Derivatives and Hedging Activities

Interest Rate Swap Derivatives

The Company is exposed to certain risk relating to its ongoing business operations. The primary risk managed by using derivative instruments is interest rate risk. Interest rate swaps are entered into to manage interest rate risk associated with the Company’s forecasted variable rate borrowings. The Company recognizes interest rate swaps as either assets or liabilities at fair value in the statements of financial condition, after taking into account the effects of bilateral collateral and master netting agreements. These agreements allow the Company to settle all interest rate swap agreements held with a single counterparty on a net basis, and to offset net interest rate swap derivative positions with related collateral, where applicable.

The interest rate swaps on variable rate borrowings were designated as cash flow hedges and were over-the-counter contracts. The contracts were entered into by the Company with a single counterparty, and the specific terms and conditions were negotiated, including forecasted notional amounts, interest rates and maturity dates. The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to the agreements. The Company controls the counterparty credit risk by maintaining bilateral collateral agreements and through monitoring policy and procedures. The Company only conducts business with primary dealers and believes that the credit risk inherent in these contracts was not significant.

Note 10. Derivatives and Hedging Activities (continued)

The Company’s interest rate swap derivative financial instruments as of December 31, 2018 are as follows:



(Dollars in thousands)	Forecasted Notional Amount		Variable Interest Rate ¹	Fixed Interest Rate ¹		Payment Term
Interest rate swap	$	160,000	3 month LIBOR	3.378	%	Oct. 21, 2014 - Oct. 21, 2021
Interest rate swap	100,000		3 month LIBOR	2.498	%	Nov. 30, 2015 - Nov. 30, 2022

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¹ The Company pays the fixed interest rate and the counterparty pays the Company the variable interest rate.

The hedging strategy converts the LIBOR-based variable interest rate on borrowings to a fixed interest rate, thereby protecting the Company from interest rate variability.

The interest rate swaps with the $160,000,000 and $100,000,000 notional amounts began their payment terms in October 2014 and November 2015, respectively. The Company designated wholesale deposits and FHLB advances as the cash flow hedge and these hedged items were determined to be fully effective during current and prior periods. The aggregate fair value of the interest rate swaps was recorded in other liabilities with changes recorded in OCI. The Company expects the hedges to remain highly effective during the remaining terms of the interest rate swaps. Interest expense recorded on the interest rate swaps totaled $8,013,000, $8,013,000 and $8,035,000 during 2018, 2017 and 2016, respectively, and is reported as a component of interest expense on deposits and FHLB advances. Unless the interest rate swaps are terminated during the next year, the Company expects $1,663,000 of the unrealized loss reported in OCI at December 31, 2018 to be reclassified to interest expense during the next twelve months.

The following table presents the pre-tax gains or losses recorded in OCI and the Company’s statements of operations relating to the interest rate swap derivative financial instruments:



	Years ended
(Dollars in thousands)	December 31, 2018			December 31, 2017		December 31, 2016
Interest rate swaps
Amount of gain (loss) recognized in OCI	$	3,286		444		(1,643	)
Amount of loss reclassified from OCI to interest expense	(2,334		)	(4,892	)	(6,417	)

The following table discloses the offsetting of financial assets and interest rate swap derivative assets.



	December 31, 2018					December 31, 2017
(Dollars in thousands)	Gross Amount of Recognized Assets		Gross Amount Offset in the Statements of Financial Position		Net Amounts of Assets Presented in the Statements of Financial Position	Gross Amount of Recognized Assets	Gross Amount Offset in the Statements of Financial Position	Net Amounts of Assets Presented in the Statements of Financial Position
Interest rate swaps	$	139	(139	)	—	—	—	—

Note 10. Derivatives and Hedging Activities (continued)

The following table discloses the offsetting of financial liabilities and interest rate swap derivative liabilities.



	December 31, 2018					December 31, 2017
(Dollars in thousands)	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Statements of Financial Position		Net Amounts of Liabilities Presented in the Statements of Financial Position	Gross Amounts of Recognized Liabilities	Gross Amounts Offset in the Statements of Financial Position	Net Amounts of Liabilities Presented in the Statements of Financial Position
Interest rate swaps	$	3,908	(139	)	3,769	9,389	—	9,389

Pursuant to the interest rate swap agreements, the Company pledged collateral to the counterparty in the form of debt securities totaling $4,730,000 at December 31, 2018. There was $0 collateral pledged from the counterparty to the Company as of December 31, 2018. There is the possibility that the Company may need to pledge additional collateral in the future if there were declines in the fair value of the interest rate swap derivative financial instruments versus the collateral pledged.

Residential Real Estate Derivatives

At December 31, 2018, the Company had residential real estate derivatives for commitments (“interest rate locks”) to fund certain residential real estate loans to be sold into the secondary market. At December 31, 2018 and 2017, loans with interest rate lock commitments totaled $59,974,000 and $67,861,000, respectively, and the fair value of the related derivatives was included in other assets with corresponding changes recorded in gain on sale of loans. It has been the Company’s practice to enter into “best efforts” forward sales commitments for the future delivery of residential real estate loans to third party investors when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from its commitments to fund the loans. Forward sales commitments on a “best efforts” basis are not designated in hedge relationships until the loan is funded. Due to the forward sales commitments being short-term in nature, the corresponding derivatives are not significant. During 2018, the Company also began to enter into free-standing derivatives to mitigate the interest rate risk associated with certain residential real estate loans to be sold. These derivatives include forward commitments to sell to-be-announced securities (“TBA”) which are used to economically hedge the interest rate risk associated with certain residential real estate loans held for sale and unfunded commitments. At December 31, 2018, TBA commitments were $40,750,000 and the fair value of the related derivatives was included in other liabilities with corresponding changes recorded in gain on sale of loans.