DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate risk, primarily by managing the amount, source, and duration of our assets and liabilities, and through the use of derivative instruments. Derivative instruments are used to reduce the effects that changes in interest rates may have on net income and cash flows. We also use derivative instruments to facilitate transactions on behalf of our customers.

All derivatives are carried on the consolidated balance sheets at fair value and do not take into account the effects of master netting arrangements we have with other financial institutions. Credit risk is included in the determination of the estimated fair value of derivatives. Derivative assets are reported in the consolidated balance sheets in other assets and derivative liabilities are reported in the consolidated balance sheets in other liabilities. Changes in fair value are recognized in earnings except for certain changes related to derivative instruments designated as part of a cash flow hedging relationship.

The following table presents notional amounts and gross fair values of our derivative assets and derivative liabilities:



	June 30, 2017						December 31, 2016
	Notional		Fair Value				Notional		Fair Value
(in thousands)	Amount		Asset		Liability		Amount		Asset		Liability
Gross Derivatives
Subject to master netting arrangements:
Interest rate contracts – designated	$	705,000	$	862	$	1,194	$	450,000	$	9,256	$	1,171
Interest rate swaps – not designated	2,014,278		472		13,758		1,689,157		12,720		34,046
Equity contracts – not designated	1,180		26		—		1,180		61		—
Total subject to master netting arrangements	2,720,458		1,360		14,952		2,140,337		22,037		35,217
Not subject to master netting arrangements:
Interest rate swaps – not designated	2,014,278		36,762		10,393		1,689,157		32,170		11,866
Interest rate lock commitments – not designated	187,375		5,437		14		—		—		—
Forward delivery commitments – not designated	206,853		574		357		—		—		—
Credit risk contracts – not designated	207,566		26		115		174,538		13		123
Equity contracts – not designated	1,180		—		26		1,180		—		61
Total not subject to master netting arrangements	2,617,252		42,799		10,905		1,864,875		32,183		12,050
Total	$	5,337,710	$	44,159	$	25,857	$	4,005,212	$	54,220	$	47,267

On January 3, 2017, the Chicago Mercantile Exchange (CME) enacted a rule change which in effect results in the legal characterization of variation margin payments for certain derivative contracts as settlement of the derivatives mark-to-market exposure and not collateral. This rule change became effective for us in the first quarter of 2017. Accordingly, we have changed our reporting of certain derivatives to record variation margin on trades cleared through CME as settled where we had previously recorded cash collateral. The daily settlement of the derivative exposure does not change or reset the contractual terms of the instrument.

Derivatives Designated as Hedging Instruments under GAAP

Interest Rate Contracts. We entered into interest rate derivative agreements to modify the interest rate characteristics of certain commercial loans and five of our FHLB advances from variable rate to fixed rate in order to reduce the impact of changes in future cash flows due to market interest rate changes. These agreements are designated as cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows). The effective portion of the derivative’s gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into earnings in the same line item associated with the forecasted transaction when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.

Following is a summary of key data related to interest rate contracts:



(in thousands)	June 30, 2017		December 31, 2016
Notional amount	$	705,000	$	450,000
Fair value included in other assets	862		9,256
Fair value included in other liabilities	1,194		1,171

The following table shows amounts reclassified from accumulated other comprehensive income (AOCI) for the six months ended June 30, 2017:



(in thousands)	Total		Net of Tax
Reclassified from AOCI to interest income	$	900	$	585
Reclassified from AOCI to interest expense	652		424

As of June 30, 2017, the maximum length of time over which forecasted interest cash flows are hedged is 6 years. In the twelve months that follow June 30, 2017, we expect to reclassify from the amount currently reported in AOCI net derivative gains of $4,000 ($3,000 net of tax), in association with interest on the hedged loans and FHLB advances. This amount could differ from amounts actually recognized due to changes in interest rates, hedge de-designations, and the addition of other hedges subsequent to June 30, 2017.

There were no components of derivative gains or losses excluded from the assessment of hedge effectiveness related to these cash flow hedges. For the six months ended June 30, 2017 and 2016, there was no hedge ineffectiveness. Also, during the six months ended June 30, 2017 and 2016, there were no gains or losses from cash flow hedge derivatives reclassified to earnings because it became probable that the original forecasted transactions would not occur.

