Derivative Financial Instruments

Risk Management Objective of Using Derivatives

Webster manages economic risks, including interest rate, liquidity, and credit risk by managing the amount, sources, and duration of its debt funding along with the use of interest rate derivative financial instruments. Webster enters into interest rate derivative financial instruments to manage exposure that arises from business activities that result in the receipt or payment of both future known and uncertain cash amounts determined by interest rates.

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 interest rate 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. Forward-settle interest rate swaps 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.

Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

The effective portion of the change in the fair value of derivatives designated and that qualify as cash flow hedges is recorded as accumulated other comprehensive loss ("AOCL") and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the six months ended June 30, 2015, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt and forecasted issuances of debt. The ineffective portion of the change in the fair value of the derivatives is recognized directly in earnings. During the three and six months ended June 30, 2015 and 2014, the Company recorded no ineffectiveness and immaterial amounts of ineffectiveness in earnings, respectively, attributable to the difference in the effective date of the swap and the effective date of the debt issuance.

At June 30, 2015, the Company has hedged its exposure to the variability in future cash flows for forecasted transactions over a maximum period of three months, excluding transactions related to the payment of variable interest on existing financial instruments.

Webster is also 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. For a qualifying derivative designated as a fair value hedge, the gain or loss on the derivative, as well as the gain or loss on the hedged item, is recognized in interest expense. Webster did not have interest rate derivative financial instruments designated as ‘fair value’ hedges as of June 30, 2015 and December 31, 2014. There was no interest expense related to previous fair value hedges during the three and six months ended June 30, 2015. During the three and six months ended June 30, 2014, there was $0.3 million and $1.1 million, respectively, related to previous fair value hedges recognized in interest expense.

Webster has additional interest rate derivatives that do not qualify for hedge accounting and are, therefore, accounted for as free-standing derivatives with changes in fair value recorded in other non-interest income. Webster's derivatives not designated as hedges are not speculative and are used to manage the Company's exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements.

The Company’s risk management strategy includes the use of interest rate derivatives, specifically futures contracts, to modify the re-pricing risk of assets and liabilities. As of June 30, 2015, all of the futures contracts have expired and there are currently no open positions.

Other derivative instruments include interest rate swap and cap contracts sold to commercial and other customers who wish to modify loan interest rate sensitivity. These contracts are offset with dealer counterparty transactions structured with matching terms. As a result, there is minimal impact on earnings, except for fee income earned in such transactions which is recorded in other non-interest income.

The Company enters into Risk Participation Agreements ("RPA") as 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 RPA guarantee is recorded on the balance sheet at fair value, with changes in fair value recognized each period in other non-interest income.

Derivative positions

The notional amount of derivative instruments are shown in the table below:



(In thousands)	At June 30, 2015		At December 31, 2014
Interest rate derivatives	$	4,907,902	$	10,237,325
RPAs	112,344		90,448
Other	60		60
Total notional amount of derivative instruments	$	5,020,306	$	10,327,833

The table below presents the fair value for Webster’s derivative instruments as well as their classification in the accompanying Condensed Consolidated Balance Sheets. Information about the valuation methods used to measure fair value is provided in Note 15: Fair Value Measurements.



	At June 30, 2015				At December 31, 2014
(In thousands)	Other Assets		Other Liabilities		Other Assets		Other Liabilities
Derivatives designated as hedging instruments:
Interest rate derivatives	$	3,907	$	1,219	$	4,481	$	4,598

Derivatives not designated as hedging instruments:
Interest rate derivatives	44,174		25,878		48,209		31,915
RPAs	159		218		182		258
Other	—		6		—		7
Total derivatives not designated as hedging instruments	$	44,333	$	26,102	$	48,391	$	32,180

Amounts recorded in AOCL related to cash flow hedges

Amounts for the effective portion of changes in the fair value of derivatives are reclassified to interest expense as interest payments are made on Webster's variable-rate debt. Over the next twelve months, the Company estimates that $1.5 million will be reclassified from AOCL as an increase to interest expense.

Webster records gains and losses related to swap terminations to AOCL. These balances are subsequently amortized into interest expense over the respective terms of the hedged debt instruments. At June 30, 2015, the remaining unamortized loss on the termination of cash flow hedges is $31.8 million. Over the next twelve months, the Company estimates that $8.5 million will be reclassified from AOCL as an increase to interest expense.

