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. The type of hedge accounting designation used depends on the specific risk being hedged. Webster uses fair value hedges to mitigate changes in fair values due to fixed rates or prices, while changes in cash flows due to variable rates or prices may be reduced or eliminated by a cash flow hedge.

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 and caps as part of its interest rate risk management strategy. Interest rate swaps and caps designated as cash flow hedges are designed to manage the risk associated with a forecasted event or an uncertain variable rate cash flow. Transactions associated with a forecasted event or transaction are presented below in sequential order.

Webster uses forward-settle 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. Forward-settle swaps are typically cash settled to coincide with a debt issuance. The change in fair value of the forward-settle swaps is recorded in accumulated other comprehensive income ("AOCI") during the swap term. Upon termination, the AOCI gain or loss at the time of debt issuance is amortized into interest expense over the life of the debt.

Webster has four $25 million forward-settle interest rate swap hedges outstanding as of December 31, 2013, which qualify for cash flow hedge accounting. The swaps, entered into in August and September 2013, 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 June 30, 2014, and maturing on June 30, 2019. Cash settlement is expected to occur on the effective date, and the forecasted five-year debt issuances are anticipated to occur between March 31, 2014 and March 31, 2015.

In addition, Webster executed five $25 million forward-settle swaps with dealer counterparties which qualify for cash flow hedge accounting that are intended to reduce interest rate variability of cash flows related to future debt issuance at the holding company. The swaps are structured as inter-affiliate transactions executed at the Bank on behalf of its holding company. The hedge designations are transferred from the Bank to the holding company through additional intercompany swap transactions at both the Bank and holding company. Each swap will pay a fixed-rate and receive 3-month LIBOR indexed floating rate, with effective dates of December 31, 2013 and March 31, 2014 and maturing on December 31, 2023 and March 31, 2024. Cash settlement is expected to occur on the effective date, and the forecasted ten-year debt issuances are anticipated to occur between October 31, 2013 and September 30, 2014.

Webster also has four $25 million forward-settle interest rate swap hedges outstanding as of December 31, 2013, which qualify for cash flow hedge accounting. The swaps, entered into in October and November 2013, 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 October 16, 2014 and November 18, 2014 and maturing on October 16, 2019 and November 18, 2019, respectively. Cash settlement is expected to occur on the effective date and the forecasted five-year debt issuances are anticipated to occur between July 16, 2014 and May 18, 2015.

Previously terminated forward-settle swap losses have been recorded in AOCI and will be amortized into earnings over the respective term of the associated debt instrument. At December 31, 2013, the remaining unamortized loss on the termination of cash flow hedges was $32.3 million. Over the next twelve months the Company will reclassify $7.6 million from OCI as an increase to interest expense. There was no hedge ineffectiveness for the years ended December 31, 2013 and 2012.

Transactions associated with an uncertain variable rate cash flow are presented below.

Webster has two $25 million interest rate caps which are designated as cash flow hedge transactions against the risk of changes in cash flows related to the Company's $150 million 3-month LIBOR indexed floating rate FHLB advance maturing December 30, 2021. The caps each have a strike rate of 3.0% indexed to 3-month LIBOR. The change in fair value of the caps is marked through AOCI and there is a $3.6 million gain as of December 31, 2013. Webster paid a $2.0 million premium, which will be reclassified from AOCI to interest expense over the life of the cap according to a predetermined cap value schedule.

Amounts reported in AOCI related to cash flow derivatives which have become effective and are accruing interest, will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. Over the next twelve months, the Company estimates that $4.2 million will be reclassified as an increase to interest expense. Hedge ineffectiveness for the years ended December 31, 2013 and 2012 was deemed insignificant.

The table below presents the fair value of Webster’s derivative financial instruments designated as cash flow hedges as well as their classification in the accompanying Consolidated Balance Sheets as of December 31, 2013 and December 31, 2012:



		At December 31, 2013						At December 31, 2012
(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 cash flow hedges:
Forward-settle interest rate swap on anticipated debt ⁽¹⁾	Other assets	4	$	100,000	$	1,815		—	$	—	$	—
Forward-settle interest rate swap on anticipated debt ⁽¹⁾	Other liabilities	1	25,000		(15		)	—	—		—
Forward-settle interest rate swap on anticipated debt	Other assets	4	100,000		1,212			—	—		—
Forward-settle interest rate swap on anticipated debt	Other liabilities	4	100,000		(607		)	4	100,000		(1,130		)
Interest rate cap on FHLB advances	Other assets	2	50,000		3,554			—	—		—
Interest rate swap on FHLB advances	Other liabilities	—	—		—			1	100,000		(497		)

(1) Inter-affiliate swaps between the Bank and holding company total an additional $250 million in aggregate notional value with gains and losses that offset.