Derivatives Not Designated as Hedging Instruments under GAAP

Interest Rate Swaps. We enter into interest rate swap agreements to meet the financing, interest rate and equity risk management needs of qualifying commercial loan customers. These agreements provide the customer the ability to convert from variable to fixed interest rates. The credit risk associated with derivatives executed with customers is essentially the same as that involved in extending loans and is subject to normal credit policies and monitoring. Swap derivative transactions with customers are not subject to enforceable master netting arrangements and are generally secured by rights to non-financial collateral, such as real and personal property.

We enter into positions with a derivative counterparty in order to offset our exposure on the fixed components of the customer interest rate swap agreements. We seek to minimize counterparty credit risk by entering into transactions only with high-quality financial dealer institutions. These arrangements meet the definition of derivatives, but are not designated as hedging instruments under ASC 815, Derivatives and Hedging. Substantially all contracts with dealers that require central clearing (generally, transactions since June 10, 2014) are novated to a SEC registered clearing agency who becomes our counterparty.

Following is a summary of key data related to interest rate swaps:



(in thousands)	June 30, 2017		December 31, 2016
Notional amount	$	4,028,556	$	3,378,314
Fair value included in other assets	37,234		44,890
Fair value included in other liabilities	24,151		45,912

The interest rate swap agreement with the loan customer and with the counterparty is reported at fair value in other assets and other liabilities on the consolidated balance sheets with any resulting gain or loss recorded in current period earnings as other income or other expense.

Interest Rate Lock Commitments. Interest rate lock commitments (IRLCs) represent an agreement to extend credit to a mortgage loan borrower, or an agreement to purchase a loan from a third-party originator, whereby the interest rate on the loan is set prior to funding. We are bound to fund the loan at a specified rate, regardless of whether interest rates have changed between the commitment date and the loan funding date, subject to the loan approval process. The borrower is not obligated to perform under the commitment. As such, outstanding IRLCs subject us to interest rate risk and related price risk during the period from the commitment to the borrower through the loan funding date, or commitment expiration. The IRLCs generally range between 30 to 90 days. The IRLCs are reported at fair value in other assets and other liabilities on the consolidated balance sheets with any resulting gain or loss recorded in current period earnings as mortgage banking operations income.

Forward Delivery Commitments. Forward delivery commitments on mortgage-backed securities are used to manage the interest rate and price risk of our IRLCs and mortgage loan held for sale inventory by fixing the forward sale price that will be realized upon sale of the mortgage loans into the secondary market. Historical commitment-to-closing ratios are considered to estimate the quantity of mortgage loans that will fund within the terms of the IRLCs. The forward delivery contracts are reported at fair value in other assets and other liabilities on the consolidated balance sheets with any resulting gain or loss recorded in current period earnings as mortgage banking operations income.

Credit Risk Contracts. We purchase and sell credit protection under risk participation agreements to share with other counterparties some of the credit exposure related to interest rate derivative contracts or to take on credit exposure to generate revenue. We will make/receive payments under these agreements if a customer defaults on our obligation to perform under certain derivative swap contracts.

Risk participation agreements sold with notional amounts totaling $145.4 million as of June 30, 2017 have remaining terms ranging from 5 months to 9 years. Under these agreements, our maximum exposure assuming a customer defaults on their obligation to perform under certain derivative swap contracts with third parties would be $115,000 and $123,000 at June 30, 2017 and December 31, 2016, respectively. The fair values of risk participation agreements purchased and sold were not material at June 30, 2017 and December 31, 2016.

Counterparty Credit Risk

We are party to master netting arrangements with most of our swap derivative counterparties. Collateral, usually marketable securities and/or cash, is exchanged between FNB and our counterparties, and is generally subject to thresholds and transfer minimums. For swap transactions that require central clearing, we post cash to our clearing agency. Collateral positions are valued daily, and adjustments to amounts received and pledged by us are made as appropriate to maintain proper collateralization for these transactions.

