Note 14 - Derivative Financial Instruments

12 Months Ended

Dec. 31, 2023

Notes to Financial Statements

Derivative Instruments and Hedging Activities Disclosure [Text Block]

NOTE  14.  DERIVATIVE FINANCIAL INSTRUMENTS

We use derivative instruments primarily to protect against the risk of adverse interest rate movements on the cash flows of certain assets and liabilities.  Derivative instruments represent contracts between parties that usually require little or no initial net investment and result in one party delivering cash or another type of asset to the other party based upon a notional amount and an underlying as specified in the contract.  A notional amount represents the number of units of a specific item, such as currency units.  An underlying represents a variable, such as an interest rate or price index.  The amount of cash or other asset delivered from one party to the other is determined based upon the interaction of the notional amount of the contract with the underlying.  Derivatives can also be implicit in certain contracts and commitments.

As with any financial instrument, derivative instruments have inherent risks, primarily market and credit risk.  Market risk associated with changes in interest rates is managed by establishing and monitoring limits as to the degree of risk that may be undertaken as part of our overall market risk monitoring process.  Credit risk occurs when a counterparty to a derivative contract with an unrealized gain fails to perform according to the terms of the agreement.  Credit risk is managed by monitoring the size and maturity structure of the derivative portfolio and applying uniform credit standards to all activities with credit risk.

All derivative instruments are recorded on the balance sheet at fair value in either other assets or other liabilities.  Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and the type of hedge transaction.

Fair Value Hedges: For transactions in which we are hedging changes in fair value of an asset, liability, or a firm commitment, changes in the fair value of the derivative instrument are generally offset in the income statement by changes in the hedged item’s fair value.

Cash Flow Hedges: For transactions in which we are hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument are reported in other comprehensive income. The gains and losses on the derivative instrument, which are reported in comprehensive income, are reclassified to earnings in the periods in which earnings are impacted by the variability of cash flows of the hedged item.

The ineffective portion of all hedges is recognized in current period earnings as a component of the interest income section of the related hedged item.

Our derivatives are governed by the terms of ISDA Master netting agreements and Credit Support Annexes. The ISDA Master agreements allow counterparties to offset trades in a gain against trades in a loss to determine net exposure and allow for the right of offset in the event of either a default or an additional termination event. Credit Support Annexes govern the terms of daily collateral posting practices. Collateral practices mitigate the potential loss impact to affected parties by requiring liquid collateral to be posted on a scheduled basis to secure the aggregate net unsecured exposure. In addition to collateral, the right of offset allows counterparties to offset net derivative values with a defaulting party against certain other contractual receivables from other obligations due to the defaulting party in determining the net termination amount.

Cash Flow Hedges

We have entered into three pay-fixed/receive LIBOR interest rate swaps as follows: 

• A $20 million notional interest rate swap with an effective date of October 18, 2021 and expiring on October 18, 2024, designated as a cash flow hedge of $20 million of forecasted series of short-term fixed rate Federal Home Loan Bank advances. Under the terms of this swap, we pay a fixed rate of 1.1055% and receive a variable rate equal to three month LIBOR.

• A $50 million notional interest rate swap with an effective date May 18, 2023 and expiring on May 18, 2025, designated as a cash flow hedge of $50 million of forecasted series of short-term fixed rate Federal Home Loan Bank advances. Under the terms of this swap, we pay a fixed rate of 3.768% and receive a variable rate equal to daily SOFR. 

• A $50 million notional interest rate swap with an effective date of July 18, 2023 and expiring on January 18, 2026, designated as a cash flow hedge of $50 million of forecasted series of short-term fixed rate Federal Home Loan Bank advances. Under the terms of this swap, we pay a fixed rate of 4.36% and receive a variable rate equal to daily SOFR. 

In addition, we have purchased two interest rate caps as follows:

• A $100 million notional interest rate cap with an effective date of July 20, 2020,and expiring on April 18, 2030, designated as a cash flow hedge of $100 million of forecasted series of short-term fixed rate Federal Home Loan Bank advances. Under the terms of this cap, we hedge the variability of cash flows when three month LIBOR is above 0.75%.

• A $100 million notional interest rate cap with an effective date of December 29, 2020 and expiring on December 18, 2025, designated as a cash flow hedge of $100 million of certain indexed interest bearing demand deposit accounts. Under the terms of this cap, we hedge the variability of cash flows when the indexed rate of daily SOFR is above 0.50%.

Fair Value Hedges

We have entered into three pay-fixed/receive variable interest rate swaps as follows:

• An original $9.95 million (current $6.6 million) notional amortizing interest rate swap with an effective date of January 15, 2015 and expiring on January 15, 2025, designated to hedge the variability in fair value of a fixed rate commercial loan with the same principal, amortization, and maturity terms of the swap. Under the terms of this swap, we pay a fixed rate of 4.33% and receive a variable rate equal to three month LIBOR plus 2.23%.

• An original $11.3 million (current $9.6 million) notional amortizing interest rate swap with an effective date of December 18, 2015 and expiring on January 15, 2026, designated to hedge the variability in fair value of a fixed rate commercial loan with the same principal, amortization, and maturity terms as the swap. Under the terms of this swap, we pay a fixed rate of 4.30% and receive a variable rate equal to one month LIBOR plus 2.18%.

• A $71.5 million notional pay fixed/receive variable interest rate swap with an effective date of April 1, 2024 (hedge designated on October 27, 2021) and expiring on February 1, 2031 to hedge the variability in fair value of a designated portfolio of available for sale taxable municipal securities. Under the terms of this swap, we will pay a fixed rate of 1.587% and will receive a variable rate equal to Federal funds.

A summary of our derivative financial instruments as of December 31, 2023 and 2022 follows:

	December 31, 2023
			Derivative Fair Value				Net Ineffective
Dollars in thousands	Notional Amount		Asset		Liability		Hedge Gains/(Losses)
CASH FLOW HEDGES
Pay-fixed/receive-variable interest rate swaps hedging:
Short term borrowings	$	120,000	$	1,059	$	375	$	—
Interest rate caps hedging :
Short term borrowings	$	100,000	$	17,578	$	—	$	—
Indexed interest bearing demand deposit accounts		100,000		6,736		—		—
FAIR VALUE HEDGES
Pay-fixed/receive-variable interest rate swaps hedging:
Commercial real estate loans	$	16,175	$	583	$	—	$	—
Available for sale taxable municipal securities		71,245		7,564		—		1
Total	$	407,420	$	33,520	$	375	$	1

	December 31, 2022
			Derivative Fair Value				Net Ineffective
Dollars in thousands	Notional Amount		Asset		Liability		Hedge Gains/(Losses)
CASH FLOW HEDGES
Pay-fixed/receive-variable interest rate swaps hedging:
Short term borrowings	$	40,000	$	1,871	$	—	$	—
Interest rate caps hedging:
Short term borrowings	$	100,000	$	20,554	$	—	$	—
Indexed interest bearing demand deposit accounts		100,000		10,047		—		—
FAIR VALUE HEDGES
Pay-fixed/receive-variable interest rate swaps hedging:
Commercial real estate loans	$	16,876	$	911	$	—	$	—
Available for sale taxable municipal securities		71,245		7,123		—		(12	)
Total	$	328,121	$	40,506	$	—	$	(12	)