Derivatives and Hedging Activities

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and, to a lesser extent, the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are generally determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to certain loans, deposits, and borrowings.

The following table presents the fair value of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheets as of June 30, 2014 and December 31, 2013:



	June 30, 2014							December 31, 2013
	Asset derivatives			Liability derivatives				Asset derivatives			Liability derivatives
	Balance sheet location	Fair value (1)		Balance sheet location	Fair value (1)			Balance sheet location	Fair value (1)		Balance sheet location	Fair value (1)
	(In thousands)
Derivatives designated as hedging instruments:
Interest rate products	Other assets	$	—	Other liabilities	$	(4,257	)	Other assets	$	921	Other liabilities	$	(4,012	)
Derivatives not designated as hedging instruments:
Interest rate products	Other assets	3,776		Other liabilities	(3,865		)	Other assets	2,045		Other liabilities	(2,029		)
Total		$	3,776		$	(8,122	)		$	2,966		$	(6,041	)

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(1)	For additional details, see Part I. Item 1. “Notes to Unaudited Consolidated Financial Statements-Note 5: Fair Value Measurements.”

The following tables present the effect of the Company’s derivative financial instruments in the consolidated statements of operations for the three and six months ended June 30, 2014 and 2013:



Derivatives in cash flow hedging relationships	Amount of gain or (loss) recognized in OCI on derivatives (effective portion)					Location of gain or (loss) reclassified from accumulated OCI into income (effective portion)	Amount of gain or (loss) reclassified from accumulated OCI into income (effective portion)
	three months ended June 30,						three months ended June 30,
	2014			2013			2014			2013
(In thousands)
Interest rate products	$	(1,513	)	$	1,197	Interest expense	$	(732	)	$	(471	)
Total	$	(1,513	)	$	1,197		$	(732	)	$	(471	)



Derivatives in cash flow hedging relationships	Amount of gain or (loss) recognized in OCI on derivatives (effective portion)					Location of gain or (loss) reclassified from accumulated OCI into income (effective portion)	Amount of gain or (loss) reclassified from accumulated OCI into income (effective portion)
	six months ended June 30,						six months ended June 30,
	2014			2013			2014			2013
(In thousands)
Interest rate products	$	(2,514	)	$	1,175	Interest expense	$	(1,348	)	$	(932	)
Total	$	(2,514	)	$	1,175		$	(1,348	)	$	(932	)

The following table presents the components of the Company’s accumulated other comprehensive income/ (loss) related to the derivatives for the three and six months ended June 30, 2014 and 2013:



	Three months ended June 30,						Six months ended June 30,
	2014			2013			2014			2013
	(In thousands)
Accumulated other comprehensive income/ (loss) on cash flow hedges, balance at beginning of period	$	(1,995	)	$	(2,762	)	$	(1,763	)	$	(2,969	)
Net change in unrealized gain/ (loss) on cash flow hedges	(463		)	1,017			(695		)	1,224
Accumulated other comprehensive income/ (loss) on cash flow hedges, balance at end of period	$	(2,458	)	$	(1,745	)	$	(2,458	)	$	(1,745	)

The Holding Company and the Bank have agreements with their derivative counterparties that contain provisions where, if the Holding Company or Bank defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, the Holding Company or the Bank could also be declared in default on its derivative obligations. The Holding Company and the Bank were in compliance with these provisions as of June 30, 2014 and December 31, 2013.

The Holding Company and the Bank also have agreements with certain of their derivative counterparties that contain provisions where, if the Holding Company or Bank fails to maintain its status as a well- or adequately-capitalized institution, the counterparty could terminate the derivative positions and the Holding Company or the Bank would be required to settle its obligations under the agreements. The Holding Company and the Bank were in compliance with these provisions as of June 30, 2014 and December 31, 2013.

Certain of the Holding Company and the Bank’s agreements with their derivative counterparties contain provisions where, if specified events or conditions occur that materially change the Holding Company’s or the Bank’s creditworthiness in an adverse manner, the Holding Company or the Bank may be required to fully collateralize their obligations under the derivative instruments. The Holding Company and the Bank were in compliance with these provisions as of June 30, 2014 and December 31, 2013.

As of June 30, 2014 and December 31, 2013, the termination amounts related to collateral determinations of derivatives in a liability position was $8.3 million and $6.1 million, respectively. The Company has minimum collateral posting thresholds with its derivative counterparty and has posted collateral of $5.1 million and $7.3 million as of June 30, 2014 and December 31, 2013, respectively, against its obligation under this agreement.

