Derivative Financial Instruments

6 Months Ended

Jun. 30, 2016

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Financial Instruments

Derivative Financial Instruments

The Corporation’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Corporation’s known or expected cash receipts and its known or expected cash payments principally to manage the Corporation’s interest rate risk. Additionally, the Corporation enters into interest rate derivatives to accommodate the business requirements of its customers. All derivatives are recognized as either assets or liabilities on the balance sheet and are measured at fair value.  The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and resulting designation.

Interest Rate Risk Management Agreements

Interest rate swaps and caps are used from time to time as part of the Corporation’s interest rate risk management strategy. Interest rate 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. Interest rate caps represent options purchased by the Corporation to manage the interest rate paid throughout the term of the option contract. The credit risk associated with these 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.

Cash Flow Hedging Instruments

As of June 30, 2016 and December 31, 2015, the Bancorp had two interest rate caps with a notional amount of $22.7 million that were designated as cash flow hedges to hedge the interest rate risk associated with our variable rate junior subordinated debentures. In the fourth quarter of 2015, the Corporation entered into the interest rate cap contracts and paid a premium totaling $257 thousand to obtain the right to receive the difference between 3-month LIBOR and a 4.5% strike for both of the interest rate caps. The caps mature in 2020. Prior to December 31, 2015, the Bancorp had two interest rate swap contracts designated as cash flow hedges to hedge the interest rate risk associated with the junior subordinated debentures noted above. During 2015, both interest rate swaps contracts matured. 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.

Loan Related Derivative Contracts

Interest Rate Swap Contracts with Customers

The Corporation 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 the risk inherent in originating loans.  As of June 30, 2016 and December 31, 2015, Washington Trust had interest rate swap contracts with commercial loan borrowers with notional amounts of $414.4 million and $302.1 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.

Risk Participation Agreements

The Corporation has entered into risk participation agreements with other banks participating in commercial loan arrangements. Participating banks guarantee the performance on borrower-related interest rate swap contracts. These derivatives are not designated as hedges and therefore, changes in fair value are recognized in earnings.

Under a risk participation-out agreement, a derivative asset, the Corporation participates out a portion of the credit risk associated with the interest rate swap position executed with the commercial borrower, for a fee paid to the participating bank. Under a risk participation-in agreement, a derivative liability, the Corporation assumes, or participates in, a portion of the credit risk associated with the interest rate swap position with the commercial borrower, for a fee received from the other bank.

At June 30, 2016 and December 31, 2015, the notional amounts of risk participation-out agreements were $38.6 million and $25.3 million, respectively. The notional amounts of risk participation-in agreements at both June 30, 2016 and December 31,2015 were $21.5 million.

Loan Commitments

Interest rate lock commitments are extended to borrowers and relate to the origination of residential real estate mortgage loans held for sale.  To mitigate the interest rate risk inherent in these rate locks, as well as closed residential real estate mortgage loans held for sale, forward commitments are established to sell individual residential real estate mortgage loans.  Both interest rate lock commitments and commitments to sell residential real estate mortgage loans are derivative financial instruments, but do not meet criteria for hedge accounting and, as such are treated as derivatives not designated as hedging instruments. The changes in fair value of these commitments are reflected in earnings in the period of change. The Corporation has elected to carry certain closed residential real estate mortgage loans held for sale at fair value, as changes in fair value in these loans held for sale generally offset changes in interest rate lock and forward sale commitments.

The following table presents the fair values of derivative instruments in the Corporation’s Consolidated Balance Sheets:

(Dollars in thousands)	Asset Derivatives					Liability Derivatives
		Fair Value					Fair Value
	Balance Sheet Location	Jun 30, 2016		Dec 31, 2015		Balance Sheet Location	Jun 30, 2016		Dec 31, 2015
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate caps	Other assets		$44		$187	Other liabilities		$—		$—
Derivatives not Designated as Hedging Instruments:
Forward loan commitments:
Interest rate lock commitments	Other assets	2,966		1,220		Other liabilities	—		—
Commitments to sell mortgage loans	Other assets	—		—		Other liabilities	4,192		2,012
Loan related derivative contracts:
Interest rate swaps with customers	Other assets	22,321		8,027		Other liabilities	—		—
Mirror swaps with counterparties	Other assets	—		—		Other liabilities	23,517		8,266
Risk participation agreements	Other assets	121		56		Other liabilities	140		69
Total			$25,452		$9,490			$27,849		$10,347

The following tables present the effect of derivative instruments in the Corporation’s Consolidated Statements of Income and Changes in Shareholders’ Equity:

(Dollars in thousands)	Gain (Loss) Recognized in Other Comprehensive Income (Effective Portion)										Location of Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Gain (Loss) Recognized in Income (Ineffective Portion)
	Three months					Six months						Three months				Six months
Periods ended June 30,	2016			2015		2016			2015			2016		2015		2016		2015
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate swap contracts		$—			$89		$—			$174	Interest Expense		$—		$—		$—		$—
Interest rate caps	(24		)	—		(90		)	—		Interest Expense	—		—		—		—
Total		($24	)		$89		($90	)		$174			$—		$—		$—		$—

(Dollars in thousands)		Amount of Gain (Loss) Recognized in Income on Derivatives						Amount of Gain (Loss) Recognized in Income on Derivatives
		Three months						Six months
Periods ended June 30,	Statement of Income Location	2016			2015			2016			2015
Derivatives not Designated as Hedging Instruments:
Forward loan commitments:
Interest rate lock commitments	Mortgage banking revenues		$501			($432	)		$1,746			$139
Commitments to sell mortgage loans	Mortgage banking revenues	(1,174		)	1,410			(2,180		)	470
Customer related derivative contracts:
Interest rate swaps with customers	Loan related derivative income	7,130			(1,365		)	17,032			2,268
Mirror swaps with counterparties	Loan related derivative income	(6,526		)	2,118			(15,777		)	(718		)
Risk participation agreements	Loan related derivative income	(96		)	(36		)	(102		)	(188		)
Total			($165	)		$1,695			$719			$1,971