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. As a service to its customers, the Company may utilize derivative instruments including customer foreign exchange forward contracts to manage its foreign exchange risk, if any.

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 December 31, 2018 and 2017.



	December 31, 2018						December 31, 2017
	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	$	553	Other liabilities	$	—	Other assets	$	555	Other liabilities	$	80
Derivatives not designated as hedging instruments:
Interest rate products	Other assets	21,889		Other liabilities	22,385		Other assets	18,575		Other liabilities	18,953
Foreign exchange contracts	Other assets	—		Other liabilities	—		Other assets	2		Other liabilities	2
Risk participation agreements	Other assets	2		Other liabilities	152		Other assets	1		Other liabilities	108
Total		$	22,444		$	22,537		$	19,133		$	19,143

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(1)	For additional details, see Part II. Item 8. “Financial Statements and Supplementary Data - Note 21: Fair Value Measurements.”

The following table presents the effect of the Company’s derivative financial instruments in the consolidated statement of operations for the years ended December 31, 2018 and 2017.



Derivatives in Cash Flow Hedging Relationships	Amount of Gain or (Loss) Recognized in OCI on Derivatives (Effective Portion) (1) Years Ended December 31,				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) Years Ended December 31,
Derivatives in Cash Flow Hedging Relationships	2018		2017			2018			2017
(In thousands)
Interest rate products	$	990	$	336	Interest Expense	$	(907	)	$	(1,168	)
Total	$	990	$	336		$	(907	)	$	(1,168	)

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(1)

There was an additional $11 thousand loss related to the ineffective portion for the year ended December 31, 2017. The guidance in ASU 2017-12 requires that amounts in accumulated other comprehensive income that are included in the assessment of effectiveness should be reclassified into earnings in the same period in which the hedged forecasted transactions impact earnings. Transition guidance for this ASU further states that upon adoption, previously recorded cumulative ineffectiveness for cash flow hedges existing at the adoption date be eliminated by means of a cumulative-effect adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the initial application date. There was a $5 thousand reclassification related to the adoption of ASU 2017-12 effective January 1, 2018.

The Bank has agreements with its derivative counterparties that contain provisions where, if the Bank defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Bank could also be declared in default on its derivative obligations. The Bank was in compliance with these provisions as of December 31, 2018 and 2017.

The Bank also has agreements with certain of its derivative counterparties that contain provisions where, if the Bank fails to maintain its status as a well- or adequately-capitalized institution, then the counterparty could terminate the derivative positions and the Bank would be required to settle its obligations under the agreements. The Bank was in compliance with these provisions as of December 31, 2018 and 2017.

Certain of the Bank’s agreements with its derivative counterparties contain provisions where if specified events or conditions occur that materially change the Bank’s creditworthiness in an adverse manner, the Bank may be required to fully collateralize its obligations under the derivative instruments. The Bank was in compliance with these provisions as of December 31, 2018 and 2017.

As of December 31, 2018 and 2017, the termination amounts related to collateral determinations of derivatives in a liability position were $2.2 million and $3.1 million, respectively. The Company has minimum collateral posting thresholds with its derivative counterparties. As of December 31, 2018, the Company has no pledged securities. As of December 31, 2017, the Company had pledged securities with a market value of $2.3 million against its obligations under these agreements. The collateral posted is typically greater than the current liability position; however, due to timing of liability position changes at period end, the funding of a collateral shortfall may take place shortly following period end.

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company has entered into interest rate swaps as part of its interest rate risk management strategy. These interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed payments. The Company has entered into interest rate swaps to hedge London Interbank Offered Rate (“LIBOR”) -indexed brokered deposits and the LIBOR component of the total cost of certain FHLB borrowings.

To accomplish this objective and strategy, the Bank has entered into a total of four interest rate swaps, one during 2017 with an effective date of March 22, 2017 and three during 2013 with effective dates of June 1, 2014, March 1, 2014, and August 1, 2013.

