Derivative Financial Instruments

Risk Management Objective of Using Derivatives

Webster is exposed to certain risks arising from both its business operations and economic conditions. Webster principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. Webster manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, Webster enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Webster’s derivative financial instruments are used to manage differences in the amount, timing, and duration of Webster’s known or expected cash receipts and its known or expected cash payments principally related to its investments and borrowings.

Cash Flow Hedges of Interest Rate Risk

Webster’s primary objective in using interest rate derivatives is to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, Webster uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges are designed to manage the risk associated with a forecasted event or an uncertain variable rate cash flow.

Webster uses forward-starting interest rate swaps to protect the Company against adverse fluctuations in interest rates by reducing its exposure to variability in cash flows relating to interest payments on forecasted debt issuances. All forward settle swaps are expected to be cash settled at debt issuance. The change in fair value of the forward settle swaps is marked through OCI during the swap term. Upon termination, the OCI gain or loss at the time of debt issuance is amortized into interest expense over the life of the debt. The valuation balance recorded in OCI related to future settle cash flow swaps was a net $14.5 million loss as of September 30, 2012.

Webster has two $25 million forward settle interest rate swap hedges outstanding as of September 30, 2012, which qualify for cash flow hedge accounting. The swaps, entered into in July 2012, protect the Company against adverse fluctuations in interest rates by reducing exposure to variability in cash flows related to interest payments on forecasted issuance of five-year debt. Each swap will pay a fixed rate and receive 1-month LIBOR indexed floating rate, effective on July 2, 2013, and maturing on July 2, 2018. Cash settlement is expected to occur on the effective date and the forecasted five-year debt issuances are anticipated to occur between April 2, 2013 and January 2, 2014.

Webster has two $25 million forward settle interest rate swap hedges outstanding as of September 30, 2012, which qualify for cash flow hedge accounting. The swaps, entered into in May and June 2012, protect the Company against adverse fluctuations in interest rates by reducing exposure to variability in cash flows related to interest payments on forecasted issuance of five-year debt. Each swap will pay a fixed rate and receive 1- month LIBOR indexed floating rate, effective on March 28, 2013, and maturing on March 28, 2018. Cash settlement is expected to occur on the effective date and the forecasted five-year debt issuances are anticipated to occur between December 28, 2012 and September 30, 2013.

Webster also has two $50 million forward settle interest rate swap hedges which became effective on September 5, 2012 and September 11, 2012, and will mature on June 5, 2018 and June 11, 2018, respectively. These swaps were entered into in May 2011 as forward settle swaps to protect the Company against adverse fluctuations in interest rates by reducing exposure to variability in cash flows related to interest payments on forecasted issuance of 6-year debt, anticipated to occur by December 11, 2012. Each $50 million swap pays a fixed rate and receives 1-month LIBOR indexed floating rate.

The Company terminated two $50 million forward settle interest rate swap hedge transactions during March 2012 which qualified for cash flow hedge accounting. The swap terminations were cash settled upon entering into two four-year repurchase agreements effective March 21, 2012 and March 26, 2012. The termination loss of $5.8 million is recorded in OCI and will be amortized into interest expense over the term of the repurchase agreements maturing on March 21, 2016 and March 28, 2016.

Previously terminated forward settle swap losses are recorded in OCI and are amortized into earnings over the respective term of the associated issued debt instrument. At September 30, 2012, the remaining unamortized loss on the termination of cash flow hedges was $29.7 million. Over the next twelve months the Company will reclassify $7.2 million from OCI as an increase to interest expense. There was no hedge ineffectiveness for the three and nine months ended September 30, 2012 and 2011.

In addition, the Company has an accruing $100 million interest rate swap which became effective April 2010 and is designated as a cash flow hedge transaction against the risk of changes in cash flows related to the Company’s $100 million 3-month LIBOR indexed floating rate FHLB advance maturing April 29, 2013. The swap’s change in fair value is marked through OCI and a component of OCI is reclassified to interest expense on a quarterly basis. The balance in OCI related to this cash flow hedge is a $0.9 million loss as of September 30, 2012.

Amounts reported in OCI related to current cash flow derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next twelve months the Company estimates that $4.2 million will be reclassified as an increase to interest expense.

