Derivative Financial Instruments

Risk Management Objective of Using Derivatives

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 exposure that arises 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. Cash flow or fair value hedge designation, for accounting, 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 cash flow hedges.

Cash Flow Hedges of Interest Rate Risk

Webster’s primary objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, 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. The change in fair value of interest rate swaps and caps is recorded in accumulated other comprehensive income ("AOCI") during the term of the cash flow hedge.

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. The current forward-settle interest rate swaps are structured as pay fixed-receive 1-month LIBOR. Forward-settle swaps are typically terminated and cash settled to coincide with a debt issuance. Upon the termination of a swap at the time of debt issuance, the gain or loss that has been recorded in AOCI is amortized into interest expense over the life of the debt.

The table below presents information for Webster's forward-settle interest rate swaps outstanding at September 30, 2014:



(Dollars in thousands)
Number of Instruments	Total Notional Amount		Trade Date	Effective Date	Maturity Date	Debt Issuance Expected

1	$	25,000	September 2013	June 2014	June 2019	At or before March 2015
4	$	100,000	October 2013, November 2013	October 2014, November 2014	October 2019, November 2019	At or before May 2015
2	$	50,000	January 2014	January 2015	January 2020	October 2014 - July 2015
2	$	50,000	April 2014, May 2014	June 2015	June 2020	March 2015 - December 2015

Webster uses interest rate swaps and caps to protect the Company from exposure to variability in cash flows relating to interest payments on floating-rate funding instruments. The swaps and caps are structured to offset fluctuations in interest rates on floating-rate debt during the life of the funding instrument.

The table below presents information for Webster's interest rate swaps and caps outstanding at September 30, 2014:



(Dollars in thousands)
Number of Instruments	Total Notional Amount		Instrument Type	Trade Date	Index Rate	Hedged Debt	Maturity Date

6	$	150,000	Cap	April 2013, January 2014, February 2014, April 2014	3.0% strike	$150 million 3-month LIBOR indexed floating-rate FHLB advance	December 2021
4	$	100,000	Swap	June 2014, July 2014	1-month LIBOR	$100 million 28 day rolling FHLB advance for a 5 year term	July 2019, August 2019, September 2019

The table below presents the notional amount and fair value for Webster’s interest rate derivatives designated as cash flow hedges as well as their classification in the accompanying Condensed Consolidated Balance Sheets:



		At September 30, 2014						At December 31, 2013
(Dollars in thousands)	Balance Sheet Classification	# of Instruments	Notional Amount		Fair Value			# of Instruments	Notional Amount		Fair Value
Forward-settle interest rate swap	Other assets	—	$	—	$	—		8	$	200,000	$	3,027
Forward-settle interest rate swap	Other liabilities	9	225,000		(2,812		)	5	125,000		(622		)
Interest rate swap	Other assets	4	100,000		263			—	—		—
Interest rate cap	Other assets	6	150,000		6,094			2	50,000		3,554

AOCI related to cash flow hedges

The changes in fair value of derivatives designated as cash flow hedges are recorded in AOCI. These amounts are reclassified to interest expense as interest payments are made on the Company's variable-rate debt. An unamortized interest rate cap premium balance of $8.0 million will be reclassified to interest expense over the term of the cap transactions according to a predetermined cap value schedule. Over the next twelve months, the Company estimates that $4.6 million will be reclassified from AOCI as an increase to interest expense.

Webster records swap gains and losses related to forward-settle terminations in AOCI with the amortization impacting earnings over the respective term of the hedged debt instruments. There was no hedge ineffectiveness for the three months ended September 30, 2014, while a loss of $107 thousand was recognized for hedge ineffectiveness for the nine months ended September 30, 2014. There was no hedge ineffectiveness for the three and nine months ended September 30, 2013. At September 30, 2014, the remaining unamortized loss on the termination of cash flow hedges is $30.9 million. Over the next twelve months, the Company estimates that $7.5 million will be reclassified from AOCI as an increase to interest expense.

