Derivatives and Hedging Activities

3 Months Ended

Mar. 31, 2021

Derivative Instruments and Hedging Activities Disclosure [Abstract]

The Company may enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and unknown cash amounts, the value of which are determined by interest rates. In addition, the Company provides certain commercial customers back-to-back swaps, which do not meet hedge accounting requirements and therefore changes in the fair value of both the customer swaps and the counterparty swaps, which have an offsetting relationship, are recognized directly in earnings.

See also Item (p), "Derivatives and Hedging," contained in Note 1, "Summary of Significant Accounting Policies," to the Company's consolidated financial statements contained in the Company's 2020 Annual Report on Form 10-K, for further information regarding the accounting for the Company's derivatives and hedging activities.

The tables below present a summary of the Company's derivative financial instruments, notional amounts and fair values for the periods presented:


	As of March 31, 2021
(Dollars in thousands)	Asset Notional Amount		Asset Derivatives(1)		Liability Notional Amount		Liability Derivatives(1)
Derivatives designated as hedging instruments
Interest-rate contracts - pay fixed, receive floating	$	—	$	—	$	75,000	$	2,002
Total cash flow hedge interest-rate swaps	$	—	$	—	$	75,000	$	2,002

Derivatives not subject to hedge accounting
Interest-rate contracts - pay floating, receive fixed	$	37,587	$	507	$	—	$	—
Interest-rate contracts - pay fixed, receive floating	—		—		37,587		507
Total back-to-back interest-rate swaps	$	37,587	$	507	$	37,587	$	507


	December 31, 2020
(Dollars in thousands)	Asset Notional Amount		Asset Derivatives(1)		Liability Notional Amount		Liability Derivatives(1)
Derivatives designated as hedging instruments
Interest-rate contracts - pay fixed, receive floating	$	—	$	—	$	75,000	$	2,814
Total cash flow hedge interest-rate swaps	$	—	$	—	$	75,000	$	2,814

Derivatives not subject to hedge accounting
Interest-rate contracts - pay floating, receive fixed	$	38,027	$	2,286	$	—	$	—
Interest-rate contracts - pay fixed, receive floating	—		—		38,027		2,286
Total back-to-back interest-rate swaps	$	38,027	$	2,286	$	38,027	$	2,286

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(1) Accrued interest balances related to the Company’s interest rate swaps are not included in the fair values above and are immaterial.

The Company had no derivative fair value hedges at either March 31, 2021 or December 31, 2020.

Cash flow hedges

Interest-rate swap agreements may be entered into as hedges against adverse interest-rate fluctuations on specifically identified assets or liabilities. The Company’s cash flow hedges 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 wholesale funding.

The Company’s objectives in using these interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. During the first quarter of 2020, the Company entered into three pay fixed, receive float interest rate swaps to hedge against adverse interest-rate changes. Each swap has a notional value of $25.0 million with respective maturities from 2023 to 2025. At March 31, 2021, these interest rate swaps are designated as cash flow hedges and involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

In relation to the Company's cash flow hedges, the Company estimates that an additional $954 thousand (pre-tax) will be reclassified out of AOCI as an increase to interest expense during the next twelve months.

Back-to-Back swaps

The Company has a "Back-to-Back Swap" program whereby the Bank enters into an interest-rate swap with qualified commercial banking customers and simultaneously enters into equal and opposite interest-rate swap with a swap counterparty. The customer interest-rate swap agreement allows commercial banking customers to convert a floating-rate loan payment to a fixed-rate payment.

Each Back-to-Back swap consists of two interest-rate swaps (a customer swap and offsetting counterparty swap) and amounted to a total number of 10 interest-rate swaps outstanding at both March 31, 2021 and December 31, 2020. The transaction structure effectively minimizes the Bank's interest rate risk exposure resulting from such transactions. Customer-related credit risk is minimized by the cross collateralization of the loan and the interest-rate swap agreement to the customer's underlying collateral.

Interest-rate swaps with the counterparty are subject to master netting agreements, while interest-rate swaps with customers are not. As a result of this offsetting relationship, there were no net gains or losses recognized in income on Back-to-Back swaps during the three months ended March 31, 2021 or March 31, 2020.

At March 31, 2021 and December 31, 2020, all the Back-to-Back swaps with the counterparty were in the same liability position, therefore there was no netting reflected in the Company’s Consolidated Balance Sheets.

Credit Risk

By using derivative financial instruments, the Company exposes itself to counterparty-credit risk. Credit risk is the risk of failure by the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk for the Company. When the fair value of a derivative is negative, the Company owes the counterparty and, therefore, it does not possess credit risk. The credit risk in derivative instruments is mitigated by entering into transactions with highly-rated counterparties that management believes to be creditworthy. Additionally, counterparty interest rate swaps contain provisions for collateral to be posted if the derivative exposure exceeds a threshold amount.

The Company had one counterparty and it was rated A and A2 by Standard & Poor's and Moody's, respectively, at March 31, 2021. The Company had no credit risk exposure at either March 31, 2021 or December 31, 2020 relating to interest-rate swaps with counterparties. When the Company has credit risk exposure, collateral is received from the counterparty and held by the Company. Collateral held by the Company is restricted and not considered an asset of the Company. Therefore, it is not carried on the Company's Consolidated Balance Sheets. If the Company posts collateral, the cash is restricted, is considered an asset of the Company and is carried on the Company's Consolidated Balance Sheets. The Company posted cash collateral of $2.9 million and $5.3 million at March 31, 2021 and December 31, 2020, respectively.

Credit-risk-related Contingent Features

The Company's interest-rate swaps with counterparties contain credit-risk-related contingent provisions. These provisions provide the counterparty with the right to terminate its derivative positions and require the Company to settle its obligations under the agreements if the Company defaults on certain of its indebtedness.

As of March 31, 2021, the fair value of derivatives in a net liability position, which excludes any adjustment for nonperformance risk, related to these agreements was $2.5 million. The Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral at March 31, 2021 as noted above.

Other Derivative Related Activity

The Company also participates in loans originated by third party banks, where the originating bank utilizes a back-to-back interest-rate swap structure; however, the Company is not a party to the swap agreements. Under the terms of the loan participations, the Company has accepted contingent liabilities that would only be realized if the swaps were terminated early and there were outstanding losses not covered by the underlying borrowers and the borrowers' pledged collateral. If applicable, the Company's swap-loss exposure would be equal to a percentage of the originating bank's swap loss based on the ratio of the Company's loan participation to the underlying loan. At both March 31, 2021 and December 31, 2020, the Company had one participation loan where the originating bank utilizes a back-to-back interest-rate swap structure. At March 31, 2021, management considers the risk of material swap-loss exposure related to this participation loan to be unlikely based on the borrower's financial and collateral strength. Management continues to closely monitor for credit changes resulting from the pandemic.

Interest-rate lock commitments related to the origination of mortgage loans that will be sold are considered derivative instruments. The commitments to sell loans are also considered derivative instruments. The Company generally does not pool mortgage loans for sale, but instead sells the loans on an individual basis. To reduce the net interest-rate exposure arising from its loan sale activity, the Company enters into the commitment to sell these loans at essentially the same time that the interest-rate lock commitment is quoted on the origination of the loan. The Company estimates the fair value of these derivatives based on current secondary mortgage market prices. At March 31, 2021 and December 31, 2020, the estimated fair value of the Company's interest-rate lock commitments and commitments to sell these mortgage loans were deemed immaterial.