6. Derivative Financial Instruments

We are required to record derivatives on our Condensed Consolidated Statements of Financial Condition as assets and liabilities measured at their fair value. The accounting for increases and decreases in the value of derivatives depends upon the use of derivatives and whether the derivatives qualify for hedge accounting.

Our derivative financial instruments according to the type of hedge in which they are designated follows:

	March 31, 2018
	Notional Amount		Average Maturity (years)		Fair Value
	(Dollars in thousands)
Cash flow hedge designation
Pay-fixed interest rate swap agreements	$	15,000		3.4	$	426
Interest rate cap agreements		45,000		3.3		1,474
	$	60,000		3.3	$	1,900
No hedge designation
Rate-lock mortgage loan commitments	$	42,159		0.1	$	958
Mandatory commitments to sell mortgage loans		61,743		0.1		(123	)
Pay-fixed interest rate swap agreements - commercial		80,449		6.2		1,348
Pay-variable interest rate swap agreements - commercial		80,449		6.2		(1,348	)
Pay-variable interest rate swap agreements		10,000		0.4		-
Purchased options		3,119		3.2		229
Written options		3,119		3.2		(229	)
Total	$	281,038		3.8	$	835

	December 31, 2017
	Notional Amount		Average Maturity (years)		Fair Value
	(Dollars in thousands)
Cash flow hedge designation
Pay-fixed interest rate swap agreements	$	15,000		3.7	$	245
Interest rate cap agreements		45,000		3.5		976
	$	60,000		3.6	$	1,221
No hedge designation
Rate-lock mortgage loan commitments	$	25,032		0.1	$	530
Mandatory commitments to sell mortgage loans		56,127		0.1		37
Pay-fixed interest rate swap agreements - commercial		75,990		6.2		292
Pay-variable interest rate swap agreements - commercial		75,990		6.2		(292	)
Purchased options		3,119		3.5		322
Written options		3,119		3.5		(322	)
Total	$	239,377		4.1	$	567

We use variable-rate and short-term fixed-rate (less than 12 months) debt obligations to fund a portion of our balance sheet, which exposes us to variability in interest rates. To meet our asset/liability management objectives, we may periodically enter into derivative financial instruments to mitigate exposure to fluctuations in cash flows resulting from changes in interest rates (“Cash Flow Hedges”). Cash Flow Hedges included certain pay-fixed interest rate swaps and interest rate cap agreements. Pay-fixed interest rate swaps convert the variable-rate cash flows on debt obligations to fixed-rates. Under interest-rate cap agreements, we will receive cash if interest rates rise above a predetermined level. As a result, we effectively have variable-rate debt with an established maximum rate. We pay an upfront premium on interest rate caps which is recognized in earnings in the same period in which the hedged item affects earnings. Unrecognized premiums from interest rate caps aggregated to $0.9 million at both March 31, 2018 and December 31, 2017, respectively.

We record the fair value of Cash Flow Hedges in accrued income and other assets and accrued expenses and other liabilities on our Condensed Consolidated Statements of Financial Condition. On an ongoing basis, we adjust our Condensed Consolidated Statements of Financial Condition to reflect the then current fair value of Cash Flow Hedges. The related gains or losses are reported in other comprehensive income or loss and are subsequently reclassified into earnings, as a yield adjustment in the same period in which the related interest on the hedged items (variable-rate debt obligations) affect earnings. It is anticipated that approximately $0.29 million, of unrealized gains on Cash Flow Hedges at March 31, 2018 will be reclassified to earnings over the next twelve months. To the extent that the Cash Flow Hedges are not effective, the ineffective portion of the Cash Flow Hedges is immediately recognized in interest expense. The maximum term of the Cash Flow Hedge at March 31, 2018 is 3.7 years.

Certain financial derivative instruments have not been designated as hedges. The fair value of these derivative financial instruments has been recorded on our Condensed Consolidated Statements of Financial Condition and is adjusted on an ongoing basis to reflect their then current fair value. The changes in fair value of derivative financial instruments not designated as hedges are recognized in our Condensed Consolidated Statements of Operations.

In the ordinary course of business, we enter into rate-lock mortgage loan commitments with customers (“Rate-Lock Commitments”). These commitments expose us to interest rate risk. We also enter into mandatory commitments to sell mortgage loans (“Mandatory Commitments”) to reduce the impact of price fluctuations of mortgage loans held for sale and Rate-Lock Commitments. Mandatory Commitments help protect our loan sale profit margin from fluctuations in interest rates. The changes in the fair value of Rate-Lock Commitments and Mandatory Commitments are recognized currently as part of net gains on mortgage loans in our Condensed Consolidated Statements of Operations. We obtain market prices on Mandatory Commitments and Rate-Lock Commitments. Net gains on mortgage loans, as well as net income may be more volatile as a result of these derivative instruments, which are not designated as hedges.

