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Derivative Financial Instruments
6 Months Ended
Jun. 30, 2022
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments

9. DERIVATIVE FINANCIAL INSTRUMENTS

 

The Bank is exposed to certain risks relating to its ongoing business operations and utilizes interest rate swap agreements (“swaps”) as part of its asset/liability management strategy to help manage its interest rate risk position. As of June 30, 2022, the Bank has entered into 129 interest-rate swap agreements with customers with a notional amount totaling $443.5 million. The Bank then entered into identical offsetting swaps with a counterparties. The swap agreements are not designated as hedging instruments. The purpose of entering into offsetting derivatives not designated as a hedging instrument is to provide the Bank a variable-rate loan receivable and to provide the customer the financial effects of a fixed-rate loan without creating significant volatility in the Bank’s earnings.

 

The structure of the swaps is as follows. The Bank enters into an interest rate swap with its customers in which the Bank pays the customer a variable rate and the customer pays the Bank a fixed rate, therefore allowing customers to convert variable rate loans to fixed rate loans. At the same time, the Bank enters into a swap with the counterparty bank in which the Bank pays the counterparty a fixed rate and the counterparty in return pays the Bank a variable rate. The net effect of the transaction allows the Bank to receive interest on the loan from the customer at a variable rate based on LIBOR, plus a spread. The changes in the fair value of the swaps primarily offset each other and therefore should not have a significant impact on the Company’s results of operations, although the Company does incur credit and counterparty risk with respect to performance on the swap agreements by the Bank’s customer and counterparty, respectively. As a result of the Bank exceeding $10 billion in assets, federal regulations required the Bank, beginning in January 2019, to clear most interest rate swaps through a clearing house (“centrally cleared”). These instruments contain language outlining collateral pledging requirements for each counterparty, in which collateral must be posted if market value exceeds certain agreed upon threshold limits. Cash or securities are pledged as collateral. Our interest rate swap derivatives are subject to a master netting arrangement with our counterparties. None of our derivative assets and liabilities are offset in the Company’s condensed consolidated balance sheet.

 

We believe our risk of loss associated with our counterparty borrowers related to interest rate swaps is mitigated as the loans with swaps are underwritten to take into account potential additional exposure, although there can be no assurances in this regard since the performance of our swaps is subject to market and counterparty risk.

 

Balance Sheet Classification of Derivative Financial Instruments

 

As of June 30, 2022 and December 31, 2021, the total notional amount of the Company’s swaps was $443.5 million, and $493.2 million, respectively. The location of the asset and liability, and their respective fair values, are summarized in the tables below.

 

 

 

June 30, 2022

 

 

 

Asset Derivatives

 

 

Liability Derivatives

 

 

 

Balance Sheet Location

 

Fair Value

 

 

Balance Sheet Location

 

Fair Value

 

 

 

(Dollars in thousands)

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Other assets

 

$

582

 

 

Other liabilities

 

$

582

 

Total derivatives

 

 

 

$

582

 

 

 

 

$

582

 

 

 

 

 

December 31, 2021

 

 

 

Asset Derivatives

 

 

Liability Derivatives

 

 

 

Balance Sheet Location

 

Fair Value

 

 

Balance Sheet Location

 

Fair Value

 

 

 

(Dollars in thousands)

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Other assets

 

$

14,163

 

 

Other liabilities

 

$

14,163

 

Total derivatives

 

 

 

$

14,163

 

 

 

 

$

14,163

 

 

The Effect of Derivative Financial Instruments on the Condensed Consolidated Statements of Earnings

 

The following table summarizes the effect of derivative financial instruments on the condensed consolidated statements of earnings for the periods presented.

 

Derivatives Not Designated
as Hedging Instruments

 

Location of Gain Recognized in
Income on Derivative Instruments

 

Amount of Gain Recognized in
Income on Derivative Instruments

 

 

 

 

 

Three Months Ended
June 30,

 

 

Six Months Ended
June 30,

 

 

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

 

 

 

 

(Dollars in thousands)

 

Interest rate swaps

 

Other income

 

$

-

 

 

$

-

 

 

$

-

 

 

$

215

 

Total

 

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

215