	404,572	$	17,839	$	86,784	$	2,259
Interest rate swaps – pay fixed, receive floating		86,784		2,259		404,572		17,839
Total derivatives not designated as hedging instruments	$	491,356	$	20,098	$	491,356	$	20,098

Changes in fair value of these derivative assets and liabilities are recorded in noninterest expense in the unaudited Consolidated Statements of Income and summarized as follows (dollars in thousands):

		Three Months Ended June 30,				Six Months Ended June 30,
	Location	2022		2021		2022		2021
Interest rate swaps
Pay floating, receive fixed	Noninterest expense	$	7,025	$	1,264	$	3,475	$	(9,331)
Pay fixed, receive floating	Noninterest expense		(7,025)		(1,264)		(3,475)		9,331
Net change in fair value of interest rate swaps		$	—	$	—	$	—	$	—

Risk Participation Agreement

To manage the credit risk exposure related to a customer-facing swap, the Company entered into one risk participation agreement in conjunction with a loan participation with another financial institution.  This risk participation agreement matures in 2028, and is summarized as follows (dollars in thousands):

	As of
	June 30,		December 31,
	2022		2021
Risk participation agreement:
Notional amount	$	3,946	$	3,990
Fair value		3		11

Mortgage Banking Derivatives

Interest Rate Lock Commitments

Interest rate lock commitments that meet the definition of derivative financial instruments under ASC Topic 815 “Derivatives and Hedging” are carried at their fair values in other assets or other liabilities in the unaudited Consolidated Balance Sheets, with changes in the fair values of the corresponding derivative financial assets or liabilities recorded as either a charge or credit to current earnings during the period in which the changes occurred.

Forward Sales Commitments

The Company economically hedges mortgage loans held for sale and interest rate lock commitments issued to its residential loan customers related to loans that will be held for sale by obtaining corresponding forward sales commitments with an investor to sell the loans at an agreed-upon price at the time the interest rate locks are issued to the customers.  Forward sales commitments that meet the definition of derivative financial instruments under ASC Topic 815 “Derivatives and Hedging” are carried at their fair values in other assets or other liabilities in the unaudited Consolidated Balance Sheets.  While such forward sales commitments generally served as an economic hedge to mortgage loans held for sale and interest rate lock commitments, the Company did not designate them for hedge accounting treatment.  Changes in fair value of the corresponding derivative financial asset or liability were recorded as either a charge or credit to current earnings during the period in which the changes occurred.

Amounts and fair values of mortgage banking derivatives included in the unaudited Consolidated Balance Sheets are summarized as follows (dollars in thousands):

		As of June 30, 2022				As of December 31, 2021
		Notional		Fair		Notional		Fair
	Location	Amount		Value		Amount		Value
Derivatives with positive fair value
Interest rate lock commitments	Other assets	$	7,201	$	151	$	19,384	$	206
Forward sales commitments	Other assets		931		4		1,884		10
Mortgage banking derivatives recorded in other assets		$	8,132	$	155	$	21,268	$	216
Derivatives with negative fair value
Interest rate lock commitments	Other liabilities	$	527	$	2	$	499	$	6
Forward sales commitments	Other liabilities		11,551		217		41,002		439
Mortgage banking derivatives recorded in other liabilities		$	12,078	$	219	$	41,501	$	445

Net gains (losses) relating to these derivative instruments are summarized as follows for the periods presented (dollars in thousands):

		Three Months Ended June 30,				Six Months Ended June 30,
	Location	2022		2021		2022		2021
Net gains (losses)
Interest rate lock commitments	Mortgage revenue	$	134	$	493	$	149	$	965
Forward sales commitments	Mortgage revenue		(319)		(1,358)		(213)		(2,178)
Net gains (losses)		$	(185)	$	(865)	$	(64)	$	(1,213)