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 which are not offset in the Balance Sheet.

TABLE 9.1



	September 30, 2018						December 31, 2017
	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	$	855,000	$	—	$	4,760	$	705,000	$	228	$	1,982
Interest rate swaps – not designated	2,674,906		5,353		6,147		2,245,442		1,169		11,599
Equity contracts – not designated	1,180		23		—		1,180		51		—
Total subject to master netting arrangements	3,531,086		5,376		10,907		2,951,622		1,448		13,581
Not subject to master netting arrangements:
Interest rate swaps – not designated	2,674,906		12,214		64,006		2,245,442		27,233		15,303
Interest rate lock commitments – not designated	67,079		772		21		88,107		1,594		5
Forward delivery commitments – not designated	90,861		362		33		106,572		233		148
Credit risk contracts – not designated	201,781		23		51		235,196		39		109
Equity contracts – not designated	1,180		—		23		1,180		—		51
Total not subject to master netting arrangements	3,035,807		13,371		64,134		2,676,497		29,099		15,616
Total	$	6,566,893	$	18,747	$	75,041	$	5,628,119	$	30,547	$	29,197

Beginning in the first quarter of 2017, certain derivative exchanges have 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 exchanges that have adopted the rule change 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 seven 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. Any ineffective portion of the gain or loss is reported in earnings immediately.

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

TABLE 9.2



(in thousands)	September 30, 2018		December 31, 2017
Notional amount	$	855,000	$	705,000
Fair value included in other assets	—		228
Fair value included in other liabilities	4,760		1,982

The following table shows amounts reclassified from accumulated other comprehensive income for the nine months ended September 30, 2018:

TABLE 9.3



(in thousands)	Total			Net of Tax
Reclassified from AOCI to interest income	$	(130	)	$	(103	)
Reclassified from AOCI to interest expense	(1,693		)	(1,337		)

As of September 30, 2018, the maximum length of time over which forecasted interest cash flows are hedged is 5 years. In the twelve months that follow September 30, 2018, we expect to reclassify from the amount currently reported in AOCI net derivative gains of $4.1 million ($3.2 million 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 September 30, 2018.

There were no components of derivative gains or losses excluded from the assessment of hedge effectiveness related to these cash flow hedges. For the nine months ended September 30, 2018 and 2017, there was no hedge ineffectiveness. Also, during the nine months ended September 30, 2018 and 2017, 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

A description of interest rate swaps, interest rate lock commitments, forward delivery commitments and credit risk contracts can be found in Note 14 "Derivative Instruments and Hedging Activities" in the Consolidated Financial Statements of the Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on February 28, 2018.

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

TABLE 9.4



(in thousands)	September 30, 2018		December 31, 2017
Notional amount	$	5,349,812	$	4,490,884
Fair value included in other assets	17,567		28,402
Fair value included in other liabilities	70,153		26,902

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.

Risk participation agreements sold with notional amounts totaling $121.7 million as of September 30, 2018 have remaining terms ranging from two months to nine 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 $0.1 million at September 30, 2018 and $0.1 million at December 31, 2017. The fair values of risk participation agreements purchased and sold were $0.02 million and $(0.05) million, respectively, at September 30, 2018 and $0.04 million and $(0.1) million, respectively at December 31, 2017.

Counterparty Credit Risk

We are party to master netting arrangements with most of our swap derivative dealer 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 settled or 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 $0.4 million and $0.9 million as of September 30, 2018 and December 31, 2017, respectively, in excess of amounts previously posted as collateral with the respective counterparty.

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:

TABLE 9.5



			Amount Not Offset in the Balance Sheet
(in thousands)	Net Amount Presented in the Balance Sheet		Financial Instruments		Cash Collateral		Net Amount
September 30, 2018
Derivative Assets
Interest rate contracts:
Designated	$	—	$	—	$	—	$	—
Not designated	5,353		5,279		—		74
Equity contracts – not designated	23		23		—		—
Total	$	5,376	$	5,302	$	—	$	74



Derivative Liabilities
Interest rate contracts:
Designated	$	4,760	$	4,760	$	—	$	—
Not designated	6,147		5,840		—		307
Total	$	10,907	$	10,600	$	—	$	307



December 31, 2017
Derivative Assets
Interest rate contracts:
Designated	$	228	$	228	$	—	$	—
Not designated	1,169		1,169		—		—
Equity contracts – not designated	51		51		—		—
Total	$	1,448	$	1,448	$	—	$	—



Derivative Liabilities
Interest rate contracts:
Designated	$	1,982	$	1,982	$	—	$	—
Not designated	11,599		10,940		—		659
Total	$	13,581	$	12,922	$	—	$	659

The following table presents the effect of certain derivative financial instruments on the Income Statement:

TABLE 9.6



		Nine Months Ended September 30,
(in thousands)	Income Statement Location	2018			2017
Interest Rate Contracts	Interest income - loans and leases	$	(130	)	$	1,185
Interest Rate Contracts	Interest expense – short-term borrowings	(1,693		)	1,059
Interest Rate Swaps	Other income	956			(592		)
Credit Risk Contracts	Other income	42			(1		)