5. Derivatives

Risk Management Objective of Using Derivatives

The Bank has 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 the net risk exposure resulting from such agreements. 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. 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 (in thousands) of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheets as of September 30, 2014 and December 31, 2013.


						Fair Values (1)
		Notional Amounts				Assets				Liabilities
	Type of Hedge	September 30, 2014		December 31, 2013		September 30, 2014		December 31, 2013		September 30, 2014		December 31, 2013
Derivatives not designated as hedging instruments:
Interest rate swaps (2)	N/A	$	753,382	$	650,667	$	14,585	$	14,147	$	14,974	$	13,777
Risk participation agreements	N/A		80,989		19,736		105		2		156		2
Forward commitments to sell residential mortgage loans	N/A		40,873		45,910		56		326		640		115
Interest rate-lock commitments on residential mortgage loans	N/A		28,025		25,956		595		56		27		107
Foreign exchange forward contracts	N/A		37,127		21,299		671		1,048		643		1,005

		$	940,396	$	763,568	$	16,012	$	15,579	$	16,440	$	15,006

(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.

Derivatives Not Designated as Hedges

Customer interest rate derivatives

The Bank enters into interest rate derivative agreements, primarily rate swaps, with commercial banking customers to facilitate their risk management strategies. The Bank simultaneously 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 as part of other income.

Risk participation agreements

The Bank 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 its normal credit review process.

Mortgage banking derivatives

The Bank also enters into certain derivative agreements as part of its 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 its 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 as part of other income.

Effect of Derivative Instruments on the Income Statement

The effect of the Company’s derivative financial instruments on the income statement was immaterial for the three-month and nine-month periods ended September 30, 2014 and 2013.

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, 2014, the aggregate fair value of derivative instruments with credit risk-related contingent features that were in a net liability position was $6 million, for which the Bank had posted collateral of $17 million.

Offsetting Assets and Liabilities

Offsetting information in regards to derivative assets and liabilities subject to master netting agreements at September 30, 2014 and December 31, 2013 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
Description	Gross Amounts Recognized		the Statement of Financial Position		the Statement of Financial Position		Financial Instruments		Cash Collateral		Net Amount
As of September 30, 2014
Derivative Assets	$	14,690	$	—	$	14,690	$	2,206	$	—	$	12,484

Total	$	14,690	$	—	$	14,690	$	2,206	$	—	$	12,484

Derivative Liabilities	$	15,129	$	—	$	15,129	$	2,206	$	16,767	$	(3,844	)

Total	$	15,129	$	—	$	15,129	$	2,206	$	16,767	$	(3,844	)

As of December 31, 2013
Derivative Assets	$	14,149	$	—	$	14,149	$	3,462	$	—	$	10,687

Total	$	14,149	$	—	$	14,149	$	3,462	$	—	$	10,687

Derivative Liabilities	$	13,779	$	—	$	13,779	$	3,462	$	7,406	$	2,911

Total	$	13,779	$	—	$	13,779	$	3,462	$	7,406	$	2,911