DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

12 Months Ended

Dec. 31, 2022

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

NOTE 15 DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Mortgage Banking Derivatives

Loans Held for Sale

The Company, through the Bank’s mortgage banking subsidiary, F&M Mortgage Company, originates residential mortgage loans for sale in the secondary market. Residential mortgage loans held for sale are sold to the permanent investor with the mortgage servicing rights released. Fair value of the Company’s LHFS is based on observable market prices for the identical instruments traded in the secondary mortgage loan markets in which the Company conducts business total $1.4 million as of December 31, 2022 of which $1.4 million is related to unpaid principal. The Company’s portfolio of LHFS is classified as Level 2.

Interest Rate Lock Commitments and Forward Sales Commitments

The Company, through F&M Mortgage Company, enters commitments to originate residential mortgage loans in which the interest rate on the loan is determined prior to funding, termed interest rate lock commitments (IRLCs). Such rate lock commitments on mortgage loans to be sold in the secondary market are derivatives. Upon entering a commitment to originate a loan, the Company protects itself from changes in interest rates during the period prior to sale by requiring a firm purchase agreement from a permanent investor before a loan can be closed (forward sales commitment).

The Company locks in the loan and rate with an investor and commits to deliver the loan if settlement occurs on a best-efforts basis, thus limiting interest rate risk. Certain additional risks exist if the investor fails to meet its purchase obligation; however, based on historical performance and the size and nature of the investors the Company does not expect them to fail to meet their obligation. The Company determines the fair value of the IRLCs based on the price of the underlying loans obtained from an investor for loans that will be delivered on a best-efforts basis while taking into consideration the probability that the rate loan commitments will close.

The fair value of these derivative instruments is reported in “Other liabilities” in the Consolidated Balance Sheet at December 31, 2022, and totaled $92 thousand, with a notional amount of $12.2 million and total positions of 38. The fair value of the IRLCs at December 31, 2021 totaled $258 thousand, with a notional amount of $18.8 million and total positions of 70. Changes in fair value are recorded as a component of “Mortgage banking income” in the Consolidated Income Statement for the period ended December 31, 2021. The Company’s IRLCs are classified as Level 2. At December 31, 2022 and 2021, each IRLC and all LHFS were subject to a forward sales commitment on a best- efforts basis.

The Company uses fair value accounting for its forward sales commitments related to IRLCs and LHFS under ASC 825-10-15-4(b). The fair value of forward sales commitments was reported in “Other Assets” in the Consolidated Balance Sheet at December 31, 2022 totaled $186 thousand, with a notional amount of $13.6 million and total positions of 43. The fair value of forward sales commitments is reported in “Other Assets” in the Consolidated Balance Sheet at December 31, 2021, and totaled $112 thousand, with a notional amount of $23.7 million and total positions of 91.

Derivative Financial Instruments

In the past, the Company issued certificates of deposit with an interest rate derived from the rate of return based on The Dow Jones Industrial Average.  To manage the interest rate risk associated with this deposit product, the Company purchased a series of forward option contracts. These contracts were accounted for as fair value hedges.  Because the certificates of deposit can be redeemed by the customer at any time and the related forward options contracts cannot be cancelled by the Company, the hedge is not considered effective. The ineffective portion of the gain or loss on the derivative instrument, if any, is recognized currently in earnings.  There was no ineffective portion included in the consolidated income statement for the years ended December 31, 2022 and 2021.

At December 31, the information pertaining to the forward option contracts, included in other assets and other liabilities on the balance sheet, is as follows (dollars in thousands):

	2022		2021
Notional amount	$	-	$	7
Fair value of contracts, included in other assets		-		3

The last certificate of deposit matured in April 2022 and the Company no longer issues this deposit product.