Derivatives and Hedging Activities

Risk Management Objective of Using Derivatives

United is exposed to certain risks arising from both its business operations and economic conditions. United principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. United manages interest rate risk primarily by managing the amount, sources, and duration of its investment securities portfolio and wholesale funding and through the use of derivative financial instruments. Specifically, United enters into derivative financial instruments to manage interest rate risk 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 determined by interest rates. Derivative financial instruments are used to manage differences in the amount, timing, and duration of known or expected cash receipts and known or expected cash payments principally related to loans, investment securities, wholesale borrowings and deposits.

In conjunction with the FASB’s fair value measurement guidance, United made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting arrangements on a gross basis.

United clears certain derivatives centrally through the Chicago Mercantile Exchange (“CME”). CME rules legally characterize variation margin payments for centrally cleared derivatives as settlements of the derivatives’ exposure rather than as collateral. As a result, the variation margin payment and the related derivative instruments are considered a single unit of account for accounting purposes. Variation margin, as determined by the CME, is settled daily. As a result, derivative contracts that clear through the CME have an estimated fair value of zero. The table below presents the fair value of derivative financial instruments as of the dates indicated as well as their classification on the consolidated balance sheets (in thousands):

Derivatives designated as hedging instruments under ASC 815



		December 31,
Interest Rate Products	Balance Sheet Location	2018		2017
Fair value hedge of corporate bonds	Derivative assets	$	—	$	336
		$	—	$	336

Fair value hedge of brokered CDs	Derivative liabilities	$	1,682	$	2,053
		$	1,682	$	2,053

Derivatives not designated as hedging instruments under ASC 815



		December 31,
Interest Rate Products	Balance Sheet Location	2018		2017
Customer derivative positions	Derivative assets	$	5,216	$	2,659
Dealer offsets to customer derivative positions	Derivative assets	7,620		6,867
Mortgage banking - loan commitment	Derivative assets	1,190		1,150
Mortgage banking - forward sales commitment	Derivative assets	28		13
Bifurcated embedded derivatives	Derivative assets	10,651		11,057
Interest rate caps	Derivative assets	—		639
		$	24,705	$	22,385

Customer derivative positions	Derivative liabilities	$	9,661	$	7,032
Dealer offsets to customer derivative positions	Derivative liabilities	781		1,551
Risk participations	Derivative liabilities	8		20
Mortgage banking - forward sales commitment	Derivative liabilities	259		49
Dealer offsets to bifurcated embedded derivatives	Derivative liabilities	13,339		14,279
De-designated hedges	Derivative liabilities	703		392
		$	24,751	$	23,323

Customer derivative positions are between United and certain commercial loan customers with offsetting positions to dealers under a back-to-back swap/cap program. United also has three interest rate swap contracts that are not designated as hedging instruments but are economic hedges of market-linked brokered certificates of deposit. The market-linked brokered certificates of deposit contain embedded derivatives that are bifurcated from the host instruments and marked to market through earnings. The fair value marks on the market linked swaps and the bifurcated embedded derivatives tend to move in opposite directions with changes in 90-day London Interbank Offered Rate (“LIBOR”) and therefore provide an economic hedge.

To accommodate customers, United occasionally enters into credit risk participation agreements with counterparty banks to accept a portion of the credit risk related to interest rate swaps. This allows customers to execute an interest rate swap with one bank while allowing for the distribution of the credit risk among participating members. Credit risk participation agreements arise when United contracts with other financial institutions, as a guarantor, to share credit risk associated with certain interest rate swaps. These agreements provide for reimbursement of losses resulting from a third party default on the underlying swap. These transactions are typically executed in conjunction with a participation in a loan with the same customer. Collateral used to support the credit risk for the underlying lending relationship is also available to offset the risk of the credit risk participation.

In addition, United originates certain residential mortgage loans with the intention of selling these loans. Between the time United enters into an interest-rate lock commitment to originate a residential mortgage loan that is to be held for sale and the time the loan is funded and eventually sold, United is subject to the risk of variability in market prices. United also enters into forward sale agreements to mitigate risk and to protect the expected gain on the eventual loan sale. The commitments to originate residential mortgage loans and forward loan sales commitments are freestanding derivative instruments. United accounts for most newly originated mortgage loans at fair value pursuant to the fair value option, and these loans are not reflected in the table above. Fair value adjustments on these derivative instruments are recorded within mortgage loan and other related fee income in the consolidated statements of income.

Cash Flow Hedges of Interest Rate Risk

At December 31, 2018 and 2017, United did not have any active cash flow hedges. Changes in balance sheet composition and interest rate risk position made cash flow hedges no longer necessary as protection against rising interest rates, and as a result, instruments previously designated as cash flow hedges were de-designated. However, as the forecasted transactions the swaps were originally designated to hedge are still expected to occur, the remaining loss from these hedges is included in other comprehensive income and is being amortized into earnings over the original term of the swaps. United expects that $198,000 will be reclassified as an increase to interest expense over the next twelve months related to these cash flow hedges.

The table below presents the effect of cash flow hedges on the consolidated statements of income (in thousands).



	Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income (Effective Portion)
Location	2018			2017			2016
Interest revenue	—			—			(7		)
Interest expense	(499		)	(891		)	(1,884		)
	$	(499	)	$	(891	)	$	(1,891	)

Fair Value Hedges of Interest Rate Risk

United is exposed to changes in the fair value of certain of its fixed-rate obligations due to changes in interest rates. United uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in interest rates. Interest rate swaps designated as fair value hedges of brokered deposits involve the receipt of fixed-rate amounts from a counterparty in exchange for United making variable rate payments over the life of the agreements without the exchange of the underlying notional amount. Interest rate swaps designated as fair value hedges of fixed-rate investments involve the receipt of variable-rate payments from a counterparty in exchange for United making fixed-rate payments over the life of the instrument without the exchange of the underlying notional amount.

At December 31, 2018, United had four interest rate swaps with an aggregate notional amount of $39.0 million that were designated as fair value hedges of interest rate risk and were pay-variable / receive-fixed swaps, hedging the changes in the fair value of fixed-rate brokered time deposits resulting from changes in interest rates. At December 31, 2017, United had four interest rate swaps with an aggregate notional amount of $40.7 million that were designated as fair value hedges of interest rate risk and were pay-variable / receive-fixed swaps, hedging the changes in the fair value of fixed rate brokered time deposits resulting from changes in interest rates. Also at December 31, 2017, United had one interest rate swap with a notional of $30 million that was designated as a pay-fixed / receive-variable fair value hedge of changes in the fair value of a fixed rate corporate bond.

For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. United includes the gain or loss on the hedged items in the same income statement line item as the offsetting loss or gain on the related derivatives. During the year ended December 31, 2018, 2017 and 2016, United recognized a net loss of $456,000, a net loss of $479,000 and a net gain of $2.29 million, respectively, related to ineffectiveness in the fair value hedging relationships. United also recognized a net increase in interest expense of $245,000 for the year ended December 31, 2018 and net reductions of interest expense of $160,000 and $1.61 million for the years ended December 31, 2017 and 2016, respectively, related to fair value hedges of brokered time deposits, which includes net settlements on the derivatives. United recognized an increase in interest revenue on securities of $17,000 during 2018 and reductions of interest revenue on securities of $302,000 and $606,000 during 2017 and 2016, respectively, related to fair value hedges of corporate bonds.

The table below presents the effect of derivatives in fair value hedging relationships on the consolidated statements of income (in thousands).



	Location of Gain (Loss) Recognized in Income on Derivative	Amount of Gain (Loss) Recognized in Income on Derivative								Amount of Gain (Loss) Recognized in Income on Hedged Item
	Location of Gain (Loss) Recognized in Income on Derivative	2018			2017			2016		2018			2017			2016
Fair value hedges of brokered CDs	Interest expense	$	(220	)	$	(657	)	$	1,972	$	(145	)	$	371		$	458
Fair value hedges of corporate bonds	Noninterest income	356			—			—		(447		)	—			—
Fair value hedges of corporate bonds	Interest revenue	—			72			234		—			(265		)	(376		)
		$	136		$	(585	)	$	2,206	$	(592	)	$	106		$	82

In certain cases, the estate of deceased brokered certificate of deposit holders may put the certificate of deposit back to United at par upon the death of the holder. When these death puts occur, a gain or loss is recognized for the difference between the fair value and the par amount of the deposits put back. The change in the fair value of brokered time deposits that are being hedged in fair value hedging relationships reported in the table above includes gains and losses from death puts and such gains and losses are included in the amount of reported ineffectiveness gains or losses.

Derivatives Not Designated as Hedging Instruments under ASC 815

The table below presents the gains and losses recognized in income on derivatives not designated as hedging instruments under ASC 815 for the periods indicated (in thousands).



	Income Statement Location	Year Ended December 31,
	Income Statement Location	2018		2017			2016
Customer derivatives and dealer offsets	Other noninterest income	$	2,658	$	2,416		$	3,744
Bifurcated embedded derivatives and dealer offsets	Other noninterest income	307		429			297
Interest rate caps	Other noninterest income	501		252			—
De-designated hedges	Other noninterest income	31		(62		)	—
Mortgage banking derivatives	Mortgage loan revenue	904		(676		)	3,002
Risk participations	Other noninterest income	12		5			360
Total gains and losses		$	4,413	$	2,364		$	7,403

Credit-risk-related Contingent Features

United manages its credit exposure on derivatives transactions by entering into a bilateral credit support agreement with each non-customer counterparty. The credit support agreements require collateralization of exposures beyond specified minimum threshold amounts. The details of these agreements, including the minimum thresholds, vary by counterparty. As of December 31, 2018, collateral totaling $16.1 million was pledged toward derivatives in a liability position.

United’s agreements with each of its derivative counterparties contain a provision where if either party defaults on any of its indebtedness, then it could also be declared in default on its derivative obligations. The agreements with derivatives counterparties also include provisions that if not met, could result in United being declared in default. United has agreements with certain of its derivative counterparties that contain a provision where if United fails to maintain its status as a well-capitalized institution or is subject to a prompt corrective action directive, the counterparty could terminate the derivative positions and United would be required to settle its obligations under the agreements. Derivatives that are centrally cleared do not have credit-risk-related features that require additional collateral if United’s credit rating were downgraded.