Derivative Financial Instruments

9 Months Ended

Sep. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

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 September 30, 2020 and December 31, 2019, the Corporation 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 Corporation obtained the right to receive the difference between 3-month LIBOR and a 4.5% strike. The caps mature in November and December of 2020.

As of September 30, 2020 and December 31, 2019, the Corporation 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 September 30, 2020, the Corporation had no interest rate floor contracts. As of December 31, 2019, the Corporation had three interest rate floor contracts with a total notional amount of $300.0 million. These contracts were designated as cash flow hedges to hedge the interest rate risk associated with a pool of variable rate commercial loans. The Corporation obtained the right to receive the difference between 1-month LIBOR and a 1.0% strike for each of the interest rate floors. During the nine months ended September 30, 2020, the three interest rate floor contracts matured.

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 the Corporation enters into an interest rate swap contract with a commercial loan borrower, it simultaneously enters 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. The Corporation retains the risk that is associated with the potential failure of counterparties and the risk inherent in originating loans. As of September 30, 2020 and December 31, 2019, Washington Trust had interest rate swap contracts with commercial loan borrowers with notional amounts of $995.7 million and $813.5 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 September 30, 2020, the notional amounts of risk participation-out agreements and risk participation-in agreements were $60.4 million and $92.9 million, respectively, compared to $61.2 million and $72.9 million, respectively, as of December 31, 2019.

Mortgage 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 September 30, 2020, the notional amounts of interest rate lock commitments and forward sale commitments were $180.1 million and $312.1 million, respectively, compared to $51.4 million and $94.8 million, respectively, as of December 31, 2019.

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


(Dollars in thousands)	Derivative Assets			Derivative Liabilities
		Fair Value			Fair Value
	Balance Sheet Location	Sep 30, 2020	Dec 31, 2019	Balance Sheet Location	Sep 30, 2020	Dec 31, 2019
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate caps	Other assets	$—	$—	Other liabilities	$—	$—
Interest rate swaps	Other assets	—	—	Other liabilities	2,224	730
Interest rate floors	Other assets	—	3	Other liabilities	—	—
Derivatives not Designated as Hedging Instruments:
Loan related derivative contracts:
Interest rate swaps with customers	Other assets	86,500	27,736	Other liabilities	—	358
Mirror swaps with counterparties	Other assets	—	351	Other liabilities	86,955	27,819
Risk participation agreements	Other assets	25	1	Other liabilities	3	1

Mortgage loan commitments:
Interest rate lock commitments	Other assets	6,882	1,097	Other liabilities	—	—
Forward sale commitments	Other assets	111	30	Other liabilities	3,726	827
Gross amounts		93,518	29,218		92,908	29,735
Less amounts offset in Consolidated Balance Sheets (1)		—	354		—	354
Net amounts presented in Consolidated Balance Sheets		93,518	28,864		92,908	29,381
Less collateral pledged (2)		—	—		85,516	27,105
Net amounts		$93,518	$28,864		$7,392	$2,276

(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 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		Nine Months
Periods ended September 30,	2020	2019	2020	2019
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate caps	$25	$18	$71	$32
Interest rate swaps	214	(211)	(1,109)	(1,442)
Interest rate floors	(85)	22	150	175
Total	$154	($171)	($888)	($1,235)

For derivatives designated as cash flow hedging instruments, see Note 15 for additional disclosure pertaining to the amounts and location of reclassifications from accumulated other comprehensive income into earnings.


(Dollars in thousands)		Amount of Gain (Loss) Recognized in Income on Derivatives
		Three Months		Nine Months
Periods ended September 30,	Statement of Income Location	2020	2019	2020	2019
Derivatives not Designated as Hedging Instruments:
Loan related derivative contracts:
Interest rate swaps with customers	Loan related derivative income	$767	$12,284	$67,258	$39,568
Mirror swaps with counterparties	Loan related derivative income	499	(11,108)	(63,655)	(36,958)
Risk participation agreements	Loan related derivative income	(2)	213	215	213
Foreign exchange contracts	Loan related derivative income	—	18	—	54
Mortgage loan commitments:
Interest rate lock commitments	Mortgage banking revenues	(1,499)	(340)	5,785	955
Forward sale commitments	Mortgage banking revenues	(4,743)	(101)	(10,733)	(1,969)
Total		($4,978)	$966	($1,130)	$1,863