Derivative Financial Instruments

9 Months Ended

Sep. 30, 2024

Derivative Instruments and Hedging Activities Disclosure [Abstract]

The Corporation’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Corporation’s known or expected cash receipts and its known or expected cash payments, principally to manage the Corporation’s interest rate risk. Additionally, the Corporation enters into interest rate derivatives to accommodate the business requirements of its customers. All derivatives are recognized as either assets or liabilities on the balance sheet and are measured at fair value. Derivative assets are included in other assets. and derivative liabilities are included in other liabilities in the Unaudited Consolidated Balance Sheets. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and resulting designation.

Interest Rate Risk Management Agreements

Interest rate risk management agreements, such as swaps, caps, floors, and collars, are used from time to time as part of the Corporation’s interest rate risk management strategy. Interest rate swaps are agreements in which the Corporation and another party agree to exchange interest payments (e.g., fixed-rate for variable-rate payments or variable-rate for fixed-rate payments) computed on a notional principal amount. Interest rate caps and floors represent options purchased by the Corporation to manage the interest rate paid throughout the term of the option contract. An interest rate collar is a derivative instrument that represents simultaneously buying an interest rate cap and selling an interest rate floor. The credit risk associated with these transactions is the risk of default by the counterparty. To minimize this risk, the Corporation enters into interest rate agreements only with highly rated counterparties that management believes to be creditworthy. The notional amounts of these agreements do not represent amounts exchanged by the parties and, thus, are not a measure of the potential loss exposure.

Cash Flow Hedging Instruments

As of September 30, 2024 and December 31, 2023, the Corporation had interest rate swap contracts that were designated as cash flow hedges. In addition, at September 30, 2024, the Corporation had an interest rate collar that was designated as a cash flow hedge. These cash flow hedges were executed to hedge the interest rate risk associated with short-term borrowings. See Note 9 for additional disclosure on borrowings.

On March 31, 2023, the Corporation terminated an interest rate swap contract that was designated as a cash flow hedge to hedge the interest rate risk associated with a pool of variable rate commercial loans. On the termination date, the derivative liability was derecognized. The loss on this interest rate swap included in the AOCL component of shareholders’ equity was updated to its termination date fair value of $26.5 million, or $20.1 million after tax. This loss is being amortized into earnings as a reduction of interest income on a straight-line basis over the remaining life of the original interest rate swap term, or through May 1, 2026. At September 30, 2024, the remaining unamortized balance of the loss included in the AOCL component of shareholders’ equity was $13.6 million, or $10.1 million after tax.

The changes in fair value of derivatives designated as cash flow hedges are recorded in other comprehensive income (loss) and subsequently reclassified to earnings when gains or losses are realized.

Fair Value Hedging Instruments

As of September 30, 2024, the Corporation had interest rate swap contracts that were designated as fair value hedges. The fair value hedges were executed to hedge the interest rate risk associated with a closed-pool of fixed-rate residential real estate loans (the “hedged item”). See Note 4 for additional disclosure on residential real estate loans.

The hedged item is measured at fair value through a basis adjustment recognized on the balance sheet. The changes in fair

value of derivatives designated as fair value hedges, as well as the offsetting changes in fair value of the hedged item are recognized in earnings.

Loan Related Derivative Contracts

Interest Rate Derivative Contracts with Customers

The Corporation enters into interest rate swap and interest rate cap contracts to help commercial loan borrowers manage their interest rate risk. These interest rate swap contracts allow borrowers to convert variable-rate loan payments to fixed-rate loan payments, while interest rate cap contracts allow borrowers to limit their interest rate exposure in a rising rate environment. When the Corporation enters into an interest rate derivative contract with a commercial loan borrower, it simultaneously enters into a “mirror” interest rate contract with a third party. For interest rate swaps, the third party exchanges the client’s fixed-rate loan payments for variable-rate loan payments. The Corporation’s credit policies with respect to interest rate contracts with commercial borrowers are similar to those used for loans. The Corporation retains the risk that is associated with the potential failure of counterparties and the risk inherent in originating loans. The interest rate contracts with counterparties are generally subject to bilateral collateralization terms. These derivatives are not designated as hedges and therefore, changes in fair value are recognized in earnings.

Risk Participation Agreements

The Corporation has entered into risk participation agreements with other banks in commercial loan arrangements. Participating banks guarantee the performance on borrower-related interest rate swap contracts. These derivatives are not designated as hedges and therefore, changes in fair value are recognized in earnings.

Under a risk participation-out agreement, a derivative asset, the Corporation participates out a portion of the credit risk associated with the interest rate swap position executed with the commercial borrower for a fee paid to the participating bank. Under a risk participation-in agreement, a derivative liability, the Corporation assumes, or participates in, a portion of the credit risk associated with the interest rate swap position with the commercial borrower for a fee received from the other bank.

