Derivative Financial Instruments

6 Months Ended

Jun. 30, 2013

Derivative Financial Instruments [Abstract]

Derivative Financial Instruments

NOTE 11: DERIVATIVE FINANCIAL INSTRUMENTS

At June 30, 2013 and December 31, 2012, we held an interest rate swap with a  notional amount of $10 million that was designated as  a cash flow hedge. The swap was used to convert a portion of the floating rate interest on our trust preferred issuance to a fixed rate of interest. The purpose of the hedge was to protect us from the risk of variability arising from the floating rate interest on the debentures. The effective portion of unrealized changes in the fair value of derivatives accounted for as cash flow hedges are reported in other comprehensive income and reclassified to earnings if gains or losses are realized. Each quarter we assess the effectiveness of the hedging relationships by comparing the changes in cash flows of the derivative hedging instruments with the changes in cash flows of the designated hedged item. The ineffective portion of changes in the fair value of the derivatives is recognized directly in earnings. There was no ineffective portion recognized in earnings during the three or six months ended June 30, 2013 or 2012. The fair value of $(802) thousand and $(1.06) million was reflected in other comprehensive income in the accompanying consolidated balance sheets at June 30, 2013 and December 31, 2012, respectively.

At June 30, 2013, we had eight interest rate derivative positions with a combined notional amount of $73.97 million, and at December 31, 2012, we had twointerest rate derivative positions with a combined notional amount of $28.63 million that were not designated as hedging instruments. These derivative positions related to transactions in which we entered into an interest rate swap with a customer while at the same time entering into an offsetting rate swap with another financial institution. In connection with the transaction, we agreed to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on the same notional amount at a fixed interest rate. At the same time, we agreed to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows our customer to effectively convert a variable rate loan to a fixed rate loan. Because the terms of the swaps with our customer and the other financial institution offset each other, with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not significantly impact our results of operations. The fair value was reflected in other assets and other liabilities in the accompanying consolidated balance sheets at June 30, 2013.

We had one additional swap at June 30, 2013 with a notional amount of  $7.35 million where we made a loan to our customer at a fixed rate and entered into an interest rate swap with another financial institution where we agreed to pay them the same fixed rate on the same notional amount, and receive variable interest on the same notional amount.  The loan agreement with the customer contains a two-way yield maintenance provision, which will be invoked in the event of prepayment of the loan, and is expected to exactly offset the fair value of unwinding the swap. The yield maintenance provision represents an embedded derivative which is bifurcated from the host loan contract and, as such, the swaps and embedded derivatives are not designated as hedges. Accordingly, both instruments are carried at fair value and changes in fair value are reported in current period earnings.

We assessed our counterparty risk at June 30, 2013 and determined any credit risk inherent in our derivative contracts was insignificant. Information about the fair value of derivative financial instruments can be found in Footnote 9 to these consolidated financial statements.