The table below presents the fair value of Webster’s derivative financial instruments designated as cash flow hedges as well as their classification on the Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011:



		At September 30, 2012						At December 31, 2011
(Dollars in thousands)	Balance Sheet Classification	# of Instruments	Notional Amount		Estimated Fair Value			# of Instruments	Notional Amount		Estimated Fair Value
Interest rate derivatives designated as hedges of cash flow:
Interest rate swap on FHLB advances	Other liabilities	1	$	100,000	$	(861	)	1	$	100,000	$	(1,521	)
Forward settle interest rate swap on anticipated debt	Other liabilities	6	200,000		(14,524		)	4	200,000		(15,050		)

The net impact on interest expense related to cash flow hedges for the three and nine months ended September 30, 2012 and 2011 is presented below:



	Three months ended September 30,
	2012								2011
(In thousands)	Interest Expense		Realized Deferred Loss (Gain)			Net Impact			Interest Expense		Realized Deferred Loss (Gain)			Net Impact
Impact reported as an increase or (reduction) in interest expense on borrowings
Interest rate swaps on FHLB advances	$	351	$	1,139		$	1,490		$	400	$	491		$	891
Interest rate swaps on subordinated debt	—		(21		)	(21		)	—		(37		)	(37		)
Interest rate swaps repurchase agreement	—		830			830			—		469			469
Interest rate swaps on Trust Preferred Securities	—		(16		)	(16		)	—		(45		)	(45		)
Net impact on interest expense on borrowings	$	351	$	1,932		$	2,283		$	400	$	878		$	1,278



	Nine months ended September 30,
	2012								2011
(In thousands)	Interest Expense		Realized Deferred Loss (Gain)			Net Impact			Interest Expense		Realized Deferred Loss (Gain)			Net Impact
Impact reported as an increase or (reduction) in interest expense on borrowings
Interest rate swaps on FHLB advances	$	1,018	$	3,417		$	4,435		$	1,170	$	1,229		$	2,399
Interest rate swaps on subordinated debt	—		(70		)	(70		)	—		(112		)	(112		)
Interest rate swaps repurchase agreement	—		2,129			2,129			—		625			625
Interest rate swaps on Trust Preferred Securities	—		(105		)	(105		)	—		(135		)	(135		)
Net impact on interest expense on borrowings	$	1,018	$	5,371		$	6,389		$	1,170	$	1,607		$	2,777

Fair Value Hedges of Interest Rate Risk

Webster is exposed to changes in the fair value of certain of its fixed rate obligations due to changes in benchmark interest rates. Webster uses interest rate swaps to manage its exposure to changes in fair value on these obligations attributable to changes in the benchmark interest rate. Interest rate swaps designated as fair value hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for Webster making variable-rate payments over the life of the agreements without the exchange of the underlying notional amount. Webster did not have any derivative financial instruments designated as fair value hedges as of September 30, 2012 and December 31, 2011.

For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk is recognized in interest expense. Webster includes the gain or loss from the period end mark to market (“MTM”) adjustments on the hedged items in the same line item as the offsetting loss or gain on the related derivatives. The impact of derivative net settlements, hedge ineffectiveness, basis amortization adjustments and amortization of deferred hedge terminations are also recognized in interest expense. At September 30, 2012, the remaining unamortized gain on the termination of fair value hedges was $5.9 million.

The net impact on interest expense related to fair value hedges for the three and nine months ended September 30, 2012 and 2011 is presented in the table below:



	Three months ended September 30,
	2012										2011
(In thousands)	Interest Income		MTM Gain		Realized Deferred (Gain) Loss			Net Impact			Interest Income		MTM Gain		Realized Deferred (Gain) Loss			Net Impact
Impact reported as a (reduction) or increase in interest expense on borrowings
Interest rate swaps on senior notes	$	—	$	—	$	(799	)	$	(799	)	$	—	$	—	$	(799	)	$	(799	)
Interest rate swaps on subordinated debt	—		—		(621		)	(621		)	—		—		(1,120		)	(1,120		)
Interest rate swaps on FHLB advances	—		—		—			—			—		—		(24		)	(24		)
Net impact on interest expense on borrowings	$	—	$	—	$	(1,420	)	$	(1,420	)	$	—	$	—	$	(1,943	)	$	(1,943	)



