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 risk management agreements, such as caps, swaps, and floors, 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 and floors 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 March 31, 2019 and December 31, 2018, the Bancorp had two interest rate caps with a total 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. For both interest rate caps, the Bancorp obtained the right to receive the difference between 3-month LIBOR and a 4.5% strike. The caps mature in 2020.

As of March 31, 2019 and December 31, 2018, the Bank had two interest rate swap contracts with a total notional amount of $60.0 million that were designated as cash flow hedges to hedge the interest rate risk associated with short-term variable rate FHLB advances. The interest rate swaps mature in 2021 and 2023.

As of March 31, 2019 and December 31, 2018, the Bank had three interest rate floor contracts with a total notional amount of $300.0 million that were designated as cash flow hedges to hedge the interest rate risk associated with a pool of variable rate commercial loans. The Bank obtained the right to receive the difference between 1-month LIBOR and a 1.0% strike for each of the interest rate floors. The floors mature in 2020.

The changes in fair value of derivatives designated as cash flow hedges are recorded in other comprehensive income and subsequently reclassified to earnings when gains or losses are realized.

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 variable-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 variable-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 March 31, 2019 and December 31, 2018, Washington Trust had interest rate swap contracts with commercial loan borrowers with notional amounts of $671.5 million and $648.0 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 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.

As of March 31, 2019, the notional amounts of risk participation-out agreements and risk participation-in agreements were $57.0 million and $46.4 million, respectively, compared to $57.3 million and $46.5 million, respectively, as of December 31, 2018.

Foreign Exchange Contracts

Foreign exchange contracts represent contractual commitments to buy or sell a foreign currency on a future date at a specified price. The Corporation uses these foreign exchange contracts on a limited basis to reduce its exposure to fluctuations in currency exchange rates associated with a commercial loan that is denominated in a foreign currency. These derivatives are not designated as hedges and therefore changes in fair value are recognized in earnings. The changes in fair value on the foreign exchange contracts substantially offset the foreign currency translation gains and losses on the related commercial loan.

As of March 31, 2019 and December 31, 2018, the notional amount of foreign exchange contracts was $2.7 million and $2.8 million, respectively.

Loan Commitments

Interest rate lock commitments are extended to borrowers and relate to the origination of mortgage loans held for sale. To mitigate the interest rate risk and pricing risk associated with rate locks and mortgage loans held for sale, the Corporation enters into forward sale commitments. Forward sale commitments are contracts for delayed delivery or net settlement of the underlying instrument, such as a residential real estate mortgage loan, where the seller agrees to deliver on a specified future date, either a specified instrument at a specified price or yield or the net cash equivalent of an underlying instrument. Both interest rate lock commitments and forward sale commitments are derivative financial instruments, but do not meet criteria for hedge accounting and therefore, the changes in fair value of these commitments are reflected in earnings.

As of March 31, 2019, the notional amounts of interest rate lock commitments and forward sale commitments were $64.1 million and $94.6 million, respectively, compared to $30.8 million and $62.0 million, respectively, as of December 31, 2018.

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



(Dollars in thousands)	Asset Derivatives					Liability Derivatives
		Fair Value					Fair Value
	Balance Sheet Location	Mar 31, 2019		Dec 31, 2018		Balance Sheet Location	Mar 31, 2019		Dec 31, 2018
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate caps	Other assets		$3		$20	Other liabilities		$—		$—
Interest rate swaps	Other assets	291		903		Other liabilities	—		—
Interest rate floors	Other assets	16		37		Other liabilities	—		—
Derivatives not Designated as Hedging Instruments:
Loan related derivative contracts:
Interest rate swaps with customers	Other assets	11,176		5,340		Other liabilities	2,952		7,719
Mirror swaps with counterparties	Other assets	2,897		7,592		Other liabilities	11,236		5,392
Risk participation agreements	Other assets	—		—		Other liabilities	1		—
Foreign exchange contracts	Other assets	8		—		Other liabilities	—		7
Forward loan commitments:
Interest rate lock commitments	Other assets	1,491		806		Other liabilities	—		—
Forward sale commitments	Other assets	—		—		Other liabilities	818		816
Gross amounts		15,882		14,698			15,007		13,934
Less amounts offset in Consolidated Balance Sheets (1)		1,899		10,732			1,899		10,732
Net amounts presented in Consolidated Balance Sheets		13,983		3,966			13,108		3,202
Less collateral pledged (2)		—		—			9,569		1,460
Net amounts			$13,983		$3,966			$3,539		$1,742


(1)	Interest rate risk management contracts and loan related derivative contracts with counterparties are subject to master netting arrangements.


(2)	Collateral pledged to derivative counterparties is in the form of cash. Washington Trust may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

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



(Dollars in thousands)	Gain (Loss) Recognized in Other Comprehensive Income, Net of Tax
Three months ended March 31,	2019			2018
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate caps		$—			$38
Interest rate swaps	(466		)	839
Interest rate floors	24			12
Total		($442	)		$889

See Note 15 for additional disclosure pertaining to the amounts reclassified from accumulated other comprehensive income into earnings for derivatives designated as cash flow hedging instruments.



(Dollars in thousands)		Amount of Gain (Loss) Recognized in Income on Derivatives
Three months ended March 31,	Statement of Income Location	2019			2018
Derivatives not Designated as Hedging Instruments:
Loan related derivative contracts:
Interest rate swaps with customers	Loan related derivative income		$10,310			($9,195	)
Mirror swaps with counterparties	Loan related derivative income	(9,604		)	9,324
Risk participation agreements	Loan related derivative income	—			—
Foreign exchange contracts	Loan related derivative income	18			12
Forward loan commitments:
Interest rate lock commitments	Mortgage banking revenues	685			(14		)
Forward sale commitments	Mortgage banking revenues	(429		)	1,318
Total			$980			$1,445