The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage the Corporation’s exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, equity commitments to affordable housing partnerships, interest rate swap agreements and commitments to originate and commitments to sell fixed rate mortgage loans. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Corporation’s Consolidated Balance Sheets. The contract or notional amounts of these instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation’s credit policies with respect to interest rate swap agreements with commercial borrowers, commitments to extend credit, and financial guarantees are similar to those used for loans. The interest rate swaps with other counterparties are generally subject to bilateral collateralization terms. The contractual and notional amounts of financial instruments with off-balance sheet risk are as follows:

(Dollars in thousands)	June 30, 2011		Dec. 31, 2010
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit:
Commercial loans	$	173,086	$	176,436
Home equity lines		180,386		182,260
Other loans		26,802		23,971
Standby letters of credit		9,228		9,510
Equity commitments to affordable housing partnerships		156		449
Financial instruments whose notional amounts exceed the amount of credit risk:
Forward loan commitments:
Commitments to originate fixed rate mortgage loans to be sold		17,637		10,893
Commitments to sell fixed rate mortgage loans		26,444		24,901
Customer related derivative contracts:
Interest rate swaps with customers		62,209		59,749
Mirror swaps with counterparties		62,209		59,749
Interest rate risk management contracts:
Interest rate swap contracts		32,991		32,991

Commitments to extend credit are agreements to lend to a customer as long as there are no violations of any conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each borrower’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the borrower.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Under a standby letter of credit, the Corporation is required to make payments to the beneficiary of the letter of credit upon request by the beneficiary contingent upon the customer’s failure to perform under the terms of the underlying contract with the beneficiary. Standby letters of credit extend up to five years. At June 30, 2011 and December 31, 2010, the maximum potential amount of undiscounted future payments, not reduced by amounts that may be recovered, totaled $9.2 million and $9.5 million, respectively. At June 30, 2011 and December 31, 2010, there was no liability to beneficiaries resulting from standby letters of credit. Fee income on standby letters of credit for the three and six months ended June 30, 2011 amounted to $33 thousand and $97 thousand, respectively. Comparable amounts for the three and six months ended June 30, 2010 were $20 thousand and $40 thousand, respectively.

At June 30, 2011 and December 31, 2010, a substantial portion of the standby letters of credit was supported by pledged collateral. The collateral obtained is determined based on management’s credit evaluation of the customer. Should the Corporation be required to make payments to the beneficiary, repayment from the customer to the Corporation is required.

As of June 30, 2011, Washington Trust has investments in two real estate limited partnerships, one of which was entered into in the latter portion of 2010. The partnerships were created for the purpose of renovating and operating low-income housing projects. Equity commitments to affordable housing partnerships represent funding commitments by Washington Trust to the limited partnerships. The funding of commitments is generally contingent upon substantial completion of the projects.

Interest rate lock commitments are extended to borrowers that relate to the origination of readily marketable mortgage loans held for sale. To mitigate the interest rate risk inherent in these rate locks, as well as closed mortgage loans held for sale, best efforts forward commitments are established to sell individual mortgage loans. Commitments to originate and commitments to sell fixed rate mortgage loans are derivative financial instruments and, therefore, changes in fair value of these commitments are recognized in earnings.

Interest rate swaps are used from time to time as part of the Corporation’s interest rate risk management strategy. Swaps are agreements in which the Corporation and another party agree to exchange interest payments (e.g., fixed-rate for variable-rate payments) computed on a notional principal amount. The credit risk associated with swap transactions is the risk of default by the counterparty. To minimize this risk, the Corporation enters into interest rate agreements only with highly rated counterparties that management believes to be creditworthy. The notional amounts of these agreements do not represent amounts exchanged by the parties and, thus, are not a measure of the potential loss exposure.

