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DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
6 Months Ended
Jun. 30, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

As of June 30, 2016, the Company held derivatives with a total notional amount of $1.7 billion. That amount included $300.0 million in interest rate swap derivatives that were designated as cash flow hedges for accounting purposes. The Company also had economic hedges and non-hedging derivatives totaling $1.3 billion and $64.4 million, respectively, which are not designated as hedges for accounting purposes and are therefore recorded at fair value. Economic hedges included interest rate swaps totaling $1.1 billion, risk participation agreements with dealer banks of $67.9 million, and $76.6 million in forward commitment contracts.

As part of the Company’s risk management strategy, the Company enters into interest rate swap agreements to mitigate the interest rate risk inherent in certain of the Company’s assets and liabilities. Interest rate swap agreements involve the risk of dealing with both Bank customers and institutional derivative counterparties and their ability to meet contractual terms. The agreements are entered into with counterparties that meet established credit standards and contain master netting and collateral provisions protecting the at-risk party. The derivatives program is overseen by the Risk Management/Capital Committee of the Company’s Board of Directors. Based on adherence to the Company’s credit standards and the presence of the netting and collateral provisions, the Company believes that the credit risk inherent in these contracts was not significant at June 30, 2016.

The Company pledged collateral to derivative counterparties in the form of cash totaling $853 thousand and securities with an amortized cost of $61.9 million and a fair value of $63.8 million as of June 30, 2016. The Company does not typically require its commercial customers to post cash or securities as collateral on its program of back-to-back economic hedges. However certain language is written into the International Swaps Dealers Association, Inc. (“ISDA”) and loan documents where, in default situations, the Bank is allowed to access collateral supporting the loan relationship to recover any losses suffered on the derivative asset or liability. The Company may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

Information about derivative assets and liabilities at June 30, 2016, follows:
 
 
 
Weighted
 
Weighted Average Rate
 
Estimated
 
Notional
 
Average
 
 
 
Contract
 
Fair Value
 
Amount
 
Maturity
 
Received
 
pay rate
 
Asset (Liability)
 
(In thousands)
 
(In years)
 
 
 
 
 
(In thousands)
Cash flow hedges:
 

 
 
 
 

 
 

 
 

Interest rate swaps on FHLBB borrowings
$
200,000

 
2.6
 
0.47
%
 
2.19
%
 
$
(8,390
)
Forward-starting interest rate swaps on FHLBB borrowings
100,000

 
3.0
 
0.47
%
 
2.48
%
 
$
(5,531
)
Total cash flow hedges
300,000

 
 
 
 

 
 

 
(13,921
)
 
 
 
 
 
 
 
 
 
 
Economic hedges:
 

 
 
 
 

 
 

 
 

Interest rate swap on tax advantaged economic development bond
11,689

 
13.4
 
0.61
%
 
5.09
%
 
(3,023
)
Interest rate swaps on loans with commercial loan customers
565,898

 
5.6
 
1.92
%
 
3.78
%
 
(38,466
)
Reverse interest rate swaps on loans with commercial loan customers
565,898

 
5.6
 
3.78
%
 
1.92
%
 
38,020

Risk Participation Agreements with Dealer Banks
67,868

 
13.2
 
 

 
 

 
60

Forward sale commitments
76,634

 
0.2
 
 

 
 

 
(869
)
Total economic hedges
1,287,987

 
 
 
 

 
 

 
(4,278
)
 
 
 
 
 
 
 
 
 
 
Non-hedging derivatives:
 

 
 
 
 

 
 

 
 

Interest rate lock commitments
64,412

 
0.2
 
 

 
 

 
1,259

Total non-hedging derivatives
64,412

 
 
 
 

 
 

 
1,259

 
 
 
 
 
 
 
 
 
 
Total
$
1,652,399

 
 
 
 

 
 

 
$
(16,940
)
Information about derivative assets and liabilities at December 31, 2015, follows:
 
 
 
Weighted
 
Weighted Average Rate
 
Estimated
 
Notional
 
Average
 
 
 
Contract
 
Fair Value
 
Amount
 
Maturity
 
Received
 
pay rate
 
Asset (Liability)
 
(In thousands)
 
(In years)
 
 
 
 
 
(In thousands)
Cash flow hedges:
 

 
 
 
 

 
 

 
 

Forward-starting interest rate swaps on FHLBB borrowings
$
300,000

 
3.3
 
0.14
%
 
2.29
%
 
$
(8,532
)
Total cash flow hedges
300,000

 
 