	Nine months ended September 30,
	2012										2011
(In thousands)	Interest Income		MTM Gain		Realized Deferred (Gain) Loss			Net Impact			Interest Income			MTM Gain			Realized Deferred (Gain) Loss			Net Impact
Impact reported as a (reduction) or increase in interest expense on borrowings
Interest rate swaps on senior notes	$	—	$	—	$	(2,398	)	$	(2,398	)	$	—		$	—		$	(2,398	)	$	(2,398	)
Interest rate swaps on subordinated debt	—		—		(2,028		)	(2,028		)	—			—			(3,359		)	(3,359		)
Interest rate swaps on FHLB advances	—		—		—			—			(61		)	(144		)	50			(155		)
Net impact on interest expense on borrowings	$	—	$	—	$	(4,426	)	$	(4,426	)	$	(61	)	$	(144	)	$	(5,707	)	$	(5,912	)

Non-Hedge Accounting Derivatives / Non-designated Hedges

Derivatives not designated as hedges for accounting are not speculative and are used to manage Webster’s exposure to interest rate movements and other identified risks but do not meet the hedge accounting requirements of ASC 815, “Derivatives and Hedging.” Changes in the fair value of these instruments are recorded as a component of non-interest income in the Condensed Consolidated Statements of Operations.

As of September 30, 2012 and December 31, 2011, Webster had the following outstanding interest rate swaps and caps that were not designated for hedge accounting:



		At September 30, 2012						At December 31, 2011
(Dollars in thousands)	Balance Sheet Classification	# of Instruments	Notional Amount		Estimated Fair Value			# of Instruments	Notional Amount		Estimated Fair Value
Webster with customer position:
Commercial loan interest rate swaps	Other assets	157	$	883,617	$	54,383		127	$	615,773	$	45,140
Commercial loan interest rate swaps with floors	Other assets	11	23,396		2,102			12	25,217		1,994
Commercial loan interest rate caps	Other liabilities	21	160,381		(139		)	13	119,186		(160		)
Webster with counterparty position:
Commercial loan interest rate swaps	Other liabilities	149	849,562		(46,562		)	119	595,542		(40,269		)
Commercial loan interest rate swaps	Other liabilities	1	34,000		55			4	20,180		13
Commercial loan interest rate swaps with floors	Other liabilities	11	23,396		(1,754		)	12	25,217		(1,597		)
Commercial loan interest rate caps	Other liabilities	21	160,381		139			13	119,186		160

Webster reported the changes in the fair value of non-hedge accounting derivatives as a component of other non-interest income in the accompanying Condensed Consolidated Statements of Operations as follows for three and nine months ended September 30, 2012 and 2011:



	Three months ended September 30,
	2012								2011
(In thousands)	Interest Income		MTM (Loss) Gain			Net Impact			Interest Income		MTM (Loss) Gain			Net Impact
Impact reported in other non-interest income:
Visa Swap	$	—	$	(60	)	$	(60	)	$	—	$	(17	)	$	(17	)
Commercial loan interest rate derivatives, net	403		1,108			1,511			234		889			1,123
Fed funds futures contracts	—		(229		)	(229		)	—		(976		)	(976		)
Net impact on other non-interest income	$	403	$	819		$	1,222		$	234	$	(104	)	$	130



	Nine months ended September 30,
	2012								2011
(In thousands)	Interest Income		MTM (Loss) Gain			Net Impact			Interest Income		MTM (Loss) Gain			Net Impact
Impact reported in other non-interest income:
Visa Swap	$	—	$	(532	)	$	(532	)	$	—	$	(134	)	$	(134	)
Commercial loan interest rate derivatives, net	1,080		3,208			4,288			657		1,155			1,812
Fed funds futures contracts	—		(12		)	(12		)	—		(1,813		)	(1,813		)
Net impact on other non-interest income	$	1,080	$	2,664		$	3,744		$	657	$	(792	)	$	(135	)

Futures Contracts. On March 30, 2010, to hedge against a rise in short term rates over the next twelve months, Webster entered into a $600 million short-selling of a one year strip of Fed funds future contracts with serial maturities between May 2010 and April 2011. Throughout 2010 and into 2012, Webster continued to roll the futures contracts but reduced the notional amount to $400 million beginning with the September 2011 contracts. This transaction is designed to work in conjunction with floating rate assets with interest rate floors which will not be affected if there is an increase in short-term interest rates. The fair value of the contracts is $0.4 million and is reflected as other liabilities on the Condensed Consolidated Balance Sheets and the related income impact as non-interest income on the Condensed Consolidated Statements of Operations. During the three and nine months ended September 30, 2012, the Company recognized $229 thousand and $12 thousand, respectively, in mark to market gains. During the three and nine months ended September 30, 2011, the Company recognized $1.0 million and $1.8 million, respectively, in mark to market losses.

