Derivative and Hedging Activities

6 Months Ended

Jun. 30, 2019

Note 12. Derivative and Hedging Activities

The Company’s derivative financial instruments consist of interest rate swaps. The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposure to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate and liquidity risks, primarily by managing the amount, sources, and duration of its assets and liabilities and, from time to time, 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 payment of future known and uncertain cash amounts, the value of which are 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 the Company’s pools of fixed-rate assets.

The Company is exposed to changes in the fair value of certain of its fixed-rate assets due to changes in benchmark interest rates. The Company uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in the designated benchmark interest rate. Interest rate swaps designated as fair value hedges involve the payment of fixed-rate amounts to a counterparty in exchange for the Company receiving variable-rate payments over the life of the agreements without the exchange of the underlying notional amount. Such derivatives were used to hedge the changes in fair value of certain of its pools of prepayable fixed rate assets. 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 interest income.

In the first quarter of 2019, the Company entered into an interest rate swap with a notional amount of

$2.0

billion to hedge certain real estate loans. For the three and six months ended June 30, 2019, the floating rate received related to the net settlement of this interest rate swap was in excess of the fixed rate payments. As such, interest income from Mortgage and Other Loans and Leases in the accompanying Consolidated Statements of Income and Comprehensive Income was increased by

$207,000 and $

446,000

for the three and six months ended June 30, 2019, respectively.

As of June 30, 2019, the following amounts were recorded on the balance sheet related to cumulative basis adjustment for fair value hedges. The Company did not have any derivative instruments at December 31, 2018:


(in thousands)	June 30, 2019
Line Item in the Consolidated Statements of Condition in which the Hedge Item is Included	Carrying Amount of the Hedged Assets		Cumulative Amount of Fair Value Hedging Adjustments Included in the Carrying Amount of the Hedged Assets
Total loans and leases, net (1)	$	2,058,354	$	58,354

(1)

These amounts include the amortized cost basis of closed portfolios used to designated hedging relationships in which the hedged item is the last layer expected to be remaining at the end of the hedging relationship. At June 30, 2019, the amortized cost basis of the closed portfolios used in these hedging relationships was $4.6 billion; the cumulative basis adjustments associated with these hedging relationships was $58.4 million; and the amount of the designated hedged items was $2.0 billion.

The following table sets forth information regarding the Company’s derivative financial instruments at June 30, 2019. The Company had no derivative financial instruments at December 31, 2018.


	June 30, 2019
			Fair Value
(in thousands)	Notional Amount		Other Assets		Other Liabilities
Derivatives designated as hedging instruments:
Fair value hedge interest rate swap	$	2,000,000	$	—	$	—

Total derivatives designated as hedging instruments	$	2,000,000	$	—	$	—

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) requires all standardized derivatives, including most interest rate swaps, to be submitted for clearing to central counterparties to reduce counterparty risk. Two of the central counterparties are the Chicago Mercantile Exchange (“CME”) and the London Clearing House (“LCH”). As of June 30, 2019, all of the Company’s $2.0 billion notional derivative contracts were cleared on the LCH. Variation margin payments on derivatives cleared through the LCH are accounted for as legal settlement. For derivatives cleared through LCH, the net gain (loss) position includes the variation margin amounts as settlement of the derivative and not collateral against the fair value of the derivative.

The Company’s exposure is limited to the value of the derivative contracts in a gain position less any collateral held and plus any collateral posted. When there is a net negative exposure, we consider our exposure to the counterparty to be zero. At June 30, 2019, the Company had a net negative exposure.

The following table sets forth the effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the periods indicated. The Company had

derivative financial instruments outstanding during 2018:

	For the Three			For the Six
	Months Ended			Months Ended
(in thousands)	June 30, 2019			June 30, 2019
Derivative – interest rate swap:
Interest income	$	(39,822	)	$	(58,354	)
Hedged item – loans:
Interest income	$	39,822		$	58,354