The increase/(reduction) to interest expense on borrowings related to cash flow hedges is presented below:



	Three months ended September 30,
	2014				2013
(In thousands)	Interest Expense		Amount Reclassified From AOCI		Interest Expense		Amount Reclassified From AOCI
Interest rate swaps on FHLB advances	$	188	$	1,355	$	—	$	1,353
Interest rate swaps on senior fixed-rate notes	—		76		—		—
Interest rate swaps on junior subordinated debt	—		—		—		—
Interest rate swaps on repurchase agreements	—		361		—		829
Interest rate swaps on brokered certificates of deposit	—		61		—		—
Net increase to interest expense on borrowings	$	188	$	1,853	$	—	$	2,182



	Nine months ended September 30,
	2014				2013
(In thousands)	Interest Expense		Amount Reclassified From AOCI		Interest Expense		Amount Reclassified From AOCI
Interest rate swaps on FHLB advances	$	188	$	4,060	$	498	$	4,604
Interest rate swaps on senior fixed-rate notes	—		191		—		—
Interest rate swaps on junior subordinated debt	—		—		—		(3		)
Interest rate swaps on repurchase agreements	—		1,864		—		2,489
Interest rate swaps on brokered certificates of deposit	—		74		—		—
Net increase to interest expense on borrowings	$	188	$	6,189	$	498	$	7,090

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, on occasion, uses interest rate swaps to manage its exposure to changes in fair value on these obligations attributable to changes in the benchmark interest rates. 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, 2014 and December 31, 2013.

For a qualifying derivative designated as a fair value hedge, 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.

The reduction to interest expense on borrowings related to fair value hedges is presented below:



	Three months ended September 30,					Nine months ended September 30,
(In thousands)	2014		2013			2014			2013
Interest rate swaps on senior fixed-rate notes	$	—	$	(799	)	$	(1,066	)	$	(2,398	)
Interest rate swaps on junior subordinated debt	—		—			—			(207		)
Net reduction to interest expense on borrowings	$	—	$	(799	)	$	(1,066	)	$	(2,605	)

Non-Hedge Accounting Derivatives / Non-designated Hedges

Webster has derivatives that do not meet hedge accounting requirements and are accounted for as free-standing derivatives with changes in fair value recorded in non interest income. The Company’s risk management strategy includes the use of derivatives to modify the repricing risk of assets and liabilities. As part of this strategy, the Company uses futures contracts to hedge certain loans. Other derivative instruments include interest rate swap and cap contracts sold to commercial and other customers who wish to modify interest rate sensitivity. These contracts are offset with dealer counterparty transactions structured with matching terms. As a result, there is minimal impact on earnings.

Webster had the following derivative positions that were not designated for hedge accounting:



		At September 30, 2014
					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	196	$	1,245,748	$	35,207	$	—		$	35,207
Commercial loan interest rate derivatives	Other liabilities	73	685,273		—		(5,534		)	(5,534		)
Total customer position		269	$	1,931,021	$	35,207	$	(5,534	)	$	29,673

Webster with counterparty position:
Commercial loan interest rate derivatives	Other assets	84	$	605,806	$	4,019	$	(2,625	)	$	1,394
Commercial loan interest rate derivatives	Other liabilities	179	1,325,151		5,828		(21,682		)	(15,854		)
Futures contracts	Other liabilities	10	8,000,000		8		(450		)	(442		)
Total counterparty position		273	$	9,930,957	$	9,855	$	(24,757	)	$	(14,902	)



		At December 31, 2013
					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	159	$	915,272	$	29,004	$	—		$	29,004
Commercial loan interest rate derivatives	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 derivatives	Other assets	111	$	914,044	$	8,944	$	(2,766	)	$	6,178
Commercial loan interest rate derivatives	Other liabilities	118	649,623		8,118		(20,094		)	(11,976		)
Futures contracts	Other liabilities	14	11,200,000		32		(259		)	(227		)
Total counterparty position		243	$	12,763,667	$	17,094	$	(23,119	)	$	(6,025	)

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 Income as follows:



	Three months ended September 30,						Nine months ended September 30,
(In thousands)	2014			2013			2014			2013
Non-hedge derivatives, net	$	1,769		$	1,511		5,335			3,144
Futures contracts	(299		)	(450		)	(585		)	(290		)
Net increase to other non-interest income	$	1,470		$	1,061		$	4,750		$	2,854

Offsetting Derivatives

Webster has entered into transactions with counterparties that are subject to a master netting agreement. 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 Condensed Consolidated Balance Sheets.

