Derivative Financial Instruments

9 Months Ended

Sep. 30, 2016

Derivative Financial Instruments

Derivative Financial Instruments

Note 16 — Derivative Financial Instruments

Cash Flow Hedge of Interest Rate Risk

The Company utilizes an interest rate swap agreement to convert a portion of its variable-rate debt to a fixed rate (cash flow hedge).  During 2009, the Company entered into a forward starting interest rate swap agreement with a notional amount of $8.0 million to manage interest rate risk due to periodic rate resets on its junior subordinated debt issued by SCBT Capital Trust II, an unconsolidated subsidiary of the Company established for the purpose of issuing trust preferred securities.  The Company hedges the variable rate cash flows of subordinated debt against future interest rate increases by using an interest rate swap that effectively fixed the rate on the debt beginning on June 15, 2010, at which time the debt contractually converted from a fixed interest rate to a variable interest rate.  This hedge expires on June 15, 2019.  The notional amount on which the interest payments are based will not be exchanged.  This derivatives contract calls for the Company to pay a fixed rate of 4.06% on $8.0 million notional amount and receive a variable rate of three-month LIBOR on the $8.0 million notional amount.

The Company recognized an after-tax unrealized gain on its cash flow hedge in other comprehensive income of $74,000 and $38,000 for the three and nine months ended September 30, 2016, respectively.  This compares to an unrealized loss of $40,000 and $10,000 for the three and nine months ended September 30, 2015, respectively.  The Company recognized a $655,000 cash flow hedge liability in other liabilities on the balance sheet at September 30, 2016, compared to $718,000 and $870,000 liability at December 31, 2015 and September 30, 2015, respectively.  There was no ineffectiveness in the cash flow hedge during the three and nine months ended September 30, 2016 and 2015.

Credit risk related to the derivative arises when amounts receivable from the counterparty (derivatives dealer) exceed those payable.  The Company controls the risk of loss by only transacting with derivatives dealers that are national market makers whose credit ratings are strong. Each party to the interest rate swap is required to provide collateral in the form of cash or securities to the counterparty when the counterparty’s exposure to a mark-to-market replacement value exceeds certain negotiated limits.  These limits are typically based on current credit ratings and vary with ratings changes.  As of September 30, 2016 and December 31, 2015, the Company provided $750,000 of collateral and at September 30, 2015, $950,000 of collateral, which is included in cash and cash equivalents on the balance sheet as interest-bearing deposits with banks.  Also, the Company has a netting agreement with the counterparty.

Mortgage Banking

The Company also has derivatives contracts that are classified as non-designated hedges.  These derivatives contracts are a part of the Company’s risk management strategy for its mortgage banking activities.  These instruments may include financial forwards, futures contracts, and options written and purchased, which are used to hedge mortgage servicing rights; while forward sales commitments are typically used to hedge the mortgage pipeline.  Such instruments derive their cash flows, and therefore their values, by reference to an underlying instrument, index or referenced interest rate.  The Company does not elect hedge accounting treatment for any of these derivative instruments and as a result, changes in fair value of the instruments (both gains and losses) are recorded in the Company’s consolidated statements of income in mortgage banking income.

Mortgage Servicing Rights

Derivatives contracts related to mortgage servicing rights are used to help offset changes in fair value and are written in amounts referred to as notional amounts.  Notional amounts provide a basis for calculating payments between counterparties but do not represent amounts to be exchanged between the parties, and are not a measure of financial risk.  On September 30, 2016, the Company had derivative financial instruments outstanding with notional amounts totaling $128.5 million related to mortgage servicing rights, compared to $92.0 million and $90.0 million on December 31, 2015 and September 30, 2015, respectively.  The estimated net fair value of the open contracts related to the mortgage servicing rights was recorded as a gain of $42,000 at September 30, 2016, compared to a loss of $98,000 at December 31, 2015 and a gain of  $863,000 at September 30, 2015.

Mortgage Pipeline

The following table presents the Company’s notional value of forward sale commitments and the fair value of those obligations along with the fair value of the mortgage pipeline.

(Dollars in thousands)	September 30, 2016		December 31, 2015		September 30, 2015
Mortgage loan pipeline	$	155,747	$	87,486	$	106,460
Expected closures		116,810		65,615		79,845
Fair Value of mortgage loan pipeline commitments		3,049		1,415		2,003
Forward sales commitments		146,000		73,000		86,000
Fair value of forward commitments		(445)		(21)		(658)