11. DERIVATIVE FINANCIAL INSTRUMENTS

United uses derivative instruments to help aid against adverse price changes or interest rate movements on the value of certain assets or liabilities and on future cash flows. These derivatives may consist of interest rate swaps, caps, floors, collars, futures, forward contracts, written and purchased options. United also executes derivative instruments with its commercial banking customers to facilitate its risk management strategies.

United accounts for its derivative financial instruments in accordance with the Derivatives and Hedging topic of the FASB Accounting Standards Codification (ASC Topic 815). The Derivatives and Hedging topic require all derivative instruments to be carried at fair value on the balance sheet. United has designated certain derivative instruments used to manage interest rate risk as hedge relationships with certain assets, liabilities or cash flows being hedged. Certain derivatives used for interest rate risk management are not designated in a hedge relationship.

Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

For a fair value hedge, the fair value of the interest rate swap is recognized on the balance sheet as either a freestanding asset or liability with a corresponding adjustment to the hedged financial instrument. Subsequent adjustments due to changes in the fair value of a derivative that qualifies as a fair value hedge are offset in current period earnings. For a cash flow hedge, the fair value of the interest rate swap is recognized on the balance sheet as either a freestanding asset or liability with a corresponding adjustment to other comprehensive income within shareholders’ equity, net of tax. Subsequent adjustments due to changes in the fair value of a derivative that qualifies as a cash flow hedge are offset to other comprehensive income, net of tax. The portion of a hedge that is ineffective is recognized immediately in earnings.

At inception of a hedge relationship, United formally documents the hedged item, the particular risk management objective, the nature of the risk being hedged, the derivative being used, how effectiveness of the hedge will be assessed and how the ineffectiveness of the hedge will be measured. United also assesses hedge effectiveness at inception and on an ongoing basis using regression analysis. Hedge ineffectiveness is measured by using the change in fair value method. The change in fair value method compares the change in the fair value of the hedging derivative to the change in the fair value of the hedged exposure, attributable to changes in the benchmark rate. The portion of a hedge that is ineffective is recognized immediately in earnings.

United through George Mason enters into interest rate lock commitments to finance residential mortgage loans with its customers. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by United. Interest rate risk arises on these commitments and subsequently closed loans if interest rates change between the time of the interest rate lock and the delivery of the loan to the investor. Market risk on interest rate lock commitments and mortgage loans held for sale is managed using corresponding forward mortgage loan sales contracts. United is a party to these forward mortgage loan sales contracts to sell loans servicing released and short sales of mortgage-backed securities. When the interest rate is locked with the borrower, the rate lock commitment, forward sale agreement, and mortgage-backed security position are undesignated derivatives and marked to fair value through earnings. The fair value of the rate lock derivative includes the servicing premium and the interest spread for the difference between retail and wholesale mortgage rates. Income from mortgage banking activities includes the gain recognized for the period presented and associated elements of fair value.

United sells mortgage loans on either a best efforts or mandatory delivery basis. For loans sold on a mandatory delivery basis, United enters into forward mortgage-backed securities (the “residual hedge”) to mitigate the effect of interest rate risk. Both the rate lock commitment under mandatory delivery and the residual hedge are recorded at fair value through earnings and are not designated as accounting hedges. At the closing of the loan, the loan commitment derivative expires and United records a loan held for sale at fair value and continues to mark these assets to market under the election of fair value option. United closes out of the trading mortgage-backed securities assigned within the residual hedge and replaces the securities with a forward sales contract once a price has been accepted by an investor and recorded at fair value. For those loans selected to be sold under best efforts delivery, at the closing of the loan, the rate lock commitment derivative expires and the Company records a loan held for sale at fair value under the election of fair value option and continues to be obligated under the same forward loan sales contract entered into at inception of the rate lock commitment.

The derivative portfolio also includes derivative financial instruments not included in hedge relationships. These derivatives consist of interest rate swaps used for interest rate management purposes and derivatives executed with commercial banking customers to facilitate their interest rate management strategies. For derivatives that are not designated in a hedge relationship, changes in the fair value of the derivatives are recognized in earnings in the same period as the change in fair value. Gains and losses on other derivative financial instruments are included in noninterest income and noninterest expense, respectively.