The tables below present the financial assets and liabilities for non-customer derivative positions, including futures contracts, summarized by dealer counterparty or Derivative Clearing Organization ("DCO"):



	At September 30, 2014
	Notional Amount		Hedge Accounting Positions					Non-Hedge Accounting Positions					Total MTM(Loss) Gain			Cash Collateral Posted (Received)			Net Exposure ⁽¹⁾
(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	$	452,476	$	263	$	—		$	3,045	$	(7,455	)	$	(4,147	)	$	4,200		$	53
Dealer B	327,019		2,031		—			1,933		(6,853		)	(2,889		)	3,160			271
Dealer C	11,714		—		—			—		(908		)	(908		)	—			—
Dealer D	318,886		1,016		—			2,219		(1,107		)	2,128			(2,200		)	—
Dealer E	386,920		3,047		—			1,800		(1,518		)	3,329			(3,250		)	—
Dealer F ⁽²⁾	8,908,942		—		(2,812		)	858		(6,916		)	(8,870		)	21,595			12,725
Total	$	10,405,957	$	6,357	$	(2,812	)	$	9,855	$	(24,757	)	$	(11,357	)	$	23,505



	At December 31, 2013
	Notional Amount		Hedge Accounting Positions					Non-Hedge Accounting Positions					Total MTM (Loss) Gain			Cash Collateral Posted (Received)			Net Exposure ⁽¹⁾
(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 ⁽²⁾	11,749,646		1,212		(607		)	1,819		(657		)	1,767			7,485			9,252
Total	$	13,138,667	$	6,581	$	(622	)	$	17,062	$	(23,087	)	$	(66	)	$	8,115

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

(2) Dealer F represents Chicago Mercantile Exchange, our designated DCO.

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 International Swap Derivative Association ("ISDA") Master agreements, including a Credit Support Annex ("CSA"), with all derivative counterparties for non-cleared trades. 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 provides, 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 with non-dealer counterparties is limited to the net favorable value, including accrued interest, reduced by the amount of collateral pledged by the counterparty. The Company's credit exposure related to derivatives with dealer counterparties is zero unless cash collateral exceeds the unfavorable market value.

In accordance with counterparty credit agreements and derivative clearing rules, the Company had approximately $23.5 million in net margin collateral posted with financial counterparties at September 30, 2014 which was comprised of approximately $29.0 million of margin collateral posted to financial counterparties or DCO and approximately $5.5 million received from financial counterparties. Collateral levels for approved financial institution counterparties are monitored daily and adjusted as necessary. In the event of default, should the collateral not be returned, the exposure would be offset by terminating the transaction.

The Company regularly evaluates the credit risk of its counterparties, taking into account likelihood of default, net exposures, and remaining contractual life, among other related factors. The Company's net current credit exposure relating to interest rate derivatives with Webster Bank customers was $35.2 million at September 30, 2014. 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 $14.2 million at September 30, 2014. The credit exposure is mitigated as transactions with customers are generally secured by the same collateral of the underlying transactions being hedged.

Futures Contracts Derivatives. Webster holds a notional $800 million short-sale of a one year strip of Fed funds futures contracts and continues to roll the maturities of these contracts. This transaction is designed to work in conjunction with floating rate assets with interest rate floors, which would not generate a benefit from an increase in short-term interest rates. Therefore, as the probability for rising short-term rates increases the notional amount would be increased and as the probability for rising short-term rates decreases the notional amount would be reduced. The fair value of these contracts is a net loss of $442 thousand and is reflected in other liabilities in the accompanying Condensed Consolidated Balance Sheets.

Mortgage Banking Derivatives. 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, interest rate lock commitments are generally extended to the borrowers. 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 causing a reduction in the anticipated gain on sale of the loans and possibly resulting in a loss. In an effort to mitigate such risk, forward delivery sales commitments are established, under which Webster agrees to deliver whole mortgage loans to various investors or issue MBS. At September 30, 2014, outstanding rate locks totaled approximately $44.8 million and the outstanding commitments to sell residential mortgage loans totaled approximately $58.7 million. Forward sales, which include mandatory forward commitments of approximately $56.7 million at September 30, 2014, 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 Condensed Consolidated Statements of Income. At September 30, 2014 and December 31, 2013, the fair value of interest rate locked loan commitments and forward sales commitments totaled gains of $0.4 million and $0.5 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 for hedge accounting to minimize fluctuations of currency exchange rates on certain lending arrangements. The carrying amount and fair value of foreign currency forward contracts is immaterial at September 30, 2014.

Risk Participation Agreements. The Company enters into financial guarantees of performance on interest rate swap derivatives. The purchased (asset) or sold (liability) guarantee allows the Company to participate-in (for a fee received) or participate-out (for a fee paid), the risk associated with certain derivative positions executed with the borrower by a lead bank. The risk participation agreement guarantee is recorded on the balance sheet at fair value, with changes in fair value recognized in earnings each period. The notional amount and fair value of risk participation agreements remain immaterial at September 30, 2014.