DERIVATIVE INSTRUMENTS

The Corporation is exposed to certain risks arising from both its business operations and economic conditions. The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate risk, primarily by managing the amount, source, and duration of its assets and liabilities, and through the use of derivative instruments. Interest rate swaps are the primary derivative instrument used by the Corporation for interest rate management. The Corporation also uses derivative instruments to facilitate transactions on behalf of its customers.

Commercial Borrower Derivatives

The Corporation enters 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 Corporation then enters into positions with a derivative counterparty in order to offset its exposure on the fixed components of the customer agreements. 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. The Corporation seeks to minimize counterparty credit risk by entering into transactions with only high-quality institutions. These arrangements meet the definition of derivatives, but are not designated as hedging instruments under ASC 815, Derivatives and Hedging. 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 sheet with any resulting gain or loss recorded in current period earnings as other income.

Risk Management Derivatives

The Corporation entered into four separate interest rate derivative agreements between December 2012 and August 2013 in order to manage its net interest income by increasing the stability of the net interest income over a range of potential interest rate scenarios. Interest rate swaps are also used to modify the interest rate characteristics of designated commercial loans from variable to fixed in order to reduce the impact of changes in future cash flows due to 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. Gains and losses from hedge ineffectiveness recognized in the consolidated statement of comprehensive income were not material for the three- and six- month periods ended September 30, 2013.

In accordance with the requirements of ASU No. 2011-04, the Corporation made an accounting policy election to use the portfolio exception with respect to measuring derivative instruments, consistent with the guidance in ASC 820. The Corporation further documents that it meets the criteria for this exception as follows:

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The Corporation manages credit risk for its derivative positions on a counterparty-by-counterparty basis, consistent with its risk management strategy for such transactions. The Corporation manages credit risk by considering indicators of risk such as credit ratings, and by negotiating terms in its master netting arrangements and credit support annex documentation with each individual counterparty. Review of credit risk plays a central role in the decision of which counterparties to consider for such relationships and when deciding with whom it will enter into derivative transactions.

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Since the effective date of ASC 820, the Corporation’s management has monitored and measured credit risk and calculated credit valuation adjustments (CVAs) for its derivative transactions on a counterparty-by-counterparty basis. Management receives reports from an independent third-party valuation specialist on a monthly basis to assist in determining CVAs by counterparty for purposes of reviewing and managing its credit risk exposures. Since the portfolio exception applies only to the fair value measurement and not to the financial statement presentation, the portfolio-level adjustments are then allocated in a reasonable and consistent manner each period to the individual assets or liabilities that make up the counterparty derivative portfolio, in accordance with the Corporation’s accounting policy elections.

The Corporation notes that key market participants take into account the existence of such arrangements that mitigate credit risk exposure in the event of default. As such, the Corporation formally elects to apply the portfolio exception in ASC 820 with respect to measuring counterparty credit risk for all of its derivative transactions subject to master netting arrangements.

At September 30, 2013, the Corporation was party to 300 swaps with customers with notional amounts totaling $801,609 and 266 swaps with derivative counterparties with notional amounts totaling $1,001,609.

Derivative assets are classified in the balance sheet under “other assets” and derivative liabilities are classified in the balance sheet under “other liabilities.” The following tables present information about derivative assets and derivative liabilities that are subject to enforceable master netting agreements as well as those not subject to enforceable master netting arrangements:


	Gross Amount		Gross Amounts Offset in the Balance Sheet		Net Amount Presented in the Balance Sheet
Offsetting of Derivative Assets:
September 30, 2013
Derivative assets subject to master netting arrangement:
Interest rate contracts	$	2,225		—	$	2,225
Equity contracts		18		—		18

Derivative assets not subject to master netting arrangement:
Interest rate contracts		35,799		—		35,799

Total derivative assets	$	38,042		—	$	38,042


December 31, 2012
Derivative assets subject to master netting arrangement:
Equity contracts	$	16		—	$	16

Derivative assets not subject to master netting arrangement:
Interest rate contracts		57,992		—		57,992