The following tables disclose the derivative instruments’ location on the Company’s Consolidated Balance Sheets and the notional amount and fair value of those instruments at June 30, 2018 and December 31, 2017.


	Asset Derivatives
	June 30, 2018						December 31, 2017
	Balance Sheet Location		Notional Amount		Fair Value		Balance Sheet Location		Notional Amount		Fair Value
Derivatives designated as hedging instruments Fair Value Hedges:
Interest rate swap contracts (hedging commercial loans)		Other assets	$	87,672	$	3,329		Other assets	$	71,831	$	538

Total derivatives designated as hedging instruments			$	87,672	$	3,329			$	71,831	$	538

Derivatives not designated as hedging instruments
Forward loan sales commitments		Other assets	$	22,107	$	112		Other assets	$	31,024	$	2
Interest rate lock commitments		Other assets		182,030		6,541		Other assets		148,866		4,559

Total derivatives not designated as hedging instruments			$	204,137	$	6,653			$	179,890	$	4,561

Total asset derivatives			$	291,809	$	9,982			$	251,721	$	5,099

	Liability Derivatives
	June 30, 2018						December 31, 2017
	Balance Sheet Location		Notional Amount		Fair Value		Balance Sheet Location		Notional Amount		Fair Value
Derivatives designated as hedging instruments Fair Value Hedges:
Interest rate swap contracts (hedging commercial loans)		Other liabilities	$	0	$	0		Other liabilities	$	18,795	$	165

Total derivatives designated as hedging instruments			$	0	$	0			$	18,795	$	165

Derivatives not designated as hedging instruments
TBA mortgage-backed securities		Other liabilities	$	343,000	$	1,422		Other liabilities	$	236,500	$	312
Interest rate lock commitments		Other liabilities		0		0		Other liabilities		0		0

Total derivatives not designated as hedging instruments			$	343,000	$	1,422			$	236,500	$	312

Total liability derivatives			$	343,000	$	1,422			$	255,295	$	477

Derivative contracts involve the risk of dealing with both bank customers and institutional derivative counterparties and their ability to meet contractual terms. Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. United’s exposure is limited to the replacement value of the contracts rather than the notional amount of the contract. The Company’s agreements generally contain provisions that limit the unsecured exposure up to an agreed upon threshold. Additionally, the Company attempts to minimize credit risk through certain approval processes established by management.

The effect of United’s derivative financial instruments on its unaudited Consolidated Statements of Income for the three and six months ended June 30, 2018 and 2017 are presented as follows:


			Three Months Ended
	Income Statement Location		June 30, 2018			June 30, 2017
Derivatives in hedging relationships Fair Value Hedges:
Interest rate swap contracts		Interest income/(expense)	$	24		$	(282	)

Total derivatives in hedging relationships			$	24		$	(282	)

Derivatives not designated as hedging instruments
Forward loan sales commitments		Income from Mortgage Banking Activities		112			(170	)
TBA mortgage-backed securities		Income from Mortgage Banking Activities		(660	)		2,784
Interest rate lock commitments		Income from Mortgage Banking Activities		2,888			1,019

Total derivatives not designated as hedging instruments			$	2,340		$	3,633

Total derivatives			$	2,364		$	3,351


			Six Months Ended
	Income Statement Location		June 30, 2018			June 30, 2017
Derivatives in fair value hedging relationships Fair Value Hedges:
Interest rate swap contracts		Interest income/(expense)	$	(18	)	$	(440	)
Cash Flow Hedges:
Forward loan sales commitments		Other income		0			0

Total derivatives in hedging relationships			$	(18	)	$	(440	)

Derivatives not designated as hedging instruments
Forward loan sales commitments		Income from Mortgage Banking Activities		185			(170	)
TBA mortgage-backed securities		Income from Mortgage Banking Activities		(1,110	)		2,784
Interest rate lock commitments		Income from Mortgage Banking Activities		1,619			1,019

Total derivatives not designated as hedging instruments			$	694		$	3,633

Total derivatives			$	676		$	3,193