NOTE 11: Derivative Financial Instruments

The Corporation uses derivative financial instruments primarily to manage risks to the Corporation associated with changing interest rates, and to assist customers with their risk management objectives. The Corporation designates certain derivatives as hedging instruments in a qualifying hedge accounting relationship (cash flow or fair value hedge). The remaining derivatives are classified as free standing derivatives consisting of customer accommodation loan swaps and IRLCs.

Cash flow hedges. The Corporation designates derivatives as cash flow hedges when they are used to manage exposure to variability in cash flows on variable rate borrowings such as the Corporation’s trust preferred capital notes. The Corporation uses interest rate swap agreements as part of its hedging strategy by exchanging variable-rate interest payments on a notional amount equal to the principal amount of the borrowings for fixed-rate interest payments. Interest rate swaps designated as cash flow hedges are expected to be highly effective in offsetting the effect of changes in interest rates on the amount of the hedged interest payments, and the Corporation assesses the effectiveness of each hedging relationship quarterly. As of March 31, 2019, the Corporation has designated cash flow hedges to manage its exposure to variability in cash flows on certain variable rate borrowings for periods that end between December 2019 and September 2020.

All interest rate swaps were entered into with counterparties that met the Corporation’s credit standards and the agreements contain collateral provisions protecting the at-risk party. The Corporation believes that the credit risk inherent in these derivative contracts is not significant.

The terms and conditions of the interest rate swaps vary and amounts receivable or payable are recognized in interest expense in the Consolidated Statements of Income as accrued under the terms of the agreements. The derivatives’ unrealized gains or losses are recorded as a component of other comprehensive income and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings. The Corporation does not expect any unrealized losses related to cash flow hedges to be reclassified into earnings in the next twelve months.

Loan swaps. The Bank also enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Bank simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and terms. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Corporation receives a floating rate. These back-to-back loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the Consolidated Balance Sheets. Changes in fair value are recorded in other noninterest expense and net to zero because of the identical amounts and terms of the swaps.

IRLCs. C&F Mortgage enters into IRLCs with customers to originate loans for which the interest rates are determined prior to funding. C&F Mortgage then mitigates interest rate risk on these IRLCs and loans held for sale by (a) entering into forward loan sales contracts with investors for loans to be delivered on a best efforts basis or (b) entering into forward sales contracts of mortgage backed securities for loans to be delivered on a mandatory basis. At March 31, 2019, each loan held for sale by C&F Mortgage was subject to a forward sales agreement on a best efforts basis. The fair value of these derivative instruments is reported in “Other assets” in the Consolidated Balance Sheets. Changes in fair value are recorded as a component of gains on sales of loans.

The following tables summarize key elements of the Corporation’s derivative instruments:


	March 31, 2019
	Notional								Collateral
(Dollars in thousands)	Amount		Positions		Assets		Liabilities		Pledged1
Cash flow hedges:
Interest rate swaps:
Variable-rate to fixed-rate swaps with counterparty	$	25,000		3	$	182	$	—	$	—
Not designated as hedges:
Customer-related interest rate contracts:
Matched interest rate swaps with borrower		45,785		8		589		789		—
Matched interest rate swaps with counterparty		45,785		8		789		589		390
Other contracts:
IRLCs		95,921		380		1,396		—		—


	December 31, 2018
	Notional								Collateral
(Dollars in thousands)	Amount		Positions		Assets		Liabilities		Pledged1
Cash flow hedges:
Interest rate swaps:
Variable-rate to fixed-rate swaps with counterparty	$	25,000		3	$	289	$	—	$	—
Not designated as hedges:
Customer-related interest rate contracts:
Matched interest rate swaps with borrower		45,961		8		216		1,391		—
Matched interest rate swaps with counterparty		45,961		8		1,391		216		—
Other contracts:
IRLCs		44,324		181		636		—		—

Collateral pledged may be comprised of cash or securities.