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 related to 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 payment of an up-front premium.

Derivative instruments designated as cash flow hedges are recorded on the balance sheet at fair value. The effective portion of the change in the fair value of derivatives which are designated as cash flow hedges, and that qualify for hedge accounting, is recorded to AOCL and is reclassified into earnings in the subsequent periods that the hedged forecasted transaction affects earnings. During the periods presented, 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. For the twelve months ended December 31, 2016 and 2015, the Company recorded no ineffectiveness in earnings attributable to the difference in the effective date of the hedge and the effective date of the debt issuance.

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 at December 31, 2016 and December 31, 2015. As a result, there was no impact to interest expense during the periods presented.

Additionally, in order to address certain other risk management matters, the Company utilizes the following derivative instruments that do not qualify for hedge accounting. These derivative instruments are recorded on the balance sheet at fair value, with changes in fair value recognized each period as other non-interest income in the accompanying Consolidated Statements of Income.

Interest rate swap and cap contracts are 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.

RPAs are entered into 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.

Other derivatives include foreign currency forward contracts related to lending arrangements, a VISA equity swap transaction, and mortgage banking derivatives such as mortgage-backed securities related to residential loan commitments and loans held for sale. Mortgage banking derivatives 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 mortgage-backed securities. Mandatory forward commitments 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.

Fair Value of Derivative Instruments

The following table presents the notional amounts and fair values of derivative positions:



	At December 31, 2016								At December 31, 2015
	Asset Derivatives				Liability Derivatives				Asset Derivatives				Liability Derivatives
(In thousands)	Notional Amounts		Fair Value		Notional Amounts		Fair Value		Notional Amounts		Fair Value		Notional Amounts		Fair Value
Designated as hedging instruments:
Positions subject to a master netting agreement ⁽¹⁾
Interest rate derivatives	$	225,000	$	3,270	$	100,000	$	792	$	200,000	$	2,507	$	100,000	$	1,359

Not designated as hedging instruments:
Positions subject to a master netting agreement ⁽¹⁾
Interest rate derivatives	1,943,485		32,226		1,242,937		24,388		989,695		2,255		1,543,479		40,302
Other	10,634		231		14,265		120		8,237		183		4,561		66
Positions not subject to a master netting agreement ⁽²⁾
Interest rate derivatives	1,734,679		38,668		1,451,762		19,001		2,050,460		58,304		482,738		571
RPAs	86,037		139		87,273		166		41,798		153		92,985		245
Mortgage banking derivatives ⁽³⁾	103,440		3,084		59,895		711		62,514		819		—		—
Other	1,438		19		181		11		—		—		60		9
Total not designated as hedging instruments	3,879,713		74,367		2,856,313		44,397		3,152,704		61,714		2,123,823		41,193
Gross derivative instruments, before netting	$	4,104,713	77,637		$	2,956,313	45,189		$	3,352,704	64,221		$	2,223,823	42,552
Less: Legally enforceable master netting agreements			24,253				24,253				4,945				4,945
Less: Cash collateral posted			11,475				600				—				31,330
Total derivative instruments, after netting			$	41,909			$	20,336			$	59,276			$	6,277


(1)	The Company has elected to report derivative positions subject to a legally enforceable master netting agreement on a net basis, net of cash collateral. Refer to the Offsetting Derivatives section of this footnote for additional information.


(2)	Derivative positions not subject to a legally enforceable master netting agreement are reported on a gross basis in the accompanying Consolidated Balance Sheets.


(3)	Notional amounts include mandatory forward commitments of $99.0 million, while notional amounts do not include approved floating rate commitments of $27.8 million, at December 31, 2016.

Changes in Fair Value

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 Consolidated Statements of Income as follows:



	Years ended December 31,
(In thousands)	2016			2015			2014
Interest rate derivatives	$	8,668		$	4,361		$	4,482
RPA	(361		)	(33		)	51
Mortgage banking derivatives	1,553			801			(522		)
Other	(67		)	(63		)	(253		)
Total impact on other non-interest income	$	9,793		$	5,066		$	3,758

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 $1.7 million will be reclassified from AOCL as an increase to interest expense.

Webster records gains and losses related to swap terminations as OCI. These balances are subsequently amortized into interest expense over the respective terms of the hedged debt instruments. At December 31, 2016, the remaining unamortized loss on the termination of cash flow hedges is $21.3 million. Over the next twelve months, the Company estimates that $6.4 million will be reclassified from AOCL as an increase to interest expense.

Additional information about cash flow hedge activity impacting AOCL, and the related amounts reclassified to interest expense is provided in Note 12: Accumulated Other Comprehensive Loss, Net of Tax. Information about the valuation methods used to measure fair value is provided in Note 16: Fair Value Measurements.

Offsetting Derivatives

Webster has entered into transactions with counterparties that are subject to a legally enforceable master netting agreement. Derivatives subject to a legally enforceable master netting agreement are reported on a net basis, net of cash collateral. Net positions are recorded in other assets for a net gain position and in other liabilities for a net loss position in the accompanying Consolidated Balance Sheets.

The following table is presented on a gross basis, prior to the application of counterparty netting agreements. Derivative assets and liabilities are shown net of cash collateral:



	At December 31, 2016							At December 31, 2015
(In thousands)	Gross Amount		Amount Offset			Net Amount ^{(1) (2)}		Gross Amount		Amount Offset			Net Amount^{(1) (2)}
Derivative instrument assets
Hedged Accounting Positions	$	3,270	$	(3,270	)	$	—	$	2,507	$	(2,507	)	$	—
Non-Hedged Accounting Positions	32,457		(32,457		)	—		2,438		(2,438		)	—
Total	$	35,727	$	(35,727	)	$	—	$	4,945	$	(4,945	)	$	—

Derivative instrument liabilities
Hedged Accounting Positions	$	792	$	(792	)	$	—	$	1,359	$	(1,359	)	$	—
Non-Hedged Accounting Positions	24,508		(24,062		)	446		40,368		(34,916		)	5,452
Total	$	25,300	$	(24,854	)	$	446	$	41,727	$	(36,275	)	$	5,452


(1)	Net amount is net of $10.9 million and $31.3 million of cash collateral at December 31, 2016 and December 31, 2015, respectively, as presented in the accompanying Consolidated Balance Sheets.


(2)	Net amount excludes $42.5 million and $20.2 million of initial margin requirements posted at the derivative clearing organization at December 31, 2016 and December 31, 2015, respectively. Initial margin is recorded as a component of accrued interest receivable and other assets in the accompanying Consolidated Balance Sheets

Counterparty Credit Risk

Use of derivative contracts may expose the bank to counterparty credit risk. The Company has ISDA master agreements, including a Credit Support Annex, 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 Credit Support Annex, 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 $23.8 million in net margin collateral posted with financial counterparties at December 31, 2016, comprised of $42.5 million in initial margin and $18.7 million in variation margin collateral received from financial counterparties or the derivative clearing organization. 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 $38.7 million at December 31, 2016. 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 $26.4 million at December 31, 2016. The credit exposures are mitigated as transactions with customers are generally secured by the same collateral of the underlying transactions being hedged.