The net impact on interest expense related to cash flow hedges for the years ended December 31, 2013, 2012, and 2011 is presented below:



	Years ended December 31,
	2013					2012					2011
(In thousands)	Interest Expense		Amount Reclassified From AOCI			Interest Expense		Amount Reclassified From AOCI			Interest Expense		Amount Reclassified From AOCI
Impact reported as an increase or (reduction) in interest expense on borrowings
Interest rate swaps on FHLB advances	$	498	$	5,956		$	1,393	$	4,754		$	1,542	$	1,962
Interest rate swaps on subordinated debt	—		(3		)	—		(92		)	—		(150		)
Interest rate swaps repurchase agreement	—		3,319			—		2,959			—		1,095
Interest rate swaps on Trust Preferred Securities	—		—			—		(105		)	—		(180		)
Net impact on interest expense on borrowings	$	498	$	9,272		$	1,393	$	7,516		$	1,542	$	2,727

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 December 31, 2013 and December 31, 2012.

For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative, as well as the offsetting gain or loss 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 gain or loss 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 December 31, 2013, the remaining unamortized gain on the termination of fair value hedges was $1.1 million.

The net impact on interest expense related to fair value hedges for the years ended December 31, 2013, 2012 and 2011 is presented in the table below:



	Years ended December 31,
(In thousands)	2013			2012			2011
Impact reported as a reduction in interest expense on borrowings
Interest rate swaps on senior notes	$	(3,197	)	$	(3,197	)	$	(3,197	)
Interest rate swaps on subordinated debt	(207		)	(2,648		)	(4,479		)
Interest rate swaps on FHLB advances	—			—			(171		)
Net impact on interest expense on borrowings	$	(3,404	)	$	(5,845	)	$	(7,847	)

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 accompanying Consolidated Statements of Income.

At December 31, 2013 and December 31, 2012, Webster had the following outstanding interest rate swaps and caps that were not designated for hedge accounting:



		At December 31, 2013
					Estimated Fair Value
(Dollars in thousands)	Balance Sheet Classification	# of Instruments	Notional Amount		Gain		Loss			Net
Webster with customer position:
Commercial loan interest rate swaps	Other assets	159	$	915,272	$	29,004	$	—		$	29,004
Commercial loan interest rate swaps	Other liabilities	76	648,456		—		(11,175		)	(11,175		)
Total customer position		235	$	1,563,728	$	29,004	$	(11,175	)	$	17,829

Webster with counterparty position:
Commercial loan interest rate swaps	Other assets	111	$	914,044	$	8,944	$	(2,766	)	$	6,178
Commercial loan interest rate swaps	Other liabilities	118	649,623		8,118		(20,094		)	(11,976		)
Total counterparty position		229	$	1,563,667	$	17,062	$	(22,860	)	$	(5,798	)



		At December 31, 2012
					Estimated Fair Value
(Dollars in thousands)	Balance Sheet Classification	# of Instruments	Notional Amount		Gain		Loss			Net
Webster with customer position:
Commercial loan interest rate derivatives	Other assets	178	$	1,009,623	$	50,970	$	—		$	50,970
Commercial loan interest rate derivatives	Other liabilities	23	193,946		—		(124		)	(124		)
Total customer position		201	$	1,203,569	$	50,970	$	(124	)	$	50,846

Webster with counterparty position:
Commercial loan interest rate derivatives	Other liabilities	194	$	1,203,512	$	544	$	(41,965	)	$	(41,421	)
Total counterparty position		194	$	1,203,512	$	544	$	(41,965	)	$	(41,421	)

Webster reported the changes in the fair value of non-hedge accounting derivatives as a component of other non-interest income in the accompanying Consolidated Statements of Income as follows.



	Years ended December 31,
(In thousands)	2013			2012			2011
Impact reported in other non-interest income:
Visa Swap	$	(120	)	$	(556	)	$	(153	)
Interest rate derivatives, net	5,890			6,128			2,889
Fed funds futures contracts	(438		)	48			(1,815		)
Net impact on other non-interest income	$	5,332		$	5,620		$	921

Offsetting Derivatives

Webster has entered into transactions with counterparties that are subject to an enforceable master netting agreement. In accordance with ASC 815, “Derivatives and Hedging”, as amended by ASU 2013-01 and ASU 2011-11, Webster recognized those financial instruments subject to master netting agreements or similar agreements. Hedge accounting positions are recorded on a gross basis in other assets for a gain position and in other liabilities for a loss position, while non-hedge accounting net positions are recorded in other assets for a net gain or in other liabilities for a net loss position, in the accompanying Consolidated Balance Sheets.

