9.	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:


	March 31, 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	$	655,000	$	603	$	1,494	$	450,000	$	9,256	$	1,171
Interest rate swaps – not designated		1,825,706		792		13,966		1,689,157		12,720		34,046
Equity contracts – not designated		1,180		46		—		1,180		61		—

Total subject to master netting arrangements		2,481,886		1,441		15,460		2,140,337		22,037		35,217


Not subject to master netting arrangements:
Interest rate swaps – not designated		1,825,706		30,263		13,820		1,689,157		32,170		11,866
Interest rate lock commitments – not designated		76,087		1,252		26		—		—		—
Forward delivery commitments – not designated		85,065		20		376		—		—		—
Credit risk contracts – not designated		186,037		15		106		174,538		13		123
Equity contracts – not designated		1,180		—		46		1,180		—		61

Total not subject to master netting arrangements		2,174,075		31,550		14,374		1,864,875		32,183		12,050

Total	$	4,655,961	$	32,991	$	29,834	$	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)	March 31, 2017		December 31, 2016
Notional amount	$	655,000	$	450,000
Fair value included in other assets		603		9,256
Fair value included in other liabilities		1,494		1,171

The following table shows amounts reclassified from accumulated other comprehensive income (AOCI) for the three months ended March 31, 2017:


(in thousands)	Total		Net of Tax
Reclassified from AOCI to interest income	$	506	$	329
Reclassified from AOCI to interest expense		148		96

As of March 31, 2017, the maximum length of time over which forecasted interest cash flows are hedged is six years. In the twelve months that follow March 31, 2017, we expect to reclassify from the amount currently reported in AOCI net derivative gains of $128,000 ($82,000 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 March 31, 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 three months ended March 31, 2017 and 2016, there was no hedge ineffectiveness. Also, during the three months ended March 31, 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)	March 31, 2017		December 31, 2016
Notional amount	$	3,651,412	$	3,378,314
Fair value included in other assets		31,055		44,890
Fair value included in other liabilities		27,786		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 $133.9 million as of March 31, 2017 have remaining terms ranging from eight months to thirteen 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 $105,000 and $123,000 at March 31, 2017 and December 31, 2016, respectively. The fair values of risk participation agreements purchased and sold were not material at March 31, 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 $0.8 million and $1.1 million as of March 31, 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
March 31, 2017
Derivative Assets
Subject to master netting arrangements:
Interest rate contracts
Designated	$	603		—	$	603
Not designated		792		—		792
Equity contracts – not designated		46		—		46

Not subject to master netting arrangements:
Interest rate contracts – not designated		30,263		—		30,263
Interest rate lock commitments – not designated		1,252		—		1,252
Forward delivery commitments – not designated		20		—		20
Credit risk contracts – not designated		15		—		15

Total derivative assets	$	32,991		—	$	32,991


Derivative Liabilities
Subject to master netting arrangements:
Interest rate contracts
Designated	$	1,494		—	$	1,494
Not designated		13,966		—		13,966

Not subject to master netting arrangements:
Interest rate contracts – not designated		13,820		—		13,820
Interest rate lock commitments – not designated		26		—		26
Forward delivery commitments – not designated		376		—		376
Credit risk contracts – not designated		106		—		106
Equity contracts – not designated		46		—		46

Total derivative liabilities	$	29,834		—	$	29,834


(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
March 31, 2017
Derivative Assets
Interest rate contracts:
Designated	$	603	$	603		—	$	—
Not designated		792		680		—		112
Equity contracts – not designated		46		46		—		—

Total	$	1,441	$	1,329		—	$	112


Derivative Liabilities
Interest rate contracts:
Designated	$	1,494	$	1,494		—	$	—
Not designated		13,966		13,208		—		758

Total	$	15,460	$	14,702		—	$	758


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:


		Three Months Ended
		March 31,
(in thousands)	Income Statement Location	2017			2016
Interest Rate Contracts	Interest income - loans and leases	$	506		$	687
Interest Rate Contracts	Interest expense – short-term borrowings		148			150
Interest Rate Swaps	Other income		(219	)		(41	)
Credit Risk Contracts	Other income		19			(71	)