Total derivative assets	$	58,008		—	$	58,008


Offsetting of Derivative Liabilities:
September 30, 2013
Derivative liabilities subject to master netting arrangement:
Interest rate contracts	$	43,045		—	$	43,045

Derivative liabilities not subject to master netting arrangement:
Interest rate contracts		1,409		—		1,409
Equity contracts		18		—		18

Total derivative liabilities	$	44,472		—	$	44,472


December 31, 2012
Derivative liabilities subject to master netting arrangement:
Interest rate contracts	$	58,134		—	$	58,134

Derivative liabilities not subject to master netting arrangement:
Equity contracts		16		—		16

Total derivative liabilities	$	58,150		—	$	58,150

The following tables present a reconciliation of the net amounts of derivative assets and derivative liabilities presented in the balance sheet to the net amounts that would result in the event of offset:


			Gross Amounts Not Offset in the Balance Sheet
	Net Amount Presented in the Balance Sheet		Financial Instruments		Cash Collateral Received		Net Amount
Derivative Assets:
September 30, 2013
Counterparty B	$	2	$	2	$	—	$	—
Counterparty D		205		205		—		—
Counterparty E		936		936		—		—
Counterparty F		205		205		—		—
Counterparty G		112		112		—		—
Counterparty I		386		386		—		—
Counterparty J		397		—		397		—

	$	2,243	$	1,846	$	397		—


December 31, 2012
Counterparty E	$	16		—		—	$	16


Derivative Liabilities:
September 30, 2013
Counterparty A	$	5,528	$	5,528	$	—	$	—
Counterparty B		3,714		3,612		—		102
Counterparty C		1,589		1,589		—		—
Counterparty D		10,131		10,131		—		—
Counterparty E		6,069		6,069		—		—
Counterparty F		25		25		—		—
Counterparty G		5,213		5,213		—		—
Counterparty H		2,634		125		—		2,509
Counterparty I		6,629		6,629		—		—
Counterparty J		1,513		—		1,513		—

	$	43,045	$	38,921	$	1,513	$	2,611


December 31, 2012
Counterparty A	$	8,393	$	8,393		—	$	—
Counterparty B		5,601		5,601		—		—
Counterparty C		2,145		2,145		—		—
Counterparty D		12,354		12,354		—		—
Counterparty E		8,846		8,846		—		—
Counterparty F		353		282		—		71
Counterparty G		5,497		5,497		—		—
Counterparty H		3,937		1,775		—		2,162
Counterparty I		11,008		11,008		—		—

	$	58,134	$	55,901		—	$	2,233

The following table presents the effect of the Corporation’s derivative financial instruments on the income statement:

Income

Nine Months Ended

Statement

September 30,

Location

2013

2012

Interest Rate Products

Other income

The Corporation has agreements with each of its derivative counterparties that contain a provision where if the Corporation defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Corporation could also be declared in default on its derivative obligations. The Corporation also has agreements with certain of its derivative counterparties that contain a provision that if the Corporation fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Corporation would be required to settle its obligations under the agreements. Certain of the Corporation’s agreements with its derivative counterparties contain provisions where if a material or adverse change occurs that materially changes the Corporation’s creditworthiness in an adverse manner, the Corporation may be required to fully collateralize its obligations under the derivative instrument.

Interest rate swap agreements generally require posting of collateral by either party under certain conditions. As of September 30, 2013, the fair value of counterparty derivatives in a net liability position, which includes accrued interest but excludes any adjustment for non-performance risk related to these agreements, was $42,093. At September 30, 2013, the Corporation has posted collateral with derivative counterparties with a fair value of $39,493 and cash collateral of $1,699. Additionally, if the Corporation had breached its agreements with its derivative counterparties it would be required to settle its obligations under the agreements at the termination value and would be required to pay an additional $3,014 in excess of amounts previously posted as collateral with the respective counterparty.

The Corporation has entered into interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans to secondary market investors. These arrangements are considered derivative instruments. The fair values of the Corporation’s rate lock commitments to customers and commitments with investors at September 30, 2013 are not material.