NOTE 19: Derivative Financial Instruments

The Corporation uses derivative financial instruments (or “derivatives”) 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 (or “loan swaps”) and interest rate lock commitments.

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, with such interest rates set based on benchmarked interest rates.

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 as accrued under the terms of the agreements. The Corporation assesses the effectiveness of each hedging relationship on a periodic basis. In accordance with ASC 815, Derivatives and Hedging, the effective portions of the derivatives’ unrealized gains or losses are recorded as a component of other comprehensive income. Based on the Corporation’s assessment its cash flow hedges are highly effective, but to the extent that any ineffectiveness exists in the hedge relationships, the amounts would be recorded in interest income and interest expense in the Corporation’s consolidated statements of income.

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 Sheet. 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 December 31, 2017, 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 Sheet.

The following tables summarize key elements of the Corporation’s derivative instruments as of December 31, 2017 and December 31, 2016, segregated by derivatives that are considered to be hedging instruments and those that are not:


	December 31, 2017
	Notional								Collateral
(Dollars in thousands)	Amount1		Positions		Assets2		Liabilities2		Pledged3
Cash flow hedges:
Interest rate swaps:
Variable-rate to fixed-rate swaps with counterparty	$	25,000		3	$	166	$	—	$	—
Not designated as hedges:
Customer-related interest rate contracts:
Matched interest rate swaps with borrower		41,295		6		284		977		—
Matched interest rate swaps with counterparty		41,295		6		977		284		—
Other contracts:
Interest rate lock commitments		99,140		440		528		—		—

Notional amounts are not recorded on the balance sheet and are generally used only as a basis on which interest and other payments are determined.

Balances represent the fair value of derivative financial instruments.

Collateral pledged may be comprised of cash or securities.


	December 31, 2016
	Notional								Collateral
(Dollars in thousands)	Amount1		Positions		Assets2		Liabilities2		Pledged3
Cash flow hedges:
Interest rate swaps:
Variable-rate to fixed-rate swaps with counterparty	$	25,000		3	$	—	$	56	$	323
Not designated as hedges:
Customer-related interest rate contracts:
Matched interest rate swaps with borrower		25,151		4		—		1,032		—
Matched interest rate swaps with counterparty		25,151		4		1,032		—		—
Other contracts:
Interest rate lock commitments		106,612		504		663		—		—

Notional amounts are not recorded on the balance sheet and are generally used only as a basis on which interest and other payments are determined.

Balances represent the fair value of derivative financial instruments.

Collateral pledged may be comprised of cash or securities.