The tables below present the financial assets and liabilities for non customer derivative positions, including futures contracts, summarized by dealer counterparty:



	At December 31, 2013
			Hedge Accounting Positions					Non-Hedge Accounting Positions
(In thousands)	Notional Amount		MTM Gain		MTM Loss			MTM Gain		MTM Loss			Total MTM(Loss) Gain			Cash Collateral Posted (Received)			Net Exposure ⁽¹⁾
Dealer A	$	387,258	$	730	$	—		$	4,643	$	(9,647	)	$	(4,274	)	$	4,300		$	26
Dealer B	322,888		615		—			3,475		(9,100		)	(5,010		)	4,940			—
Dealer C	14,477		—		—			—		(1,348		)	(1,348		)	—			—
Dealer D	291,627		1,734		—			4,108		(592		)	5,250			(5,300		)	—
Dealer E	372,771		2,290		(15		)	3,017		(1,743		)	3,549			(3,310		)	—
Dealer F	11,749,646		1,212		(607		)	1,819		(657		)	1,767			7,485			9,252
Totals	$	13,138,667	$	6,581	$	(622	)	$	17,062	$	(23,087	)	$	(66	)	$	8,115



	At December 31, 2012
			Hedge Accounting Positions					Non-Hedge Accounting Positions
(In thousands)	Notional Amount		MTM Gain		MTM Loss			MTM Gain		MTM Loss			Total MTM(Loss) Gain			Cash Collateral Posted (Received)		Net Exposure ⁽¹⁾
Dealer A	$	561,716	$	—	$	(985	)	$	199	$	(16,721	)	$	(17,507	)	$	17,900	$	393
Dealer B	403,097		—		(642		)	139		(15,281		)	(15,784		)	16,980		1,196
Dealer C	15,221		—		—			1		(2,038		)	(2,037		)	—		—
Dealer D	184,648		—		—			53		(2,506		)	(2,453		)	2,600		147
Dealer E	238,830		—		—			152		(5,419		)	(5,267		)	5,290		23
Dealer F	6,600,000									(125		)	(125		)	674		549
Totals	$	8,003,512	$	—	$	(1,627	)	$	544	$	(42,090	)	$	(43,173	)	$	43,444


(1)	Net positive exposure represents over-collateralized loss positions which can be the result of OTC clearing house initial margin requirements posted in compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank").

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 International Swap Derivative Association ("ISDA") agreements with all derivative counterparties for non-cleared trades. Additionally, the Company has executed a Credit Support Annex ("CSA") to the master ISDA 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 a negotiated threshold is secured by posted cash collateral. The Company has negotiated a zero threshold with the majority of its approved financial institution counterparties. In accordance with Webster policies, institutional counterparties must be analyzed and approved through the Company’s credit approval process.

The Company’s credit exposure on interest rate derivatives is limited to the net favorable value and interest payments of all derivatives 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 unless cash collateral exceeds the unfavorable market value.

In accordance with derivative clearing rules, the Company had $8.1 million in net margin collateral pledged with financial counterparties at December 31, 2013. Approximately $16.7 million of margin collateral was pledged to financial counterparties and approximately $8.6 million was received from financial counterparties at December 31, 2013. 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.

On an ongoing basis 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. The Company's net current credit exposure relating to interest rate derivatives with Webster Bank customers was $29.0 million at December 31, 2013. In addition, the Company monitors potential future exposure, representing its best estimate of exposure to remaining contractual maturity. The potential future exposure relating to interest rate derivatives with Webster Bank customers totaled $11.6 million at December 31, 2013. The credit exposure is mitigated as transactions with customers are generally secured by the same collateral securing the underlying transaction being hedged. No losses on derivative instruments have occurred as a result of counterparty nonperformance.

Futures Contracts. In March 2010, Webster entered into a $600 million short-selling of a one year strip of Fed funds futures contracts with serial maturities between May 2010 and April 2011 to hedge against a rise in short-term rates. Since then, Webster has continued to roll the futures contracts and, beginning with the September 2011 contracts, reduced the notional amount to $400 million, then, beginning with the March 2013 contracts, increased the notional amount to $800 million. 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 a loss of $227 thousand and is reflected as other liabilities in the accompanying Consolidated Balance Sheets and the related income impact as non-interest income in the accompanying Consolidated Statements of Income. During the years ended December 31, 2013, 2012, and 2011, the Company recognized $438 thousand in mark-to-market losses, $48.0 thousand in mark-to-market gains and $1.8 million in mark-to-market losses, respectively.

Mortgage Banking Derivatives. Certain derivative instruments, primarily forward sales of mortgage loans and 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 December 31, 2013, outstanding rate locks totaled approximately $39.4 million, and the outstanding commitments to sell residential mortgage loans totaled approximately $52.1 million. Forward sales, which include mandatory forward commitments of approximately $51.0 million at December 31, 2013, 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 accompanying Consolidated Statements of Income. As of December 31, 2013 and December 31, 2012, the fair value of interest rate locked loan commitments and forward sales commitments totaled $0.5 million and $2.9 million, respectively, and were recorded as a component of other assets in the accompanying Consolidated Balance Sheets.

Foreign Currency Derivatives. The Company enters into foreign currency forward contracts that are not designated as hedging instruments to minimize fluctuations of currency exchange rates on lending arrangements. On occasion, the Company enters into foreign contracts on behalf 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 carrying amounts and fair values of foreign currency forward contracts were not material at December 31, 2013 and December 31, 2012.