Cash Flow Hedges of Interest Rate Risk

The Company’s objective in using derivatives is to add stability to interest income and expense and to manage the risk related to exposure to changes in interest rates. To accomplish this objective, the Holding Company entered into an interest rate swap in the second quarter of 2010 with a notional amount of $75 million related to the Holding Company’s cash outflows associated with the subordinated debt related to trust preferred securities to protect against an increase in the London Interbank Offered Rate (“LIBOR”). The interest rate swap had an effective date of December 30, 2010 and a term of five years. As of December 30, 2010, the subordinated debt switched from a fixed rate of 6.25% to a variable rate of three-month LIBOR plus 1.68%. The interest rate swap effectively fixed the Holding Company’s interest rate payments on the $75 million of debt at 4.45%.

The Bank entered into a total of six interest rate swaps, five during 2013 with effective dates of August 1, 2013, March 1, 2014, June 1, 2014, September 2, 2014, and December 1, 2014, and one during 2014 with an effective date of June 1, 2014. The six interest rate swaps each have a notional amount of $25 million and have terms ranging from three to six years. The Bank’s risk management objective and strategy for these interest rate swaps is to reduce its exposure to variability in interest-related cash outflows attributable to changes in the LIBOR swap rate associated with borrowing programs for each of the periods, initially expected to be accomplished with LIBOR-indexed brokered deposits, but may also include LIBOR-indexed FHLB advances. The interest rate swaps will effectively fix the Bank’s interest payments on $150 million of its LIBOR-indexed liabilities at rates between 1.17% and 2.32%, and a weighted average rate of 1.85%.

The Company uses the “Hypothetical Derivative Method” described in ASC 815, Derivatives and Hedging (“ASC 815”), for quarterly prospective and retrospective assessments of hedge effectiveness, as well as for measurements of hedge ineffectiveness. Under this method, the Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. The effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (“OCI”) (outside of earnings) and subsequently reclassified to earnings in interest and dividend income when the hedged transactions affect earnings. Ineffectiveness resulting from the hedge is recorded as a gain or loss in the consolidated statement of operations as part of fees and other income. The Company had no hedge ineffectiveness recognized in earnings during the three and six months ended June 30, 2014 and 2013. The Company also monitors the risk of counterparty default on an ongoing basis.

A portion of the balance reported in accumulated other comprehensive income related to derivatives will be reclassified to interest income or expense as interest payments are made or received on the Company’s interest rate swaps. During the next twelve months, the Company estimates that $3.8 million will be reclassified as an increase in interest expense.

Non-designated Hedges

Derivatives not designated as hedges are not speculative and result from two different services the Bank provides to qualified commercial clients. The Bank offers certain derivative products directly to such clients. The Bank economically hedges derivative transactions executed with commercial clients by entering into mirror-image, offsetting derivatives with third parties. Derivative transactions executed as part of these programs are not designated in ASC 815-qualifying hedging relationships and are, therefore, marked-to-market through earnings each period. Because the derivatives have mirror-image contractual terms, the changes in fair value substantially offset through earnings. Fees earned in connection with the execution of derivatives related to this program are recognized in the consolidated statement of operations in other income. The derivative asset and liability values above include an adjustment related to the consideration of credit risk required under ASC 820 of less than ($0.1) million in earnings for the three and six months ended June 30, 2014 and 2013, respectively. As of June 30, 2014 and December 31, 2013, the Bank had 16 and 12 interest rate swaps related to this program with an aggregate notional amount of $189.4 million and $150.8 million, respectively. As of June 30, 2014 and December 31, 2013, the Bank had no foreign currency exchange contracts outstanding related to this program.

The following table presents the effect of the Bank’s derivative financial instruments not designated as hedging instruments in the consolidated statement of operations for the three and six months ended June 30, 2014 and 2013.



		Amount of gain or (loss), net, recognized in income on derivatives
Derivatives not designated as hedging instruments	Location of gain or (loss) recognized in income on derivative	Three months ended June 30,					Six months ended June 30,
Derivatives not designated as hedging instruments		2014			2013		2014			2013
		(In thousands)
Interest rate products	Other income/ (expense)	$	(80	)	$	23	$	(106	)	$	19
Foreign exchange contracts	Other income/ (expense)	—			3		—			5
Total		$	(80	)	$	26	$	(106	)	$	24