Note 14 - Derivatives

6 Months Ended

Jun. 30, 2016

Notes to Financial Statements

Derivative Instruments and Hedging Activities Disclosure [Text Block]

NOTE 14. DERIVATIVES

During March of 2016, we paid off the $75.0 million Federal Home Loan Bank of San Francisco borrowing (the “hedged instrument”) and terminated all of our interest rate swaps (active and forward starting). Prior to the time of termination, a $2.3 million unrealized pretax loss on swaps was carried in

Other Liabilities

in our

Consolidated Balance Sheets.

At termination, we immediately reclassified the loss to noninterest expense.

Prior to March of 2016, we used derivatives to hedge the risk of changes in market interest rates to limit the impact on earnings and cash flows relating to specific groups of assets and liabilities. During 2015 and the first quarter of 2016 we utilized interest rate swaps (the “hedging instrument”) with other major financial institutions (counterparties) to hedge interest expenses associated with certain Federal Home Loan Bank of San Francisco borrowings (the “hedged instrument”). We do not use derivative instruments for trading or speculative purposes.

For derivative financial instruments accounted for as hedging instruments, we formally designate and document, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective, and the manner in which the effectiveness of the hedge will be assessed. We formally assess both at inception and at each reporting period thereafter, whether the derivative financial instruments used in hedging transactions are effective in offsetting changes in cash flows of the related underlying exposures. Any ineffective portion of the changes in cash flow of the instruments is recognized immediately into earnings.

ASC 815-10,

Derivatives and Hedging

(“ASC 815”) requires companies to recognize all derivative instruments as assets or liabilities at fair value in the

Consolidated Balance Sheets

. In accordance with ASC 815, we designated our interest rate swaps as cash flow hedges of certain active and forecasted variable rate Federal Home Loan Bank of San Francisco advances. Changes in the fair value of the hedging instrument, except any ineffective portion, are recorded in accumulated other comprehensive income until earnings are impacted by the hedged instrument. No components of our hedging instruments are excluded from the assessment of hedge effectiveness in hedging exposure to variability in cash flows.

Classification of the gain or loss in the

Consolidated Statements of Operations

upon release from accumulated other comprehensive income is the same as that of the underlying exposure. We discontinue the use of hedge accounting prospectively when (1) the derivative instrument is no longer effective in offsetting changes in fair value or cash flows of the underlying hedged item; (2) the derivative instrument expires, is sold, terminated, or exercised; or (3) designating the derivative instrument as a hedge is no longer appropriate. When we discontinue hedge accounting because it is no longer probable that an anticipated transaction will occur in the originally expected period, or within an additional two-month period thereafter, changes to fair value that were recorded in accumulated other comprehensive income are recognized immediately in earnings.

At December 31, 2015, we had one active interest rate swap, and one forward starting interest rate swap to hedge interest rate risk associated with current and forecasted variable rate Federal Home Loan Bank of San Francisco advances. The hedge strategy converted LIBOR based variable rate of interest on active and forecasted Federal Home Loan Bank of San Francisco advances to fixed interest rates.

The following table summarizes our interest rate swap contracts with counterparties outstanding at December 31, 2015. The interest rate swap contracts were made with a single issuer and included the right of offset.

(Amounts in thousands)
Description	We Pay Fixed			We Receive Variable (1)			Notional Amount		Effective Date	Maturity Date
Interest rate swap		2.64	%		0.33	%	$	75,000	August 3, 2015	August 1, 2016
Forward starting interest rate swap		3.22	%	Variable			$	75,000	August 1, 2016	August 1, 2017

(1)

Rate floats to three month LIBOR payable quarterly on February 1, May 1, August 1, and November 1.

The following table individually lists the active and forward starting interest rate swap derivatives that were in a liability (loss) position, and the fair value of such derivatives at June 30, 2016, and December 31, 2015. There were no interest rate swap derivatives that were in an asset (gain) position at June 30, 2016, or at December 31, 2015.

		Liability Derivatives
(Amounts in thousands)		June 30,		December 31,
Description	Balance Sheet Location	2016		2015
Interest rate swap	Cash flow hedge	$	—	$	869
Forward starting interest rate swap	Cash flow hedge		—		1,500
Total		$	—	$	2,369

The following table summarizes the losses recorded during the three and six months ended June 30, 2016 and 2015, and their locations within the

Consolidated Statements of Operations

.

		Three Months Ended June 30,				Six Months Ended June 30,
(Amounts in thousands) Description	Consolidated Statement of Operations Location	2016		2015		2016		2015
Interest rate swap (1)	Interest on term debt	$	—	$	292	$	396	$	587
Forward starting interest rate swap - terminated (2)	Other noninterest expense		—		—		2,325		—
Total		$	—	$	292	$	2,721	$	587

(1)

Losses represent tax effected amounts reclassified from accumulated other comprehensive income pertaining to net settlements recorded during the period on active interest rate swaps.

(2)

Losses represent tax effected amounts reclassified from accumulated other comprehensive income pertaining to the terminated active and forward starting interest rate swaps.

The following table summarizes the loss, net of tax, on all derivative instruments (active and forward starting) designated as cash flow hedges that were reclassified from accumulated other comprehensive income into earnings during the three and six months ended June 30, 2016 and 2015.

(Amounts in thousands)	Three Months Ended June 30,				Six Months Ended June 30,
Description	2016		2015		2016		2015
Interest rate swaps	$	—	$	177	$	1,601	$	350

The following table summarizes the derivatives that have a right of offset at December 31, 2015.

						Gross Amounts Not Offset In The Consolidated Balance Sheets
(Amounts in thousands)	Gross Amounts of Recognized Assets / (Liabilities)			Gross Amounts Offset In The Consolidated Balance Sheets		Net Amounts of Assets / (Liabilities) Included In The Consolidated Balance Sheets			Collateral Posted		Net Amount
December 31, 2015
Derivative liabilities
Interest rate swaps	$	(2,369	)	$	—	$	(2,369	)	$	4,008	$	1,639

Derivative financial instruments contain an element of credit risk if counterparties are unable to meet the terms of the contract. Credit risk associated with derivative financial instruments is measured as the net replacement cost should the counterparties fail to perform under the terms of those contracts. Assuming no recoveries of underlying collateral, credit risk is measured by the market value of the derivative financial instrument.

The contracts with the derivative counterparties contain a provision where if we fail to maintain our status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions and we would be required to settle our obligations under the agreements. Similarly, we could be required to settle our obligations under certain of our agreements if specific regulatory events occur, such as if we were issued a prompt corrective action directive or a cease and desist order, or if certain regulatory ratios fall below specified levels.

We were required to post collateral against the obligations of $2.4 million at December 31, 2015. Accordingly, we pledged three mortgage backed securities with an aggregate par value of $3.8 million and an aggregate fair value of $4.0 million. In March of 2016, upon the termination of all of our interest rate swaps the securities were returned to us.