Derivatives

The Bank may use derivatives to hedge the risk of changes in the fair values of interest rate lock commitments, residential mortgage loans held for sale, and mortgage servicing rights. None of the Company’s derivatives are designated as hedging instruments. Rather, they are accounted for as free-standing derivatives, or economic hedges, with changes in the fair value of the derivatives reported in income. The Company primarily utilizes forward interest rate contracts in its derivative risk management strategy.

The Bank enters into forward delivery contracts to sell residential mortgage loans or mortgage-backed securities to broker/dealers at specific prices and dates in order to hedge the interest rate risk in its portfolio of mortgage loans held for sale and its residential mortgage loan commitments. Credit risk associated with forward contracts is limited to the replacement cost of those forward contracts in a gain position. There were no counterparty default losses on forward contracts in 2013, 2012, and 2011. Market risk with respect to forward contracts arises principally from changes in the value of contractual positions due to changes in interest rates. The Bank limits its exposure to market risk by monitoring differences between commitments to customers and forward contracts with broker/dealers. In the event the Company has forward delivery contract commitments in excess of available mortgage loans, the Company completes the transaction by either paying or receiving a fee to or from the broker/dealer equal to the increase or decrease in the market value of the forward contract. At December 31, 2013, the Bank had commitments to originate mortgage loans held for sale totaling $77.3 million and forward sales commitments of $152.5 million.

The Bank’s mortgage banking derivative instruments do not have specific credit risk-related contingent features. The forward sales commitments do have contingent features that may require transferring collateral to the broker/dealers upon their request. However, this amount would be limited to the net unsecured loss exposure at such point in time and would not materially affect the Company’s liquidity or results of operations.

The Bank executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting the interest rate swaps that the Bank executes with a third party, such that the Bank minimizes its net risk exposure. As of December 31, 2013, the Bank had 254 interest rate swaps with an aggregate notional amount of $1.3 billion related to this program. As of December 31, 2012, the Bank had 164 interest rate swaps with an aggregate notional amount of $912.0 million related to this program.

In connection with the interest rate swap program with commercial customers, the Bank has agreements with its derivative counterparties that contain a provision where if the Bank defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Bank could also be declared in default on its derivative obligations. The Bank also has agreements with its derivative counterparties that contain a provision where if the Bank fails to maintain its status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions and the Bank would be required to settle its obligations under the agreements. Similarly, the Bank could be required to settle its obligations under certain of its agreements if specific regulatory events occur, such as if the Bank were issued a prompt corrective action directive or a cease and desist order, or if certain regulatory ratios fall below specified levels. If the Bank had breached any of these provisions at December 31, 2013, it could have been required to settle its obligations under the agreements at the termination value.

As of December 31, 2013 and 2012, the termination value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $12.1 million and $21.8 million, respectively. The Bank has collateral posting requirements for initial or variation margins with its clearing members and clearing houses and has been required to post collateral against its obligations under these agreements of $13.0 million and none as of December 31, 2013 and 2012, respectively. The Bank also has minimum collateral posting thresholds with certain of its derivative counterparties, and has been required to post collateral against its obligations under these agreements of none and $22.5 million as of December 31, 2013 and 2012, respectively.

The fair value of the interest rate swaps is determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves. In addition, to comply with the provisions of ASC 820, the Bank incorporates credit valuation adjustments (“CVA”) to appropriately reflect nonperformance risk in the fair value measurements of its derivatives. The CVA is calculated by determining the total expected exposure of the derivatives (which incorporates both the current and potential future exposure) and then applying the counterparties’ credit spreads to the exposure. For derivatives with two-way exposure, specifically, the Bank’s interest rate swaps, the counterparty’s credit spread is applied to the Bank’s exposure to the counterparty, and the Bank’s own credit spread is applied to the counterparty’s exposure to the Bank, and the net CVA is reflected in the Bank’s derivative valuations. The total expected exposure of a derivative is derived using market-observable inputs, such as yield curves and volatilities. For the Bank’s own credit spread and for counterparties having publicly available credit information, the credit spreads over LIBOR used in the calculations represent implied credit default swap spreads obtained from a third party credit data provider. For counterparties without publicly available credit information, which are primarily commercial banking customers, the credit spreads over LIBOR used in the calculations are estimated by the Bank based on current market conditions, including consideration of current borrowing spreads for similar customers and transactions, review of existing collateralization or other credit enhancements, and changes in credit sector and entity-specific credit information. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Bank has considered the impact of netting and any applicable credit enhancements. Effective January 1, 2012, the Company made an accounting policy election to use the exception commonly referred to as the “portfolio exception” with respect to measuring counterparty credit risk for its interest rate swap derivative instruments that are subject to master netting agreements with commercial banking customers that are hedged with offsetting interest rate swaps with third parties.

