Derivatives

9 Months Ended

Sep. 30, 2021

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivatives

NOTE 5 - DERIVATIVES

The Bank regularly enters into commitments to originate and sell loans held for sale. The Bank has established a hedging strategy to protect itself against the risk of loss associated with interest rate movements on loan commitments. The Bank enters into contracts to sell forward To-Be-Announced (“TBA”) mortgage-backed securities. These commitments and contracts are considered derivatives but have not been designated as hedging instruments for reporting purposes under U.S. GAAP. Rather, they are accounted for as free-standing derivatives, or economic hedges, with changes in the fair value of the derivatives reported in noninterest income or noninterest expense. The Bank recognizes all derivative instruments as either other assets or other liabilities on the Consolidated Balance Sheets and measures those instruments at fair value.

Derivative instruments not related to mortgage banking activities primarily relate to interest rate swap agreements. The Bank's objectives in using certain interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Bank uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Bank making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The Bank has entered into interest rate swaps to reduce the exposure to variability in interest-related cash outflows attributable to changes in forecasted LIBOR-based borrowings and brokered deposits. These derivative instruments are designated as cash flow hedges. The hedged item is the LIBOR portion of the series of future adjustable-rate borrowings and deposits over the term of the interest rate swap. Accordingly, changes to the amount of interest payment cash flows for the hedged transactions attributable to a change in credit risk are excluded from management’s assessment of hedge effectiveness. The Bank tests for hedging effectiveness on a quarterly basis. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The Bank has not recorded any hedge ineffectiveness since inception.  The Bank has master netting agreements with derivative dealers with which it does business, but reflects gross assets and liabilities as other assets and other liabilities, respectively, on the Consolidated Balance Sheets.

The net unrealized loss on cash flow hedges recorded in accumulated other comprehensive income was $34,000 and $967,000, net of tax, at September 30, 2021 and December 31, 2020, respectively.  The Bank reclassified realized losses of $135,000 and $98,000 from accumulated other comprehensive income to interest expense related to these cash flow hedges for the three months ended September 30, 2021 and September 30, 2020, respectively, and realized losses of $373,000 and $84,000 for the nine months ended September 30, 2021 and September 30, 2020, respectively.  The Bank expects that approximately $468,000 will be reclassified from accumulated other comprehensive income as an increase to interest expense over the next twelve months related to these cash flow hedges.

The following tables summarize the Bank’s derivative instruments at the dates indicated:

	September 30, 2021
			Fair Value
Cash flow hedges:	Notional		Asset		Liability
Interest rate swaps	$	90,000	$	527	$	571
Non-hedging derivatives:
Fallout adjusted interest rate lock commitments with customers		90,277		1,171		—
Mandatory and best effort forward commitments with investors		50,658		558		—
Forward TBA mortgage-backed securities		147,000		587		—

	December 31, 2020
			Fair Value
Cash flow hedges:	Notional		Asset		Liability
Interest rate swaps	$	90,000	$	21	$	1,252
Non-hedging derivatives:
Fallout adjusted interest rate lock commitments with customers		136,739		4,024		—
Mandatory and best effort forward commitments with investors		25,027		—		67
Forward TBA mortgage-backed securities		232,000		—		1,602

At September 30, 2021 and December 31, 2020, the Bank had $147.0 million and $232.0 million of TBA trades with counterparties that held margin collateral of $1.1 million and $3.3 million, respectively.  At September 30, 2021, the Bank had pledged two securities with a carrying value of $3.4 million to secure interest rate swaps designated as cash flow hedges.

Changes in the fair value of the non-hedging derivatives recognized in noninterest income on the Consolidated Statements of Income and included in gain on sale of loans resulted in a net loss of $402,000 and a net gain of $2.8 million for the three months ended September 30, 2021 and 2020, respectively, and a net loss of $4.3 million and net gain of $8.8 million for the nine months ended September 30, 2021 and 2020, respectively.