Derivative Instruments

9 Months Ended

Sep. 30, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Note 8. Derivative Instruments

Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship.

Non-hedge derivatives

For derivatives not designated as hedges, the gain or loss is recognized in current period earnings. Pinnacle Financial enters into interest rate swaps (swaps) to facilitate customer transactions and meet their financing needs. Upon entering into these instruments to

meet customer needs, Pinnacle Financial enters into offsetting positions in order to minimize the risk to Pinnacle Financial. These swaps qualify as derivatives, but are not designated as hedging instruments. The income statement impact of the offsetting positions is limited to changes in the reserve for counterparty credit risk. A summary of Pinnacle Financial's interest rate swaps to facilitate customers' transactions as of September 30, 2019 and December 31, 2018 is included in the following table (in thousands):



		September 30, 2019					December 31, 2018
	Balance Sheet Location	Notional Amount		Estimated Fair Value			Notional Amount		Estimated Fair Value
Interest rate swap agreements:
Assets	Other assets	$	1,269,880	$	56,846		$	1,059,724	$	22,273
Liabilities	Other liabilities	1,269,880		(57,120		)	1,059,724		(22,401		)
Total		$	2,539,760	$	(274	)	$	2,119,448	$	(128	)

The effects of Pinnacle Financial's interest rate swaps to facilitate customers' transactions on the income statement during the three and nine months ended September 30, 2019 and 2018 were as follows (in thousands):



		Amount of Loss Recognized in Income
	Location of Loss Recognized in Income	Three Months Ended September 30,						Nine Months Ended September 30,
	Location of Loss Recognized in Income	2019			2018			2019			2018
Interest rate swap agreements	Other noninterest income	$	(44	)	$	(8	)	$	(146	)	$	(42	)

Derivatives designated as cash flow hedges

For derivative instruments that are designated and qualify as a cash flow hedge, the aggregate fair value of the derivative instrument is recorded in other assets or other liabilities with any gain or loss related to changes in fair value recorded in accumulated other comprehensive income, net of tax. The gain or loss is reclassified into earnings in the same period during which the hedged asset or liability affects earnings and is presented in the same income statement line item as the earnings effect of the hedged asset or liability. Pinnacle Financial uses forward cash flow hedges in an effort to manage future interest rate exposure on borrowings. The hedging strategy converts the LIBOR-based variable interest rate on forecasted borrowings to a fixed interest rate and is used in an effort to protect Pinnacle Financial from floating interest rate variability. During the second quarter of 2019, Pinnacle Financial purchased an interest rate floor to mitigate the impact of declining interest rates on LIBOR-based variable rate loans. A summary of Pinnacle Financial's cash flow hedge relationships as of September 30, 2019 and December 31, 2018 are as follows (in thousands):



					September 30, 2019					December 31, 2018
	Balance Sheet Location	Weighted Average Remaining Maturity (In Years)	Weighted Average Pay Rate	Receive Rate	Notional Amount		Estimated Fair Value			Notional Amount		Estimated Fair Value
Asset derivatives
Interest rate floor	Other assets	2.09	—%	2.75% minus 1 month LIBOR	$	1,300,000	$	35,681		$	—	$	—
Liability derivatives
Interest rate swaps	Other liabilities	2.60	3.09%	3 month LIBOR	$	99,000	$	(3,886	)	$	99,000	$	(1,757	)

The effects of Pinnacle Financial's cash flow hedge relationships on the statement of comprehensive income (loss) during the three and nine months ended September 30, 2019 and 2018 were as follows, net of tax (in thousands):



	Amount of Gain (Loss) Recognized in Other Comprehensive Income (Loss)
	Three Months Ended September 30,					Nine Months Ended September 30,
Asset derivatives	2019			2018		2019			2018
Interest rate floor - loans	$	1,951		$	—	$	9,875		$	—
Liability derivatives
Interest rate swaps - borrowings	$	(69	)	$	783	$	(1,572	)	$	3,453
	$	1,882		$	783	$	8,303		$	3,453

