NOTE

13.

DERIVATIVES

During

March

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.

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 Income

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.

The following table summarizes the losses recorded during the

three

months ended

March

31,

2016,

and their locations within the

Consolidated

Statements of Income

(Amounts in thousands)		Three Months Ended March 31,
Description	Consolidated Statement of Income Location	2016
Interest rate swap (1)	Interest on term debt	$	396
Forward starting interest rate swap - terminated (2)	Other noninterest expense		2,325
Total		$	2,721

(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.

During the

three

months ended

March

31,

2016,

$1.6

million in losses on derivative instruments designated as cash flow hedges recorded in accumulated other comprehensive income were reclassified into earnings.

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.