Mortgage Loan Commitments

Interest rate lock commitments are extended to borrowers and relate to the origination of mortgage loans held for sale. To mitigate the interest rate risk and pricing risk associated with rate locks and mortgage loans held for sale, the Corporation enters into forward sale commitments. Forward sale commitments are contracts for delayed delivery or net settlement of the underlying instrument, such as a residential real estate mortgage loan, where the seller agrees to deliver on a specified future date, either a specified instrument at a specified price or yield or the net cash equivalent of an underlying instrument. Both interest rate lock commitments and forward sale commitments are derivative financial instruments, but do not meet criteria for hedge accounting and therefore, the changes in fair value of these commitments are recognized in earnings.

The following table presents the notional amounts and fair values of derivative instruments in the Unaudited Consolidated Balance Sheets:


(Dollars in thousands)	September 30, 2024			December 31, 2023
		Fair Value			Fair Value
	Notional Amounts	Derivative Assets	Derivative Liabilities	Notional Amounts	Derivative Assets	Derivative Liabilities
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:

Interest rate swaps (1)	$120,000	$307	$1,640	$120,000	$802	$1,119
Interest rate collar	50,000	—	198	—	—	—

Derivatives Designated as Fair Value Hedging Instruments:
Interest rate risk management contracts:
Interest rate swaps	100,000	33	14	—	—	—
Derivatives not Designated as Hedging Instruments:
Loan related derivative contracts:
Interest rate contracts with customers	902,068	8,069	36,501	938,872	6,594	52,102
Mirror contracts with counterparties	902,068	36,346	8,206	938,872	51,859	6,757
Risk participation agreements	340,822	58	1	321,055	66	1

Mortgage loan commitments:
Interest rate lock commitments	41,191	684	—	20,980	504	1
Forward sale commitments	76,213	78	513	50,117	18	711
Gross amounts		45,575	47,073		59,843	60,691
Less: amounts offset (2)		8,528	8,528		7,877	7,877
Derivative balances, net of offset		37,047	38,545		51,966	52,814
Less: collateral pledged (3)		—	—		—	—
Net amounts		$37,047	$38,545		$51,966	$52,814

(1)The fair value of derivative assets includes accrued interest receivable of $218 thousand and $239 thousand, respectively, at September 30, 2024 and December 31, 2023. There was no accrued interest payable included in the fair value of derivative liabilities at September 30, 2024 or at December 31, 2023.

(2)Interest rate risk management contracts and loan related derivative contracts with counterparties are subject to master netting arrangements.

(3)Collateral contractually required to be pledged to derivative counterparties is in the form of cash. Washington Trust may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

The following table presents the effect of derivative instruments in the Unaudited Consolidated Statements of Changes in Shareholders’ Equity:


(Dollars in thousands)	Amounts Recognized in Other Comprehensive Income (Loss), Net of Tax
	Three Months		Nine Months
Periods ended September 30,	2024	2023	2024	2023
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate swaps	($992)	$2,833	$4,059	$8,345
Interest rate collar	(116)	—	(147)	—


Total	($1,108)	$2,833	$3,912	$8,345

The following table presents the effect of derivative instruments in the Unaudited Consolidated Statements of Income:


(Dollars in thousands)		Amount of Gain (Loss) Recognized in the Unaudited Consolidated Statements of Income
		Three Months		Nine Months
Periods ended September 30,	Statement of Income Location	2024	2023	2024	2023
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate swaps	Interest income: Interest and fees on loans	(2,164)	(2,164)	(6,441)	(7,065)
Interest rate swaps	Interest expense: FHLB advances	487	631	1,475	1,022

Derivatives Designated as Fair Value Hedging Instruments:
Interest rate risk management contracts:
Interest rate swaps	Interest income: Interest and fees on loans	19	—	19	—
Hedged item	Interest income: Interest and fees on loans	(19)	—	(19)	—
Derivatives not Designated as Hedging Instruments:
Loan related derivative contracts:
Interest rate contracts with customers	Loan related derivative income	$22,742	($18,684)	($2,615)	($28,044)
Mirror interest rate contracts with counterparties	Loan related derivative income	(22,733)	20,291	2,981	29,815
Risk participation agreements	Loan related derivative income	117	(525)	93	(493)

Mortgage loan commitments:
Interest rate lock commitments	Mortgage banking revenues	(20)	(17)	180	174
Forward sale commitments	Mortgage banking revenues	(432)	456	(189)	814
Total		($2,003)	($12)	($4,516)	($3,777)

For derivatives designated as cash flow hedging instruments in the table above, the amounts represent the pre-tax reclassifications from AOCL into earnings.