At of June 30, 2011 and December 31, 2010, the Bancorp had three interest rate swap contracts designated as cash flow hedges to hedge the interest rate associated with $33 million of variable rate junior subordinated debenture. The effective portion of the changes in fair value of derivatives designated as cash flow hedges is recorded in other comprehensive income and subsequently reclassified to earnings when gains or losses are realized. The ineffective portion of changes in fair value of the derivatives is recognized directly in earnings as interest expense. The Bancorp pledged collateral to derivative counterparties in the form of cash totaling $1.6 million and $1.9 million, respectively, as of June 30, 2011 and December 31, 2010. The Bancorp may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

The Bank has entered into interest rate swap contracts to help commercial loan borrowers manage their interest rate risk. The interest rate swap contracts with commercial loan borrowers allow them to convert floating rate loan payments to fixed rate loan payments. When we enter into an interest rate swap contract with a commercial loan borrower, we simultaneously enter into a “mirror” swap contract with a third party. The third party exchanges the client’s fixed rate loan payments for floating rate loan payments. We retain the risk that is associated with the potential failure of counterparties and inherent in making loans. At June 30, 2011 and December 31, 2010, Washington Trust had interest rate swap contracts with commercial loan borrowers with notional amounts of $62.2 million and $59.7 million, respectively, and equal amounts of “mirror” swap contracts with third-party financial institutions. These derivatives are not designated as hedges and therefore, changes in fair value are recognized in earnings.

(Dollars in thousands)	Asset Derivatives					Liability Derivatives
		Fair Value					Fair Value
	Balance Sheet Location	June 30, 2011		Dec. 31, 2010		Balance Sheet Location	June 30, 2011		Dec. 31, 2010
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate swap contracts		$	–	$	–	Other liabilities	$	1,369	$	1,098
Derivatives not Designated as Hedging Instruments:
Forward loan commitments:
Commitments to originate fixed rate mortgage loans to be sold	Other assets		33		31	Other liabilities		104		135
Commitments to sell fixed rate mortgage loans	Other assets		127		571	Other liabilities		94		32
Customer related derivative contracts:
Interest rate swaps with customers	Other assets		3,893		3,690			–		–
Mirror swaps with counterparties			–		–	Other liabilities		4,015		3,806
Total		$	4,053	$	4,292		$	5,582	$	5,071

(Dollars in thousands)					Location of Gain
	Gain (Loss)				(Loss) Recognized in
	Recognized in Other				Income on Derivative	Gain (Loss)
	Comprehensive				(Ineffective Portion	Recognized in Income
	Income				and Amount	on Derivative
	(Effective Portion)				Excluded from	(Ineffective Portion)
	Three Months		Six Months		Effectiveness	Three Months		Six Months
Periods ended June 30,	2011	2010	2011	2010	Testing)	2011	2010	2011	2010
Derivatives in Cash Flow Hedging Relationships:
Interest rate risk management contracts:
Interest rate swap contracts	$(346)	$(551)	$(174)	$(544)	Interest Expense	$ –	$ –	$ –	$(78)
Total	$(346)	$(551)	$(174)	$(544)		$ –	$ –	$ –	$(78)

(Dollars in thousands)		Amount of Gain (Loss)
	Location of Gain	Recognized in Income on Derivative
	(Loss) Recognized in	Three Months						Six Months
Periods ended June 30,	Income on Derivative	2011			2010			2011			2010
Derivatives not Designated as Hedging Instruments:
Forward loan commitments:
Commitments to originate fixed rate mortgage loans to be sold	Net gains on loan sales & commissions on loans originated for others	$	(53	)	$	249		$	33		$	398
Commitments to sell fixed rate mortgage loans	Net gains on loan sales & commissions on loans originated for others		42			(442	)		(506	)		(735	)
Customer related derivative contracts:
Interest rate swaps with customers	Net gains (losses) on interest rate swaps		1,214			2,007			1,118			3,114
Mirror swaps with counterparties	Net gains (losses) on interest rate swaps		(1,249	)		(2,128	)		(1,077	)		(3,167	)
Total		$	(46	)	$	(314	)	$	(432	)	$	(390	)