Note 10 - Derivative Financial Instruments

3 Months Ended

Sep. 30, 2011

Derivative Instruments and Hedging Activities Disclosure [Text Block]

10.  DERIVATIVE FINANCIAL INSTRUMENTS

The fair value of derivative financial instruments outstanding is included in other assets and other liabilities in the accompanying consolidated balance sheets and in the net change in each of these financial statement line items in the accompanying consolidated statements of cash flows.

Interest Rate Derivatives. The Company uses derivatives (interest rate swaps and caps) to mitigate exposure to interest rate risk and the objectives of such are described below.

During the third quarter of 2009, the Company entered into a forward-starting interest rate swap contract on its junior subordinated debentures with a notional amount of $17.5 million. The interest rate swap contract was designated as a hedging instrument in a cash flow hedge with the objective of protecting the quarterly interest payments on a portion of the Company’s $36.1 million of junior subordinated debentures issued to the Company’s unconsolidated subsidiary trust, MCBI Statutory Trust I, throughout the five-year period beginning in December 2010 and ending in December 2015 from the risk of variability of those payments resulting from changes in the three-month LIBOR interest rate. Under the swap contract, beginning December 2010, the Company will pay a fixed interest rate of 5.38% and receive a variable interest rate of three-month LIBOR plus a margin of 1.55% on a total notional amount of $17.5 million, with quarterly settlements which began in March 2011.

The Company applies hedge accounting to the interest rate swap above.  To qualify for hedge accounting, a derivative must be highly effective at reducing the risk associated with the exposure being hedged. In addition, for a derivative to be designated as a hedge, the risk management objective and strategy must be documented. Hedge documentation must identify the derivative hedging instrument, the asset or liability and type of risk to be hedged, and how the effectiveness of the derivative will be assessed prospectively and retrospectively. To assess effectiveness, the Company compares the dollar-value of the change in the fair value of the derivative to the change in the fair value or cash flows of the hedged item. The extent to which a derivative has been, and is expected to continue to be, effective at offsetting changes in the fair value or cash flows of the hedged item must be assessed and documented at least quarterly. Any hedge ineffectiveness (i.e., the amount by which the gain or loss on the designated derivative instrument does not exactly offset the gain or loss on the hedged item attributable to the hedged risk) must be reported in current-period earnings. If it is determined that a derivative is not highly effective at hedging the designated exposure, hedge accounting is discontinued.

At the end of the second quarter of 2011, the Company entered into an interest rate cap with a notional amount of $15.0 million with the objective of mitigating the effect of potential future interest rate increases.  The interest rate cap contract is not designated nor accounted for as a hedging instrument.  The interest rate cap contract was effective July 1, 2011 for a five-year term. Under the interest rate cap contract, beginning October 3, 2011 and ending July 1, 2016, the Company will receive quarterly settlements for the difference between the three-month LIBOR interest rate and the cap rate of 2.0%, if the three-month LIBOR interest rate exceeds the cap rate on the settlement date.

           The Company obtains dealer quotations to value its interest rate derivative contract designated as a hedge of cash flows and its non-hedging interest rate derivative.  The notional amounts and estimated fair values of interest rate derivative contracts outstanding at September 30, 2011 and December 31, 2010 are presented in the following table (in thousands).

	September 30, 2011					December 31, 2010
	Notional Amount		Estimated Fair Value			Notional Amount		Estimated Fair Value
Interest rate derivative contract designated as a hedge of cash flows	$	17,500	$	(2,091	)	$	17,500	$	(1,483	)
Interest rate derivative contract not designated as a hedge of cash flows	$	15,000	$	247		$	—	$	—

Gains, Losses and Derivative Cash Flows.   For designated cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income in the Condensed Consolidated Statement of Comprehensive Income, while the ineffective portion (indicated by the excess of the cumulative change in the fair value of the derivative over that which is necessary to offset the cumulative change in expected future cash flows on the hedge transaction) is included in other non-interest income in the Condensed Consolidated Statement of Operations. Net cash flows from the interest rate swap on junior subordinated debentures designated as a hedging instrument in an effective hedge of cash flows are included in interest expense on junior subordinated debentures in the Condensed Consolidated Statement of Operations.

For interest rate derivatives not designated as a hedging instrument, gains or losses due to changes in fair value are included in other non-interest income in the Condensed Consolidated Statement of Operations.

Amounts included in the Condensed Consolidated Statements of Operations and in the Condensed Consolidated Statement of Comprehensive Income for the period related to the interest rate derivative designated as a hedge of cash flows were as follows.  There were no interest rate derivatives designated as hedges of fair value at September 30, 2011.

	Gains/(losses) recorded in income and other comprehensive income (loss) (in thousands)
Three months ended September 30, 2011	Derivative effective portion reclassified from AOCI into income		Hedge ineffectiveness recorded directly in income		Total income statement impact		Derivative effective portion recorded in OCI			Total change in OCI for period
Interest rate derivative designated as a hedge of cash flows:
Interest rate swap	$	—	$	—	$	—	$	(464	)	$	(464	)
Three months ended September 30, 2010
Interest rate derivative designated as a hedge of cash flows:
Interest rate swap	$	—	$	—	$	—	$	(609	)	$	(609	)

	Gains/(losses) recorded in income and other comprehensive income (loss) (in thousands)
Nine months ended September 30, 2011	Derivative effective portion reclassified from AOCI into income		Hedge ineffectiveness recorded directly in income		Total income statement impact		Derivative effective portion recorded in OCI			Total change in OCI for period
Interest rate derivative designated as a hedge of cash flows:
Interest rate swap	$	—	$	—	$	—	$	(608	)	$	(608	)
Nine months ended September 30, 2010
Interest rate derivative designated as a hedge of cash flows:
Interest rate swap	$	—	$	—	$	—	$	(1,861	)	$	(1,861	)

Amounts included in the consolidated statements of operations for the period related to non-hedging interest rate derivatives were as follows (in thousands).

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Non-hedging interest rate derivative:
Other non-interest income	$	(348)	$	—	$	(337)	$	—

Counterparty Credit Risk. Derivative contracts involve the risk of dealing with institutional derivative counterparties and their ability to meet contractual terms. Derivative contracts are generally executed with a Credit Support Annex, (“CSA”), which is a bilateral ratings-sensitive agreement that requires collateral postings at established credit threshold levels.  CSA agreements protect the interests of the Company and its counterparties, should either party suffer a credit rating deterioration. Institutional counterparties must have an investment grade credit rating. There was no CSA on the interest rate cap contract because the counterparty was the FHLB of Dallas, a government sponsored enterprise. The Company’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty. The Company’s credit exposure on the interest rate cap is the value of the expected interest payments that would be collected over the life of the cap contract.   Credit exposure may be reduced by the amount of collateral pledged by the counterparty. There are no credit-risk-related contingent features associated with any of the Company’s derivative contracts.  The Company had no credit exposure relating to the interest rate swap at September 30, 2011.  The amount of cash collateral posted by the Company related to derivative contracts was $2.3 million and $2.1 million at September 30, 2011 and December 31, 2010, respectively.