 
 

 
 

 
(8,532
)
 
 
 
 
 
 
 
 
 
 
Economic hedges:
 

 
 
 
 

 
 

 
 

Interest rate swap on tax advantaged economic development bond
11,984

 
13.9
 
0.61
%
 
5.09
%
 
(2,450
)
Interest rate swaps on loans with commercial loan customers
457,392

 
6.7
 
2.18
%
 
4.49
%
 
(17,143
)
Reverse interest rate swaps on loans with commercial loan customers
457,392

 
6.7
 
4.49
%
 
2.18
%
 
17,129

Risk participation agreements with dealer banks
59,016

 
15.0
 
 

 
 

 
(56
)
Forward sale commitments
44,840

 
0.2
 
 

 
 

 
53

Total economic hedges
1,030,624

 
 
 
 

 
 

 
(2,467
)
 
 
 
 
 
 
 
 
 
 
Non-hedging derivatives:
 

 
 
 
 

 
 

 
 

Interest rate lock commitments
36,043

 
0.2
 
 

 
 

 
323

Total non-hedging derivatives
36,043

 
 
 
 

 
 

 
323

 
 
 
 
 
 
 
 
 
 
Total
$
1,366,667

 
 
 
 

 
 

 
$
(10,676
)

Cash flow hedges
The effective portion of unrealized changes in the fair value of derivatives accounted for as cash flow hedges is reported in other comprehensive income and subsequently reclassified to earnings in the same period or periods during which the hedged transaction is forecasted to affect earnings. Each quarter, the Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction. The ineffective portion of changes in the fair value of the derivatives is recognized directly in earnings.

The Company has entered into four interest rate swap contracts with an aggregate notional value of $200 million and two forward-starting interest rate swap contracts with an aggregate notional value of $100 million as of June 30, 2016. The two forward starting swaps will become effective in 2016. All have durations of three years. This hedge strategy converts the one month rolling FHLBB borrowings based on the FHLBB’s one month fixed interest rate to fixed interest rates, thereby protecting the Company from floating interest rate variability.

Amounts included in the Consolidated Statements of Income and in the other comprehensive income section of the Consolidated Statements of Comprehensive Income (related to interest rate derivatives designated as hedges of cash flows), were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
2016
 
2015
 
2016
 
2015
Interest rate swaps on FHLBB borrowings:
 

 
 

 
 

 
 

Unrealized (loss) gain recognized in accumulated other comprehensive loss
$
(1,771
)
 
$
784

 
$
(6,684
)
 
$
(3,117
)
 
 
 
 
 
 
 
 
Reclassification of unrealized loss from accumulated other comprehensive income to interest expense
887

 

 
1,295

 

 
 
 
 
 
 
 
 
Net tax benefit (expense) on items recognized in accumulated other comprehensive income
355

 
(316
)
 
2,162

 
1,256

 
 
 
 
 
 
 
 
Other comprehensive (loss) gain recorded in accumulated other comprehensive income, net of reclassification adjustments and tax effects
$
(529
)
 
$
468

 
$
(3,227
)
 
$
(1,861
)
 
 
 
 
 
 
 
 
Net interest expense recognized in interest expense on hedged FHLBB borrowings
$
887

 
$

 
$
1,295

 
$



Hedge ineffectiveness on interest rate swaps designated as cash flow hedges was immaterial to the Company’s financial statements during the three and six months ended June 30, 2016 and 2015.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate liabilities. During the next twelve months, the Company anticipates reclassification of approximately $5.4 million.
Economic hedges
As of June 30, 2016, the Company has an interest rate swap with a $11.7 million notional amount to swap out the fixed rate of interest on an economic development bond bearing a fixed rate of 5.09%, currently within the Company’s trading portfolio under the fair value option, in exchange for a LIBOR-based floating rate. The intent of the economic hedge is to improve the Company’s asset sensitivity to changing interest rates in anticipation of favorable average floating rates of interest over the 21-year life of the bond. The fair value changes of the economic development bond are mostly offset by fair value changes of the related interest rate swap.

The Company also offers certain derivative products directly to qualified commercial borrowers. The Company economically hedges derivative transactions executed with commercial borrowers by entering into mirror-image, offsetting derivatives with third-party financial institutions. The transaction allows the Company’s customer to convert a variable-rate loan to a fixed rate loan. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts mostly offset each other in earnings. Credit valuation adjustments arising from the difference in credit worthiness of the commercial loan and financial institution counterparties totaled $(372) thousand as of June 30, 2016. The interest income and expense on these mirror image swaps exactly offset each other.