The cash flow hedges were determined to be highly effective during the periods presented and as a result qualify for hedge accounting treatment. The hedge would no longer be considered effective if a portion of the hedge becomes ineffective, the item

hedged is no longer in existence or Pinnacle Financial discontinues hedge accounting. Pinnacle Financial expects the hedges to continue to be highly effective and qualify for hedge accounting during the remaining terms of the swaps. Losses totaling $1.1 million and $946,000 net of tax, respectively, were reclassified from accumulated other comprehensive income (loss) into net income during the three and nine months ended September 30, 2019 compared to gains of $145,000 and $429,000 net of tax, respectively, for the three and nine months ended September 30, 2018. Approximately $908,000 in unrealized gains, net of tax, are expected to be reclassified from accumulated other comprehensive income (loss) into net income over the next twelve months related to previously terminated cash flow hedges.

Derivatives designated as fair value hedges

For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged asset or liability attributable to the hedged risk are recognized in current earnings. The gain or loss on the derivative instrument is presented on the same income statement line item as the earnings effect of the hedged item. Pinnacle Financial utilizes interest rate swaps designated as fair value hedges to mitigate the effect of changing interest rates on the fair values of fixed rate callable securities available-for-sale and fixed rate prepayable loans. The hedging strategy on securities converts the fixed interest rates to LIBOR-based variable interest rates. These derivatives are designated as partial term hedges of selected cash flows covering specified periods of time prior to the call dates of the hedged securities.

A summary of Pinnacle Financial's fair value hedge relationships as of September 30, 2019 and December 31, 2018 are as follows (in thousands):



					September 30, 2019					December 31, 2018
	Balance Sheet Location	Weighted Average Remaining Maturity (In Years)	Weighted Average Pay Rate	Receive Rate	Notional Amount		Estimated Fair Value			Notional Amount		Estimated Fair Value
Liability derivatives
Interest rate swap agreements - securities	Other liabilities	7.29	3.08%	3 month LIBOR	$	477,905	$	(51,927	)	$	477,905	$	(14,796	)
Interest rate swap agreements - loans	Other liabilities	—	—	—	—		—			900,000		(7,037		)
		7.29	3.08%		$	477,905	$	(51,927	)	$	1,377,905	$	(21,833	)

The effects of Pinnacle Financial's fair value hedge relationships on the income statement during the three and nine months ended September 30, 2019 and 2018 were as follows (in thousands):



	Location of Gain (Loss) on Derivative	Amount of Gain (Loss) Recognized in Income
		Three Months Ended September 30,					Nine Months Ended September 30,
Liability derivatives		2019			2018		2019			2018
Interest rate swaps - securities	Interest income on securities	$	(10,888	)	$	1,755	$	(37,131	)	$	1,991
Interest rate swaps - loans	Interest income on loans	$	—		$	2,236	$	(6,915	)	$	3,358



	Location of Gain (Loss) on Hedged Item
		Three Months Ended September 30,					Nine Months Ended September 30,
Liability derivatives - hedged items		2019		2018			2019		2018
Interest rate swaps - securities	Interest income on securities	$	10,888	$	(1,755	)	$	37,131	$	(1,991	)
Interest rate swaps - loans	Interest income on loans	$	—	$	(2,236	)	$	6,915	$	(3,358	)

The following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges at September 30, 2019 and December 31, 2018 (in thousands):



	Carrying Amount of the Hedged Assets				Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Assets
	September 30, 2019		December 31, 2018		September 30, 2019		December 31, 2018
Line item on the balance sheet
Securities available-for-sale	$	512,035	$	515,063	$	51,927	$	14,796
Loans ⁽¹⁾	$	—	$	907,037	$	—	$	7,037


(1)	The carrying amount as shown represents the designated last-of-layer. At December 31, 2018, the total amortized cost basis of the closed portfolio of loans designated in these hedging relationships was $2.7 billion.

During the second quarter of 2019, a fair value hedging relationship on loans was unwound resulting in a swap termination payment to the counterparty of approximately $14.0 million. The corresponding loan fair value hedging adjustment of $14.0 million as of the date of termination is being amortized over the remaining lives of the designated loans. During the three and nine months ended September 30, 2019, amortization expense totaling $931,000 and $1.4 million, respectively, was recognized as a reduction to interest income on loans.