Derivatives and Hedging Activities

6 Months Ended

Jun. 30, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

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 June 30, 2019 and December 31, 2018:



	June 30, 2019						December 31, 2018
	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 swaps	Other assets	$	5	Other liabilities	$	—	Other assets	$	553	Other liabilities	$	—
Derivatives not designated as hedging instruments:
Interest rate swaps	Other assets	33,835		Other liabilities	34,586		Other assets	21,889		Other liabilities	22,385
Risk participation agreements	Other assets	12		Other liabilities	272		Other assets	2		Other liabilities	152
Total		$	33,852		$	34,858		$	22,444		$	22,537

_____________________


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

The following table presents the effect of the Company’s derivative financial instruments on accumulated other comprehensive income for the three and six months ended June 30, 2019 and 2018:



Derivatives in cash flow hedging relationships	Amount of gain or (loss) recognized in OCI on derivatives					Location of gain or (loss) reclassified from accumulated OCI into income	Amount of gain or (loss) reclassified from accumulated OCI into income
	Three months ended June 30,						Three months ended June 30,
	2019			2018			2019		2018
	(In thousands)						(In thousands)
Interest rate swaps	$	(9	)	$	175	Interest expense	$	191	$	263
Total	$	(9	)	$	175		$	191	$	263



Derivatives in cash flow hedging relationships	Amount of gain or (loss) recognized in OCI on derivatives (1)					Location of gain or (loss) reclassified from accumulated OCI into income	Amount of gain or (loss) reclassified from accumulated OCI into income
	Six months ended June 30,						Six months ended June 30,
	2019			2018			2019		2018
	(In thousands)						(In thousands)
Interest rate swaps	$	(47	)	$	1,011	Interest expense	$	502	$	284
Total	$	(47	)	$	1,011		$	502	$	284

____________________

(1)

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 following table presents the effect of the Company’s derivative financial instruments in the consolidated statements of operations for the three and six months ended June 30, 2019 and 2018:



	Location of gain or (loss) reclassified from accumulated OCI into income	Amount of gain or (loss) recognized in income on cash flow hedging relationships				Amount of gain or (loss) recognized in income on cash flow hedging relationships
		Three months ended June 30,				Six months ended June 30,
		2019		2018		2019		2018
		(In thousands)
Total amounts of income and (expense) line items presented in the statement of operations in which the effects of fair value or cash flow hedges are recorded	Interest expense	$	191	$	263	$	502	$	284
The effects of cash flow hedging:
Gain or (loss) on cash flow hedging relationships in ASC 815
Interest contracts - amount of gain or (loss) reclassified from accumulated other comprehensive income into income	Interest expense	$	191	$	263	$	502	$	284

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 June 30, 2019 and December 31, 2018.

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 June 30, 2019 and December 31, 2018.

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 June 30, 2019 and December 31, 2018.

As of June 30, 2019 and December 31, 2018, the termination amounts related to collateral determinations of derivatives in a liability position were $33.1 million and $2.2 million, respectively. The Company has minimum collateral posting thresholds with its derivative counterparties. As of June 30, 2019, the Company had pledged securities with a market value of $35.2 million against its obligations under these agreements. As of December 31, 2018, the Company had no pledged securities. 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 and strategy, the Bank entered into one interest rate swap during 2013 with an effective date of August 1, 2013. This interest rate swap is designated as a cash flow hedge and involves the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed payments. The swap has a notional amount of $25 million and a term of six years from its respective effective date. The interest rate swap will effectively fix the Bank’s interest payments on $25 million of its LIBOR-indexed deposit liabilities at a rate of 2.03%.

Per 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 an immaterial amount 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 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. The Bank has interest rate swaps and caps related to this program with an aggregate notional amount of $1.4 billion as of June 30, 2019 and $1.3 billion as of December 31, 2018. As of June 30, 2019, there were no foreign currency exchange contracts and as of December 31, 2018, there were foreign currency exchange contracts with an aggregate notional amount of $0.1 million related to this program.

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 June 30, 2019, there were seven of these risk participation transactions with an aggregate notional amount of $59.4 million and, as of December 31, 2018, there were seven of these risk participation transactions with an aggregate notional amount of $59.8 million.

The Bank has also participated out to other financial institutions a pro-rated portion of 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 June 30, 2019, there were four of these risk participation transactions with a pro-rated notional amount of $20.6 million and, as of December 31, 2018, there were four of these risk participation transactions with a pro-rated notional amount of $20.7 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 three and six months ended June 30, 2019 and 2018.



		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 derivatives	Three months ended June 30,						Six months ended June 30,
Derivatives not designated as hedging instruments		2019			2018			2019			2018
		(In thousands)
Interest rate swaps	Other income/ (expense)	$	(64	)	$	(139	)	$	(255	)	$	(47	)
Risk participation agreements	Other income/ (expense)	(213		)	47			(109		)	213
Total		$	(277	)	$	(92	)	$	(364	)	$	166