The Company has risk participation agreements with dealer banks. Risk participation agreements occur when the Company participates on a loan and a swap where another bank is the lead. The Company gets paid a fee to take on the risk associated with having to make the lead bank whole on Berkshire’s portion of the pro-rated swap should the borrower default. Changes in fair value are recorded in current period earnings.

The Company utilizes forward sale commitments to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans originated for sale. The forward sale commitments are accounted for as derivatives with changes in fair value recorded in current period earnings.

The Company uses the following types of forward sale commitments contracts:
Best efforts loan sales,
Mandatory delivery loan sales, and
To Be Announced (“TBA”) mortgage-backed securities sales.

A best efforts contract refers to a loan sale agreement where the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. The Company may enter into a best efforts contract once the price is known, which is shortly after the potential borrower’s interest rate is locked.

A mandatory delivery contract is a loan sale agreement where the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, the Company may enter into mandatory delivery contracts shortly after the loan closes with a customer.

The Company may sell TBA mortgage-backed securities to hedge the changes in fair value of interest rate lock commitments and held for sale loans, which do not have corresponding best efforts or mandatory delivery contracts. These security sales transactions are closed once mandatory contracts are written. On the closing date the price of the security is locked-in, and the sale is paired-off with a purchase of the same security. Settlement of the security purchase/sale transaction is done with cash on a net-basis.
Non-hedging derivatives
The Company enters into interest rate lock commitments (“IRLCs”) for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. IRLCs that relate to the origination of mortgage loans that will be held for sale are considered derivative financial instruments under applicable accounting guidance. Outstanding IRLCs expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The IRLCs are free-standing derivatives which are carried at fair value with changes recorded in noninterest income in the Company’s consolidated statements of income. Changes in the fair value of IRLCs subsequent to inception are based on changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and changes in the probability that the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time.

Amounts included in the Consolidated Statements of Income related to economic hedges and non-hedging derivatives were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
2016
 
2015
 
2016
 
2015
Economic hedges
 

 
 

 
 

 
 

Interest rate swap on industrial revenue bond:
 

 
 

 
 

 
 

Unrealized gain (loss) recognized in other non-interest income
$
(292
)
 
$
331

 
$
(831
)
 
$
60

 
 
 
 
 
 
 
 
Interest rate swaps on loans with commercial loan customers:
 

 
 

 
 

 
 

Unrealized (loss) gain recognized in other non-interest income
(7,725
)
 
3,889

 
(21,322
)
 
775

 
 
 
 
 
 
 
 
Reverse interest rate swaps on loans with commercial loan customers:
 

 
 

 
 

 
 

Unrealized gain (loss) recognized in other non-interest income
7,725

 
(3,889
)
 
21,322

 
(755
)
 
 
 
 
 
 
 
 
(Unfavorable) Favorable change in credit valuation adjustment recognized in other non-interest income
(372
)
 
56

 
(433
)
 
57

 
 
 
 
 
 
 
 
Risk Participation Agreements:
 

 
 

 
 

 
 

Unrealized gain (loss) recognized in other non-interest income
33

 
31

 
116

 
(40
)
 
 
 
 
 
 
 
 
Forward Commitments:
 

 
 

 
 

 
 

Unrealized (loss) gain recognized in other non-interest income
(869
)
 
475

 
(1,316
)
 
87

Realized gain (loss) in other non-interest income
50

 
504

 
(333
)
 
413

 
 
 
 
 
 
 
 
Non-hedging derivatives
 

 
 

 
 

 
 

Interest rate lock commitments
 

 
 

 
 

 
 

Unrealized gain recognized in other non-interest income
$
1,259

 
$
382

 
$
2,061

 
$
1,359

Realized gain in other non-interest income
896

 
186

 
1,745

 
941


Assets and Liabilities Subject to Enforceable Master Netting Arrangements
Interest Rate Swap Agreements (“Swap Agreements”)
The Company enters into swap agreements to facilitate the risk management strategies for commercial banking customers. The Company mitigates this risk by entering into equal and offsetting swap agreements with highly rated third party financial institutions. The swap agreements are free-standing derivatives and are recorded at fair value in the Company’s consolidated statements of condition. The Company is party to master netting arrangements with its financial institution counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral generally in the form of marketable securities is received or posted by the counterparty with net liability positions, respectively, in accordance with contract thresholds.