Mortgage Banking Derivatives. Certain derivative instruments, primarily forward sales of mortgage loans and mortgage-backed securities (“MBS”) are utilized by Webster in its efforts to manage risk of loss associated with its mortgage loan commitments and mortgage loans held for sale. Prior to closing and funding certain single-family residential mortgage loans, an interest rate lock commitment is generally extended to the borrower. During the period from commitment date to closing date, Webster is subject to the risk that market rates of interest may change. If market rates rise, investors generally will pay less to purchase such loans resulting in a reduction in the gain on sale of the loans or, possibly, a loss. In an effort to mitigate such risk, forward delivery sales commitments, under which Webster agrees to deliver whole mortgage loans to various investors or issue MBS, are established. At September 30, 2012, outstanding rate locks totaled approximately $194.3 million and the outstanding commitments to sell residential mortgage loans totaled approximately $225.2 million. Forward sales, which include mandatory forward commitments of approximately $220.0 million at September 30, 2012, establish the price to be received upon the sale of the related mortgage loan, thereby mitigating certain interest rate risk. There is, however, still certain execution risk specifically related to Webster’s ability to close and deliver to its investors the mortgage loans it has committed to sell. The interest rate locked loan commitments and forward sales commitments are recorded at fair value, with changes in fair value recorded as non-interest income in the Condensed Consolidated Statements of Operations. As of September 30, 2012 and December 31, 2011, the fair value of interest rate locked loan commitments and forward sales commitments totaled $1.3 million and $0.2 million, respectively, and were recorded as a component of other assets in the accompanying Condensed Consolidated Balance Sheets.

Foreign Currency Derivatives. The Company enters into foreign currency forward contracts that are not designated as hedging instruments primarily to accommodate the business needs of its customers. Upon the origination of a foreign currency forward contract with a customer, the Company simultaneously enters into an offsetting contract with a third party to negate the exposure to fluctuations in foreign currency exchange rates. The notional amounts and fair values of open foreign currency forward contracts were not material at September 30, 2012 and December 31, 2011.

Counterparty Credit Risk. Derivative contracts involve the risk of dealing with both bank customers and institutional derivative counterparties and their ability to meet contractual terms. The Company has master ISDA agreements with all derivative counterparties. Additionally, the Company has executed a Credit Support Annex (CSA) to the master agreement with each of its institutional derivative counterparties. The ISDA master agreements provide that on each payment date all amounts otherwise owing the same currency under the same transaction are netted so that only a single amount is owed in that currency. The ISDA master agreements also provide, if the parties so elect, for such netting of amounts in the same currency among all transactions identified as being subject to such election that have common payment dates and booking offices. Under the CSA daily net exposure in excess of our negotiated threshold is secured by posted collateral. The Company has adopted a zero threshold with the majority of its approved financial institution counterparties. In accordance with Webster policies, institutional counterparties must be fully underwritten and approved through the Company’s credit approval process. The Company’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each of the counterparties for the amounts up to the established threshold for collateralization. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. The Company’s credit exposure related to derivatives with approved financial institutions is zero as the positions each have a net unfavorable market value. In accordance with our CSA Agreements, approximately $61.4 million of collateral was pledged to those counterparties at September 30, 2012. Collateral levels for approved financial institution counterparties are monitored on a daily basis and adjusted as necessary. In the event of default, should the collateral not be returned, the exposure would be offset by terminating the transactions.

The Company evaluates the credit risk of its counterparties, taking into account such factors as the likelihood of default, its net exposures, and remaining contractual life , among other things, in determining if any adjustments related to credit risk are required. The Company's net current credit exposure relating to interest rate swaps with bank customers was $56.5 million at September 30, 2012. In addition, the Company monitors potential future exposure, representing our best estimate of exposure to remaining contractual maturity. The potential future exposure relating to interest rate swaps with bank customers totaled $8.0 million at September 30, 2012. The credit exposure is mitigated as transactions with customers are secured by the collateral securing the underlying transaction being hedged. No losses on derivative instruments have occurred as a result of counterparty nonperformance.