The net losses included in the Condensed Consolidated Statements of Income and Condensed Consolidated Statements of Comprehensive Income, on a pre-tax basis, related to interest rate derivatives designated as hedges of cash flows were as follows:



	Three months ended June 30,					Six months ended June 30,
(In thousands)	2015		2014			2015			2014
Amount of net loss reclassified from AOCL to interest expense	$	2,192	$	2,115		$	4,284		$	4,336
Amount of net loss (income) recognized as OCI	1,482		(6,084		)	(3,407		)	(14,113		)

Changes in the fair value of derivatives not qualifying for hedge accounting treatment are reported as a component of other non-interest income in the accompanying Condensed Consolidated Statements of Income as follows:



	Three months ended June 30,						Six months ended June 30,
(In thousands)	2015			2014			2015			2014
Interest rate derivatives	$	1,671		$	1,422		$	4,308		$	3,205
RPA	(42		)	53			(118		)	143
Other	(43		)	(33		)	(85		)	(68		)
Total impact on non-interest income	$	1,586		$	1,442		$	4,105		$	3,280

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 gain positions and in other liabilities for loss positions, while non-hedge accounting net positions are recorded in other assets for a net gain position and in other liabilities for a net loss position in the accompanying Condensed Consolidated Balance Sheets.

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



	At June 30, 2015
	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	$	387,958	$	—	$	(1,219	)	$	1,180	$	(4,789	)	$	(4,828	)	$	4,100		$	—
Dealer B	297,085		1,302		—			695		(5,271		)	(3,274		)	3,210			—
Dealer C	5,944		—		—			—		(520		)	(520		)	—			—
Dealer D	346,829		651		—			429		(1,376		)	(296		)	—			—
Dealer E	437,134		1,954		—			536		(1,669		)	821			(1,470		)	—
Dealer F ⁽²⁾	1,103,969		—		—			4,175		(16,714		)	(12,539		)	33,034			20,495
Total	$	2,578,919	$	3,907	$	(1,219	)	$	7,015	$	(30,339	)	$	(20,636	)	$	38,874



	At December 31, 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	$	427,430	$	—	$	(739	)	$	1,861	$	(6,576	)	$	(5,454	)	$	5,300		$	—
Dealer B	319,663		1,494		—			978		(6,420		)	(3,948		)	3,610			—
Dealer C	11,538		—		—			—		(834		)	(834		)	—			—
Dealer D	303,663		747		—			1,147		(1,627		)	267			(400		)	—
Dealer E	424,401		2,240		—			867		(1,698		)	1,409			(1,420		)	—
Dealer F ⁽²⁾	6,631,936		—		(3,858		)	555		(17,629		)	(20,932		)	39,037			18,105
Total	$	8,118,631	$	4,481	$	(4,597	)	$	5,408	$	(34,784	)	$	(29,492	)	$	46,127


(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. 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, of all such instruments, reduced by the amount of collateral pledged by the counterparties. The Company's credit exposure related to derivatives with dealer counterparties is significantly mitigated with cash collateral equal to, or in excess of, the market value of the instrument, updated daily.

In accordance with counterparty credit agreements and derivative clearing rules, the Company had approximately $38.9 million in net margin collateral posted with financial counterparties at June 30, 2015, which were comprised of approximately $40.4 million in margin collateral posted to financial counterparties or DCO and approximately $1.5 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 the 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 $44.2 million at June 30, 2015. 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 $18.4 million at June 30, 2015. The credit exposure is mitigated as transactions with customers are generally secured by the same collateral of the underlying transactions being hedged.

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 June 30, 2015, outstanding rate locks totaled approximately $70.5 million, and the outstanding commitments to sell residential mortgage loans totaled approximately $114.3 million. Forward sales, which include mandatory forward commitments of approximately $112.7 million at June 30, 2015, 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 June 30, 2015, the fair value of interest rate locked loan commitments and forward sales commitments totaled gains of $1.6 million and a loss of $0.1 million at December 31, 2014 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 are immaterial at June 30, 2015 and December 31, 2014.