Financial Derivatives

6 Months Ended

Jun. 30, 2011

Financial Derivatives

Financial Derivatives

Note 11 – Financial Derivatives

The Board of Directors has given Management authorization to enter into derivative activity including interest rate swaps, caps and floors, forward-rate agreements, options and futures contracts in order to hedge interest rate risk.  The Bank is exposed to credit risk equal to the positive fair value of a derivative instrument, if any, as a positive fair value indicates that the counterparty to the agreement is financially liable to the Bank.  To limit this risk, counterparties must have an investment grade long-term debt rating and individual counterparty credit exposure is limited by Board approved parameters.  Management anticipates continuing to use derivatives, as permitted by its Board-approved policy, to manage interest rate risk.  In 2008, the Bank entered into two interest rate swap transactions in order to hedge the Corporation's exposure to changes in cash flows attributable to the effect of interest rate changes on variable rate liabilities.

Information regarding the interest rate swaps as of June 30, 2011 follows:

(Dollars in thousands)									Amount Expected to
									be Expensed into
Notional		Maturity	Interest Rate						Earnings within the
Amount		Date	Fixed			Variable			next 12 Months
$	10,000	5/30/2013		3.60	%		0.03	%	$	358
$	10,000	5/30/2015		3.87	%		0.03	%	$	385

The variable rate is indexed to the 91-day Treasury Bill auction (discount) rate and resets weekly.

Derivatives with a positive fair value are reflected as other assets in the consolidated balance sheet while those with a negative fair value are reflected as other liabilities.  As short-term interest rates decrease, the net expense of the swap increases.  As short-term rates increase, the net expense of the swap decreases.

Fair Value of Derivative Instruments in the Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010 are as follows:

Fair Value of Derivative Instruments
(Dollars in thousands)		Balance Sheet
Date	Type	Location	Fair Value
June 30, 2011	Interest rate contracts	Other liabilities	$	1,675
December 31, 2010	Interest rate contracts	Other liabilities	$	1,752

The Effect of Derivative Instruments on the Statement of Income for the Three and Six Months Ended June 30, 2011 and 2010 follows:

Derivatives in ASC Topic 815 Cash Flow Hedging Relationships
(Dollars in thousands)
				Location of	Amount of Gain
				Gain or (Loss)	or (Loss)
	Amount of Gain or (Loss)			Reclassified from	Reclassified from			Location of  Gain or	Amount of Gain or
	Recognized in OCI			Accumulated OCI	Accumulated OCI			(Loss) Recognized in	(Loss) Recognized in
	net of tax on Derivative			into Income	into Income			Income on Derivative	Income on Derivative
Type / Date	(Effective Portion)			(Effective Portion)	(Effective Portion)			(Ineffective Portion)	(Ineffective Portion)
Interest Rate Contracts
Three months ended:
June 30, 2011	$	(108	)	Interest Expense	$	(180	)	Other income (expense)	$	-
June 30, 2010	$	(332	)	Interest Expense	$	(174	)	Other income (expense)	$	-
Six months ended:
June 30 2011	$	50		Interest Expense	$	(356	)	Other income (expense)	$	-
June 30, 2010	$	(435	)	Interest Expense	$	(354	)	Other income (expense)	$	-