6. Derivatives

Risk Management Objective of Using Derivatives

The Company enters into derivative financial instruments to manage risks related to differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments, currently related to select pools of variable rate loans. The Bank has also entered into interest rate derivative agreements as a service to certain qualifying customers. The Bank manages a matched book with respect to these customer derivatives in order to minimize its net risk exposure resulting from such agreements. The Bank also enters into risk participation agreements under which it may either sell or buy credit risk associated with a customer’s performance under certain interest rate derivative contracts related to loans in which participation interests have been sold to or purchased from other banks.

Fair Values of Derivative Instruments on the Balance Sheet

The table below presents the notional amounts and fair values of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheets as of September 30, 2016 and December 31, 2015.



						Fair Values (1)
		Notional Amounts				Assets				Liabilities
	Type of	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
(in thousands)	Hedge	2016		2015		2016		2015		2016		2015
Derivatives designated as hedging instruments:
Interest rate swaps	Cash Flow	$	1,100,000	$	500,000	$	1,135	$	—	$	254	$	281
		$	1,100,000	$	500,000	$	1,135	$	—	$	254	$	281
Derivatives not designated as hedging instruments:
Interest rate swaps (2)	N/A	$	905,662	$	780,871	$	33,732	$	20,622	$	35,447	$	21,007
Risk participation agreements	N/A		86,839		83,430		97		83		215		162
Forward commitments to sell residential mortgage loans	N/A		102,495		55,128		88		263		997		336
Interest rate-lock commitments on residential mortgage loans	N/A		60,757		38,853		532		243		33		167
Foreign exchange forward contracts	N/A		29,700		44,068		970		2,040		953		2,015
		$	1,185,453	$	1,002,350	$	35,419	$	23,251	$	37,645	$	23,687

(1)

Derivative assets and liabilities are reported with other assets or other liabilities, respectively, in the consolidated balance sheets.

(2)

The notional amount represents both the customer accommodation agreements and offsetting agreements with unrelated financial institutions.

Cash Flow Hedges of Interest Rate Risk

The Company is party to eight interest rate swap agreements designated and qualifying as cash flow hedges of the Company’s forecasted variable cash flows for pools of variable rate loans. For each agreement, the Company receives interest at a fixed rate and pays at a variable rate. The eight swap agreements expire as follows: notional amount of $300 million expires in January 2017; notional amount of $200 million expires in June 2017; three contracts each with notional amounts of $100 million expire in April 2018, 2019, 2020; and three contracts each with notional amounts of $100 million expire in September 2018, 2019, 2020.

During the terms of the swap agreements, the effective portion of changes in the fair value of the derivative instruments are recorded in Accumulated Other Comprehensive Income (“AOCI”) and subsequently reclassified into earnings in the periods that the hedged forecasted variable-rate interest payments affect earnings. The impact on AOCI is reflected in Note 7. There was no ineffective portion of the change in fair value of the derivative recognized directly in earnings.

Derivatives Not Designated as Hedges

Customer interest rate derivative program

The Bank enters into interest rate derivative agreements, primarily rate swaps, with commercial banking customers to facilitate their risk management strategies. The Bank enters into offsetting agreements with unrelated financial institutions, thereby mitigating its net risk exposure resulting from such transactions. Because the interest rate derivatives associated with this program do not meet hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.

Risk participation agreements

The Bank also enters into risk participation agreements under which it may either assume or sell credit risk associated with a borrower’s performance under certain interest rate derivative contracts. In those instances where the Bank has assumed credit risk, it is not a direct counterparty to the derivative contract with the borrower and has entered into the risk participation agreement because it is a party to the related loan agreement with the borrower. In those instances in which the Bank has sold credit risk, it is the sole counterparty to the derivative contract with the borrower and has entered into the risk participation agreement because other banks participate in the related loan agreement. The Bank manages its credit risk under risk participation agreements by monitoring the creditworthiness of the borrower, based on the Bank’s normal credit review process.

Mortgage banking derivatives

The Bank also enters into certain derivative agreements as part of their mortgage banking activities. These agreements include interest rate lock commitments on prospective residential mortgage loans and forward commitments to sell these loans to investors on a best efforts delivery basis.

Customer foreign exchange forward contract derivatives

The Bank enters into foreign exchange forward derivative agreements, primarily forward currency contracts, with commercial banking customers to facilitate their risk management strategies. The Bank manages its risk exposure from such transactions by entering into offsetting agreements with unrelated financial institutions. Because the foreign exchange forward contract derivatives associated with this program do not meet hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.

Effect of Derivative Instruments on the Income Statement

Derivative income consisting primarily of customer interest rate swap fees, net of fair value adjustments, is reflected in the income statement in other noninterest income, totaling $1.7 million and $1.5 million for the nine months ended September 30, 2016 and 2015, respectively. The impact to interest income from cash flow hedges was $1.7 million and $1.5 million for the nine months ended September 30, 2016 and 2015, respectively.

Credit risk-related Contingent Features

Certain of the Bank’s derivative instruments contain provisions allowing the financial institution counterparty to terminate the contracts in certain circumstances, such as the downgrade of the Bank’s credit ratings below specified levels, a default by the Bank on its indebtedness, or the failure of the Bank to maintain specified minimum regulatory capital ratios or its regulatory status as a well-capitalized institution. These derivative agreements also contain provisions regarding the posting of collateral by each party. As of September 30, 2016, the aggregate fair value of derivative instruments with credit risk-related contingent features that were in a net liability position was $36.3 million, for which the Bank had posted collateral of $37.5 million.

Offsetting Assets and Liabilities

The Bank’s derivative instruments to certain counterparties contain legally enforceable netting provisions that allow for net settlement of multiple transactions to a single amount, which may be positive, negative, or zero. Offsetting information in regards to derivative assets and liabilities subject to these master netting agreements at September 30, 2016 and December 31, 2015 is presented in the following tables.



(in thousands)			Gross Amounts Offset in		Net Amounts Presented in		Gross Amounts Not Offset in the Statement of Financial Position
Description	Gross Amounts Recognized		the Statement of Financial Position		the Statement of Financial Position		Financial Instruments		Cash Collateral		Net Amount
As of September 30, 2016
Derivative Assets	$	1,352	$	—	$	1,352	$	1,352	$	—	$	—

Derivative Liabilities	$	36,267	$	—	$	36,267	$	1,352	$	37,451	$	(2,536)



(in thousands)			Gross Amounts Offset in		Net Amounts Presented in		Gross Amounts Not Offset in the Statement of Financial Position
Description	Gross Amounts Recognized		the Statement of Financial Position		the Statement of Financial Position		Financial Instruments		Cash Collateral		Net Amount
As of December 31, 2015
Derivative Assets	$	224	$	—	$	224	$	224	$	—	$	—

Derivative Liabilities	$	21,034	$	—	$	21,034	$	224	$	23,482	$	(2,672)

The Company has excess collateral compared to total exposure due to initial margin requirements for day-to-day rate volatility.