Certain master netting agreements contain provisions that, if violated, could cause the counterparties to request immediate settlement or demand full collateralization under the derivative instrument. If we had breached our agreements with our derivative counterparties we would be required to settle our obligations under the agreements at the termination value and would be required to pay an additional $1.3 million and $1.1 million as of June 30, 2017 and December 31, 2016, respectively, in excess of amounts previously posted as collateral with the respective counterparty.

The following table presents information about derivative assets and derivative liabilities that are subject to enforceable master netting arrangements as well as those not subject to enforceable master netting arrangements:



(in thousands)	Gross Amount		Gross Amounts Offset in the Balance Sheet		Net Amount Presented in the Balance Sheet
June 30, 2017
Derivative Assets
Subject to master netting arrangements:
Interest rate contracts
Designated	$	862	$	—	$	862
Not designated	472		—		472
Equity contracts – not designated	26		—		26
Not subject to master netting arrangements:
Interest rate contracts – not designated	36,762		—		36,762
Interest rate lock commitments – not designated	5,437		—		5,437
Forward delivery commitments – not designated	574		—		574
Credit risk contracts – not designated	26		—		26
Total derivative assets	$	44,159	$	—	$	44,159



Derivative Liabilities
Subject to master netting arrangements:
Interest rate contracts
Designated	$	1,194	$	—	$	1,194
Not designated	13,758		—		13,758
Not subject to master netting arrangements:
Interest rate contracts – not designated	10,393		—		10,393
Interest rate lock commitments – not designated	14		—		14
Forward delivery commitments – not designated	357		—		357
Credit risk contracts – not designated	115		—		115
Equity contracts – not designated	26		—		26
Total derivative liabilities	$	25,857	$	—	$	25,857



(in thousands)	Gross Amount		Gross Amounts Offset in the Balance Sheet		Net Amount Presented in the Balance Sheet
December 31, 2016
Derivative Assets
Subject to master netting arrangements:
Interest rate contracts
Designated	$	9,256	$	—	$	9,256
Not designated	12,720		—		12,720
Equity contracts – not designated	61		—		61
Not subject to master netting arrangements:
Interest rate contracts – not designated	32,170		—		32,170
Credit contracts – not designated	13		—		13
Total derivative assets	$	54,220	$	—	$	54,220



Derivative Liabilities
Subject to master netting arrangements:
Interest rate contracts
Designated	$	1,171	$	—	$	1,171
Not designated	34,046		—		34,046
Not subject to master netting arrangements:
Interest rate contracts – not designated	11,866		—		11,866
Credit contracts – not designated	123		—		123
Equity contracts – not designated	61		—		61
Total derivative liabilities	$	47,267	$	—	$	47,267

The following table presents a reconciliation of the net amounts of derivative assets and derivative liabilities presented in the balance sheets to the net amounts that would result in the event of offset:



			Amount Not Offset in the Balance Sheet
(in thousands)	Net Amount Presented in the Balance Sheet		Financial Instruments		Cash Collateral		Net Amount
June 30, 2017
Derivative Assets
Interest rate contracts:
Designated	$	862	$	862	$	—	$	—
Not designated	472		405		—		67
Equity contracts – not designated	26		26		—		—
Total	$	1,360	$	1,293	$	—	$	67



Derivative Liabilities
Interest rate contracts:
Designated	$	1,194	$	1,194	$	—	$	—
Not designated	13,758		12,418		—		1,340
Total	$	14,952	$	13,612	$	—	$	1,340



December 31, 2016
Derivative Assets
Interest rate contracts:
Designated	$	9,256	$	843	$	8,413	$	—
Not designated	12,720		474		12,132		114
Equity contracts – not designated	61		61		—		—
Total	$	22,037	$	1,378	$	20,545	$	114



Derivative Liabilities
Interest rate contracts:
Designated	$	1,171	$	1,171	$	—	$	—
Not designated	34,046		15,490		17,651		905
Total	$	35,217	$	16,661	$	17,651	$	905

The following table presents the effect of certain derivative financial instruments on the income statement:



		Six Months Ended June 30,
(in thousands)	Income Statement Location	2017			2016
Interest Rate Contracts	Interest income - loans and leases	$	900		$	1,368
Interest Rate Contracts	Interest expense – short-term borrowings	652			286
Interest Rate Swaps	Other income	(465		)	(168		)
Credit Risk Contracts	Other income	21			(234		)