We currently offer to our deposit customers an equity linked time deposit product (“Altitude CD”). The Altitude CD is a time deposit that provides the customer a guaranteed return of principal at maturity plus a potential equity return (a written option), while we receive a like stream of funds based on the equity return (a purchased option). The written and purchased options will generally move in opposite directions resulting in little or no net impact on our Condensed Consolidated Statements of Operations. All of the written and purchased options in the table above relate to this Altitude CD product.

We have a program that allows commercial loan customers to lock in a fixed rate for a longer period of time than we would normally offer for interest rate risk reasons. We will enter into a variable rate commercial loan and an interest rate swap agreement with a customer and then enter into an offsetting interest rate swap agreement with an unrelated party. The interest rate swap agreement fair values will generally move in opposite directions resulting in little or no net impact on our Condensed Consolidated Statements of Operations. All of the interest rate swap agreements noted as commercial in the table above with no hedge designation relate to this program.

We have also entered into a pay-variable interest rate swap agreement unrelated to the commercial loan program noted above. While we have not designated this swap agreement as an accounting hedge the use of this hedge has the expectation to turn certain short-term fixed rate debt into short-term variable rate debt. The change in the swap agreement fair value will be recorded in earnings in our Condensed Consolidated Statement of Operations.

The following tables illustrate the impact that the derivative financial instruments discussed above have on individual line items in the Condensed Consolidated Statements of Financial Condition for the periods presented:

	Asset Derivatives						Liability Derivatives
	March 31, 2018			December 31, 2017			March 31, 2018			December 31, 2017
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
	(In thousands)

Derivatives designated as hedging instruments
Pay-fixed interest rate swap agreements	Other assets	$	426	Other assets	$	245	Other liabilities	$	-	Other liabilities	$	-
Interest rate cap agreements	Other assets		1,474	Other assets		976	Other liabilities		-	Other liabilities		-
			1,900			1,221			-			-
Derivatives not designated as hedging instruments
Rate-lock mortgage loan commitments	Other assets		958	Other assets		530	Other liabilities		-	Other liabilities		-
Mandatory commitments to sell mortgage loans	Other assets		-	Other assets		37	Other liabilities		123	Other liabilities		-
Pay-fixed interest rate swap agreements - commercial	Other assets		1,526	Other assets		631	Other liabilities		178	Other liabilities		339
Pay-variable interest rate swap agreements - commercial	Other assets		178	Other assets		339	Other liabilities		1,526	Other liabilities		631
Pay-variable interest rate swap agreements	Other assets		-	Other assets		-	Other liabilities		-	Other liabilities		-
Purchased options	Other assets		229	Other assets		322	Other liabilities		-	Other liabilities		-
Written options	Other assets		-	Other assets		-	Other liabilities		229	Other liabilities		322
			2,891			1,859			2,056			1,292
Total derivatives		$	4,791		$	3,080		$	2,056		$	1,292

The effect of derivative financial instruments on the Condensed Consolidated Statements of Operations follows:

Three Month Periods Ended March 31,
	Gain Recognized in Other Comprehensive Income (Loss) (Effective Portion)				Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective	Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)					Location of Gain (Loss) Recognized	Gain (Loss) Recognized in Income (1)
	2018		2017		Portion)	2018			2017		in Income (1)	2018			2017
	(In thousands)
Cash Flow Hedges
Interest rate cap agreements	$	513	$	-	Interest expense	$	7		$	-	Interest expense	$	-		$	-
Pay-fixed interest rate swap agreements		171		-	Interest expense		(1	)		-	Interest expense		12			-
Total	$	684	$	-		$	6		$	-		$	12		$	-

No hedge designation
Rate-lock mortgage loan commitments											Net gains on on mortage loans	$	428		$	371
Mandatory commitments to sell mortgage loans											Net gains on on mortage loans		(160	)		(796	)
Pay-fixed interest rate swap agreements - commercial											Interest income		1,056			110
Pay-variable interest rate swap agreements - commercial											Interest income		(1,056	)		(110	)
Pay-variable interest rate swap agreements											Interest expense		-			-
Purchased options											Interest expense		(93	)		69
Written options											Interest expense		93			(69	)
Total												$	268		$	(425	)

(1)	For cash flow hedges, this location and amount refers to the ineffective portion.