The Company had net asset positions with its commercial banking counterparties totaling $38.0 million and $17.1 million as of June 30, 2016 and December 31, 2015, respectively. The Company had net liability positions with its financial institution counterparties totaling $55.5 million and $28.2 million as of June 30, 2016 and December 31, 2015, respectively. At June 30, 2016, the Company did not have a net liability position with its commercial banking counterparties. The collateral posted by the Company that covered liability positions was $55.5 million and $28.2 million as of June 30, 2016 and December 31, 2015, respectively.

The following table presents the assets and liabilities subject to an enforceable master netting arrangement as of June 30, 2016 and December 31, 2015:

Offsetting of Financial Assets and Derivative Assets
 
 
Gross
Amounts of
 
Gross Amounts
Offset in the
 
Net Amounts
of Assets
Presented in the
 
Gross Amounts Not Offset in
the Statements of Condition
 
 
 
 
Recognized
 
Statements of
 
Statements of
 
Financial
 
Cash
 
 
(in thousands)
 
Assets
 
Condition
 
Condition
 
Instruments
 
Collateral Received
 
Net Amount
June 30, 2016
 
 

 
 

 
 

 
 

 
 

 
 

Interest Rate Swap Agreements:
 
 

 
 

 
 

 
 

 
 

 
 

Institutional counterparties
 
$
132

 
$

 
$
132

 
$

 
$

 
$
132

Commercial counterparties
 
38,020

 

 
38,020

 

 

 
38,020

Total
 
$
38,152

 
$

 
$
38,152

 
$

 
$

 
$
38,152



Offsetting of Financial Liabilities and Derivative Liabilities
 
 
Gross
Amounts of
 
Gross Amounts
Offset in the
 
Net Amounts
of Liabilities
Presented in the
 
Gross Amounts Not Offset in
the Statements of Condition
 
 
 
 
Recognized
 
Statements of
 
Statements of
 
Financial
 
Cash
 
 
(in thousands)
 
Liabilities
 
Condition
 
Condition
 
Instruments
 
Collateral Pledged
 
Net Amount
June 30, 2016
 
 

 
 

 
 

 
 

 
 

 
 

Interest Rate Swap Agreements:
 
 

 
 

 
 

 
 

 
 

 
 

Institutional counterparties
 
$
(55,528
)
 
$
46

 
$
(55,482
)
 
$
54,832

 
$
650

 
$

Commercial counterparties
 

 

 

 

 

 

Total
 
$
(55,528
)
 
$
46

 
$
(55,482
)
 
$
54,832

 
$
650

 
$


Offsetting of Financial Assets and Derivative Assets
 
 
Gross
Amounts of
 
Gross Amounts
Offset in the
 
Net Amounts
of Assets
Presented in the
 
Gross Amounts Not Offset in
the Statements of Condition
 
 
 
 
Recognized
 
Statements of
 
Statements of
 
Financial
 
Cash
 
 
(in thousands)
 
Assets
 
Condition
 
Condition
 
Instruments
 
Collateral Received
 
Net Amount
December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

Interest Rate Swap Agreements:
 
 

 
 

 
 

 
 

 
 

 
 

Institutional counterparties
 
$
40

 
$

 
$
40

 
$

 
$

 
$
40

Commercial counterparties
 
17,129

 

 
17,129

 

 

 
17,129

Total
 
$
17,169

 
$

 
$
17,169

 
$

 
$

 
$
17,169



Offsetting of Financial Liabilities and Derivative Liabilities
 
 
Gross
Amounts of
 
Gross Amounts
Offset in the
 
Net Amounts
of Liabilities
Presented in the
 
Gross Amounts Not Offset in
the Statements of Condition
 
 
 
 
Recognized
 
Statements of
 
Statements of
 
Financial
 
Cash
 
 
(in thousands)
 
Liabilities
 
Condition
 
Condition
 
Instruments
 
Collateral Pledged
 
Net Amount
December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

Interest Rate Swap Agreements:
 
 

 
 

 
 

 
 

 
 

 
 

Institutional counterparties
 
$
(28,220
)
 
$

 
$
(28,220
)
 
$
18,500

 
$
9,720

 
$

Commercial counterparties
 

 

 

 

 

 

Total
 
$
(28,220
)
 
$

 
$
(28,220
)
 
$
18,500

 
$
9,720

 
$