The one interest rate swap entered into during 2017 has a notional amount of $60 million with a term of 2.25 years. This interest rate swap will effectively fix the Bank’s interest payments on $60 million in interest-related cash outflows attributable to changes in the LIBOR component of FHLB borrowing liabilities at a rate of 1.65%. The borrowings hedged will initially be expected to be issuances and quarterly rollovers of 3-month FHLB advances but may also then include future issuances of 3-month repurchase agreements with similar characteristics and/or future issuances of either floating or fixed rate borrowings that are issued with the specific intent to replace the quarterly rollovers of the advances or repurchase agreements.

The three interest rate swaps entered into during 2013 each have a notional amount of $25 million and have terms ranging from five to six years from their respective effective dates. The interest rate swaps effectively fix the Bank’s interest payments on $75 million of its LIBOR-indexed deposit liabilities at rates between 1.68% and 2.03%, and a weighted average rate of 1.82%.

Prior to the implementation of ASU 2017-12, which was implemented on a modified retrospective basis on January 1, 2018, the Company used 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 assessed 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 was 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 was recorded as a gain or loss in the consolidated statement of operations as part of fees and other income. There was an immaterial amount of hedge ineffectiveness during the years ended December 31, 2018 and December 31, 2017. The Company also monitors the risk of counterparty default on an ongoing basis.

Upon implementation of ASU 2017-12, for derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income and subsequently reclassified into interest expense in the same period during which the hedged transaction affects earnings. A portion of the balance reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made or received on the Company’s interest rate swaps. During the next twelve months, the Company estimates that $0.6 million will be reclassified as a decrease in interest expense. The Company monitors the risk of counterparty default on an ongoing basis.

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. The net effect on earnings is primarily driven by changes in the credit valuation adjustment (“CVA”). The CVA represents the dollar amount of fair value adjustment related to nonperformance risk of both the Bank and its counterparties. Fees earned in connection with the execution of derivatives related to this program are recognized in the consolidated statement of operations in other income. As of December 31, 2018 and 2017, the Bank had 160 and 142 derivatives, respectively, related to this program, comprised of interest rate swaps and caps, with an aggregate notional amount of $1.3 billion and $1.1 billion, respectively, as of December 31, 2018 and 2017. As of December 31, 2018, there were two foreign currency exchange contracts with an aggregate notional amount of $0.1 million and, as of December 31, 2017, there were three foreign currency exchange contract with an aggregate notional amount of $0.2 million.

In addition, as a participant lender, the Bank has guaranteed performance on the pro-rated portion of swaps executed by other financial institutions. As the participant lender, the Bank is providing a partial guarantee, but is not a direct party to the related swap transactions. The Bank has no obligations under the risk participation agreements unless the borrower defaults on their swap transaction with the lead bank and the swap is in a liability position to the borrower. In that instance, the Bank has agreed to pay the lead bank a portion of the swap’s termination value at the time of the default. The derivative transactions entered into as part of these agreements are not designated, as per ASC 815, as qualifying hedging relationships and are, therefore, marked-to-market through earnings each period. As of December 31, 2018, there were seven of these risk participation agreements with an aggregate notional amount of $59.8 million and, as of December 31, 2017, there were six of these risk participation transactions with an aggregate notional amount of $48.0 million.

The Bank has also participated out to other financial institutions a pro-rated portion of four swaps executed by the Bank. The other financial institution has no obligations under the risk participation agreements unless the borrowers default on their swap transactions with the Bank and the swaps are in liability positions to the borrower. In those instances, the other financial institution has agreed to pay the Bank a portion of the swap’s termination value at the time of the default. The derivative transactions entered into as part of these agreements are not designated, as per ASC 815, as qualifying hedging relationships and are, therefore, marked-to-market through earnings each period. As of December 31, 2018, there were four of these risk participation transactions with a pro-rated notional amount of $20.7 million. As of December 31, 2017, there were two of these risk participation transactions with a pro-rated notional amount of $6.1 million.

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 years ended December 31, 2018, 2017 and 2016.



Derivatives Not Designated as Hedging Instruments	Location of Gain or (Loss) Recognized in Income on Derivatives	Amount of Gain or (Loss), Net, Recognized in Income on Derivatives for Years Ended December 31,
Derivatives Not Designated as Hedging Instruments		2018			2017			2016
		(In thousands)
Interest rate products	Other income/(expense)	$	(118	)	$	(851	)	$	596
Risk participation agreements	Other income/(expense)	158			354			4
Total		$	40		$	(497	)	$	600