Derivatives and Hedging Activities

12 Months Ended

Jun. 30, 2015

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivatives and Hedging Activities

NOTE 10. DERIVATIVES AND HEDGING ACTIVITIES

The Company is exposed to certain risks relating to its ongoing business operations. The primary risk managed by using derivative instruments is interest rate risk. The Company entered into an interest rate swap agreement on August 27, 2010 with a third party to manage interest rate risk associated with a fixed-rate loan.  The interest rate swap agreement effectively converted the loan’s fixed rate into a variable rate. Derivatives and hedging accounting requires that the Company recognize all derivative instruments as either assets or liabilities at fair value in the statement of financial position. In accordance with this guidance, the Company designated the interest rate swap on this fixed-rate loan as a fair value hedge.

The Company was exposed to credit-related losses in the event of nonperformance by the counterparties to this agreement. The Company controlled the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and did not expect any counterparties to fail their obligations. The Company deals only with primary dealers.

If certain hedging criteria specified in derivatives and hedging accounting guidance are met, including testing for hedge effectiveness, hedge accounting may be applied. The hedge effectiveness assessment methodologies for similar hedges are performed in a similar manner and are used consistently throughout the hedging relationships.

The hedge documentation specifies the terms of the hedged item and the interest rate swap. The documentation also indicates that the derivative is hedging a fixed-rate item, that the hedge exposure is to the changes in the fair value of the hedged item, and that the strategy is to eliminate fair value variability by converting fixed-rate interest payments to variable-rate interest payments.

For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings. The Company includes the gain or loss on the hedged items in the same line item—noninterest income—as the offsetting loss or gain on the related interest rate swap.

The hedged fixed rate loan had an original maturity of 20 years and was not callable.  This loan was hedged with a “pay fixed rate, receive variable rate” swap with a similar notional amount, maturity, and fixed rate coupons. The swap is not callable. At December 31, 2014, the loan had an outstanding principal balance of $10,641,000 and the interest rate swap had a notional value of $10,673,000.

At December 31, 2014, the interest rate swap on the fixed-rate loan was ineffective.  The Bank recorded a loss of $317,000 in noninterest income during the quarter ended December 31, 2014 related to the ineffectiveness.  The interest rate swap was terminated during the quarter ended March 31, 2015.  The Bank recorded a loss of $93,000 in noninterest income during the quarter ended March 31, 2015 related to the swap termination.  The loan fair value adjustment of $138,000 at March 31, 2015 will be amortized over the remaining life of the loan which matures September 1, 2030.

Effect of Derivative Instruments on Statement of Financial Condition

Fair Value of Derivative Instruments

Asset Derivatives

Liabilities Derivatives

June 30, 2015

December 31, 2014

June 30, 2015

December 31, 2014

Balance

Balance

Balance

Balance

Sheet

Fair

Sheet

Fair

Sheet

Fair

Sheet

Fair

Location

Value

Location

Value

Location

Value

Location

Value

(In Thousands)

Derivatives designated

as hedging instruments

under ASC 815

Other

Interest rate contracts

n/a

$

-

n/a

$

-

n/a

$

-

Liabilities

$

579

Change in fair value of

financial instrument being

hedged under ASC 815

Interest rate contracts

Loans

$

137

Loans

$

138

n/a

$

-

n/a

$

-

Effect of Derivative Instruments on Statement of Income

For the Three Months Ended June 30, 2015 and 2014

(In Thousands)

Amount of

Location of

Gain or (Loss)

Derivatives Designated

Gain or (Loss)

Recognized in

as Hedging Instruments

Recognized in

Income on Derivative

Under ASC 815

Income on Derivative

2015

2014

Interest rate contracts

Noninterest income

$

-

$

(62

)

Effect of Derivative Instruments on Statement of Income

For the Six Months Ended June 30, 2015 and 2014

(In Thousands)

Amount of

Location of

Gain or (Loss)

Derivatives Designated

Gain or (Loss)

Recognized in

as Hedging Instruments

Recognized in

Income on Derivative

Under ASC 815

Income on Derivative

2015

2014

Interest rate contracts

Noninterest income

$

(93

)

$

(134

)

Derivative loan commitments – Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held-for-sale upon funding. The Company enters into commitments to fund residential mortgage loans at specified times in the future, with the intention that these loans will subsequently be sold in the secondary market. A mortgage loan commitment binds the Company to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 60 days after inception of the rate lock.

Outstanding derivative loan commitments expose the Company to the risk that the price of the loans arising from exercise of the loan commitment might decline from inception of the rate lock to funding of the loan due to increases in mortgage interest rates.  If interest rates increase, the value of these loan commitments decreases. Conversely, if interest rates decrease, the value of these loan commitments increases.  The notional amount of interest rate lock commitments was $17,165,000 and $12,276,000 at June 30, 2015 and December 31, 2014, respectively.

The Company has no other off-balance-sheet arrangements or transactions with unconsolidated, special purpose entities that would expose the Company to liability that is not reflected on the face of the financial statements.