Derivative Financial Instruments

6 Months Ended

Jun. 30, 2017

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Risk Management Objective of Using Derivatives

Webster manages economic risks, such as interest rate, liquidity, and credit risks by managing the amount, sources, and duration of its debt funding in conjunction with the use of interest rate derivative financial instruments. Webster enters into interest rate derivatives to mitigate the exposure related to business activities that result in the future receipt or payment of, both known and uncertain, cash amounts that are impacted by interest rates. The primary objective for using interest rate derivatives is to add stability to interest expense by managing exposure to interest rate movements. To accomplish this objective, Webster uses interest rate swaps and interest rate caps as part of its interest rate risk management strategy.

Interest rate swaps and interest rate 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.

Cash flow hedges are used to regulate the variable cash flows associated with existing variable-rate debt and forecasted issuances of debt. Derivative instruments designated as cash flow hedges are recorded on the balance sheet at fair value. The effective portion of the change in fair value of the 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. The ineffective portion of the change in fair value of these derivatives, attributable to the difference in the effective date of the hedge and the effective date of the debt issuance, is recognized directly in earnings. During the periods presented, there was no ineffectiveness to be recognized in earnings.

Certain fixed-rate obligations can be exposed to a change in fair value attributable to changes in benchmark interest rates. On occasion, interest rate swaps will be used to manage this exposure. An interest rate swap which involves the receipt of fixed-rate amounts from a counterparty in exchange for Webster making variable-rate payments over the life of the agreement, without the exchange of the underlying notional amount, is designated as a fair value hedge. 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. During the periods presented, Webster did not have any interest rate derivative financial instruments designated as fair value hedges and as a result, there was no impact to interest expense.

Additionally, in order to address certain other risk management matters, the Company also utilizes derivative instruments that do not qualify for hedge accounting. These derivative instruments, which 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 Condensed Consolidated Statements of Income, are described in the following paragraphs.

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 (fee received) or participate-out (fee paid) the risk associated with certain derivative positions executed with the borrower by the lead bank in a loan syndication.

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, or 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 June 30, 2017								At December 31, 2016
	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	$	2,198	$	100,000	$	367	$	225,000	$	3,270	$	100,000	$	792
Not designated as hedging instruments:
Positions subject to a master netting agreement ⁽¹⁾
Interest rate derivatives	2,132,888		6,740		1,205,406		4,224		1,943,485		32,226		1,242,937		24,388
Other	3,566		109		22,588		395		10,634		231		14,265		120
Positions not subject to a master netting agreement
Interest rate derivatives	1,822,285		38,495		1,516,009		15,915		1,734,679		38,668		1,451,762		19,001
RPAs	85,447		119		97,528		145		86,037		139		87,273		166
Mortgage banking derivatives ⁽²⁾	88,120		998		52,491		293		103,440		3,084		59,895		711
Other	—		—		1,857		106		1,438		19		181		11
Total not designated as hedging instruments	4,132,306		46,461		2,895,879		21,078		3,879,713		74,367		2,856,313		44,397
Gross derivative instruments, before netting	$	4,357,306	48,659		$	2,995,879	21,445		$	4,104,713	77,637		$	2,956,313	45,189
Less: Legally enforceable master netting agreements			3,802				3,802				24,252				24,254
Less: Cash collateral posted			1,680				999				11,475				600
Total derivative instruments, after netting			$	43,177			$	16,644			$	41,910			$	20,335


(1)	One of Webster's counterparty relationships was impacted by a Chicago Mercantile Exchange rulebook amendment, resulting in the presentation of that relationship on a settlement basis, as a single unit of account at June 30, 2017, versus a netting basis at December 31, 2016.


(2)	Notional amounts include mandatory forward commitments of $77.9 million, while notional amounts do not include approved floating rate commitments of $22.8 million, at June 30, 2017.

Changes in Fair Value

Changes in the fair value of derivatives not qualifying for hedge accounting treatment were recognized as follows:



	Three months ended June 30,						Six months ended June 30,
(In thousands)	2017			2016			2017			2016
Interest rate derivatives	$	30		$	3,574		$	279		$	5,907
RPAs	53			(167		)	106			(253		)
Mortgage banking derivatives	374			(162		)	(1,667		)	(363		)
Other	(283		)	216			(627		)	(297		)
Total impact on other non-interest income	$	174		$	3,461		$	(1,909	)	$	4,994

Amounts for the effective portion of changes in the fair value of derivatives qualifying for hedge accounting treatment 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 $1.3 million will be reclassified from AOCL as an increase to interest expense.

Webster records gains and losses related to hedge terminations to AOCL. These balances are subsequently amortized into interest expense over the respective terms of the hedged debt instruments. At June 30, 2017, the remaining unamortized loss on the termination of cash flow hedges is $18.1 million. Over the next twelve months, the Company estimates that $6.3 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 9: Accumulated Other Comprehensive Loss, Net of Tax. Information about the valuation methods used to measure the fair value of derivatives is provided in Note 13: 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 gain positions are recorded as assets and are included in accrued interest receivable and other assets, while, net loss positions are recorded as liabilities and are included in accrued expenses and other liabilities, in the accompanying Condensed Consolidated Balance Sheets.

The following table is presented on a gross basis, prior to the application of counterparty netting agreements:



	At June 30, 2017								At December 31, 2016
(In thousands)	Gross Amount		Relationship Offset		Cash Collateral Offset		Net Amount		Gross Amount		Relationship Offset		Cash Collateral Offset		Net Amount
Derivative instrument gains:
Hedge accounting	$	2,198	$	1,046	$	398	$	754	$	3,270	$	2,335	$	935	$	—
Non-hedge accounting	4,319		2,756		1,282		281		32,457		21,917		10,540		—
Total assets	$	6,517	$	3,802	$	1,680	$	1,035	$	35,727	$	24,252	$	11,475	$	—

Derivative instrument losses:
Hedge accounting	$	367	$	367	$	—	$	—	$	792	$	792	$	—	$	—
Non-hedge accounting	4,620		3,435		999		186		24,508		23,462		600		446
Total liabilities	$	4,987	$	3,802	$	999	$	186	$	25,300	$	24,254	$	600	$	446

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 $28.1 million in net margin collateral posted with financial counterparties at June 30, 2017, comprised of $30.7 million in initial margin and $2.6 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 $38.5 million at June 30, 2017. 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 $27.4 million at June 30, 2017. Credit risk exposure is mitigated as transactions with customers are generally secured by the same collateral of the underlying transactions being hedged.