As of January 1, 2013, the Bank changed its valuation methodology for interest rate swap derivatives to discount cash flows based on Overnight Index Swap (“OIS”) rates. Fully collateralized trades are discounted using OIS with no additional economic adjustments to arrive at fair value. Uncollateralized or partially-collateralized trades are also discounted at OIS, but include appropriate economic adjustments for funding costs (e.g., a LIBOR-OIS basis adjustment to approximate uncollateralized cost of funds) and credit risk. The Company is making the changes to better align its inputs, assumptions, and pricing methodologies with those used in its principal market by most dealers and major market participants. The changes in valuation methodology are applied prospectively as a change in accounting estimate and are immaterial to the Company's financial statements.

The following tables summarize the types of derivatives, separately by assets and liabilities, their locations on the Consolidated Balance Sheets, and the fair values of such derivatives as of December 31, 2013 and December 31, 2012:

(in thousands)



		Asset Derivatives				Liability Derivatives
Derivatives not designated	Balance Sheet	December 31,		December 31,		December 31,		December 31,
as hedging instrument	Location	2013		2012		2013		2012
Interest rate lock commitments	Other assets/Other liabilities	$	706	$	1,496	$	—	$	18
Interest rate forward sales commitments	Other assets/Other liabilities	1,250		133		6		905
Interest rate swaps	Other assets/Other liabilities	15,965		22,213		14,556		22,048
Total		$	17,921	$	23,842	$	14,562	$	22,971

The following table summarizes the types of derivatives, their locations within the Consolidated Statements of Income, and the gains (losses) recorded during the 2013, 2012, and 2011:

(in thousands)



Derivatives not designated	Income Statement	December 31,
as hedging instrument	Location	2013			2012			2011
Interest rate lock commitments	Mortgage banking revenue	$	(772	)	$	(271	)	$	1,613
Interest rate forward sales commitments	Mortgage banking revenue	13,225			(21,281		)	(10,579		)
Interest rate swaps	Other income	1,243			336			(187		)
Total		$	13,696		$	(21,216	)	$	(9,153	)

As of December 31, 2013 and 2012, the net CVA increased the settlement values of the Bank’s net derivative assets by $1.4 million and decreased the settlement values of the Bank's net derivative assets by $45,000, respectively. The gains (losses) above on the interest rate swaps relate to CVAs. Various factors impact changes in the CVA over time, including changes in the credit spreads of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments.

The following table summarizes the offsetting derivatives assets that have a right of offset as of December 31, 2013 and December 31, 2012:

(in thousands)



							Gross Amounts Not Offset in the Statement of Financial Position
	Gross Amounts of Recognized Assets/Liabilities		Gross Amounts Offset in the Statement of Financial Position		Net Amounts of Assets/Liabilities presented in the Statement of Financial Position		Financial Instruments			Collateral Posted			Net Amount
December 31, 2013
Derivative Assets
Interest rate swaps	$	15,965	$	—	$	15,965	$	(4,852	)	$	(2,207	)	$	8,906
Derivative Liabilities
Interest rate swaps	$	14,556	$	—	$	14,556	$	(4,852	)	$	(9,704	)	$	—

December 31, 2012
Derivative Assets
Interest rate swaps	$	22,213	$	—	$	22,213	$	(16	)	$	—		$	22,197
Derivative Liabilities
Interest rate swaps	$	22,048	$	—	$	22,048	$	(16	)	$	(22,032	)	$	—