DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

3 Months Ended

Mar. 31, 2017

Derivative Instruments and Hedging Activities Disclosure [Abstract]

DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

As part of its overall asset and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility.  The Bank’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets or liabilities so that changes in interest rates do not have a significant effect on net interest income.

The Company recognizes its derivative instruments on the consolidated balance sheet at fair value.  On the date the derivative instrument is entered into, the Bank designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Bank formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Bank also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items.

Changes in fair value of derivative instruments that are highly effective and qualify as cash flow hedges are recorded in other comprehensive income or loss. Any ineffective portion is recorded in earnings. The Bank discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk on the hedged item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.

Information about derivative assets and liabilities at March 31, 2017, follows:

			Weighted	Estimated
	Notional Amount		Average Maturity	Fair Value Asset (Liability)
	(In thousands)		(In years)	(In thousands)
Cash flow hedges:
Interest rate caps agreements	$	90,000	5.9	$	1,387
Total cash flow hedges	90,000		5.9	1,387
Economic hedges:
Forward sale commitments	13,379		0.2	(55		)
Total economic hedges	13,379		0.2	(55		)
Non-hedging derivatives:
Interest rate lock commitments	12,206		0.2	98
Total non-hedging derivatives	12,206		0.2	98
Total	$	115,585		$	1,430

As of December 31, 2016 the Company had interest rate cap agreements totaling $90 million (notional amount), with a weighted average maturity of 6.1 years, and an estimated fair value of $1,748.

Information about derivative assets and liabilities for the three months ended March 31, 2017 and March 31, 2016, follows:

	Three Months Ended March 31,
(In thousands)	2017			2016
Cash flow hedges:
Interest rate cap agreements
Realized in interest expense	$	39		$	3
Economic hedges:
Forward commitments
Realized gain in other non-interest income	(78		)	—
Non-hedging derivatives:
Interest rate lock commitments
Realized loss in other non-interest income	2			—

Cash flow hedges

In 2014, interest rate cap agreements were purchased to limit the Bank’s exposure to rising interest rates on four rolling, three-month borrowings indexed to three month LIBOR.  Under the terms of the agreements, the Bank paid total premiums of $4,566 for the right to receive cash flow payments if 3-month LIBOR rises above the caps of 3.00%, thus effectively ensuring interest expense on the borrowings at maximum rates of 3.00% for the duration of the agreements. The interest rate cap agreements were designated as cash flow hedges.  The fair values of the interest rate cap agreements are included in other assets on the Company’s consolidated balance sheets. Changes in the fair value, representing unrealized gains or losses, are recorded in accumulated other comprehensive income, net of tax.  The premiums paid on the interest rate cap agreements are being recognized as increases in interest expense over the duration of the agreements using the caplet method.

Economic hedges

The Company utilizes forward sale commitments to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans originated for sale. The forward sale commitments are accounted for as derivatives with changes in fair value recorded in current period earnings.  The Company typically uses mandatory delivery contracts, which are loan sale agreements where the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, the Company may enter into mandatory delivery contracts shortly after the loan closes with a customer.

Non-hedging derivatives

The Company enters into interest rate lock commitments (“IRLCs”) for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. IRLCs that relate to the origination of mortgage loans that will be held for sale are considered derivative financial instruments under applicable accounting guidance. Outstanding IRLCs expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The IRLCs are free-standing derivatives which are carried at fair value with changes recorded in noninterest income in the Company’s consolidated statements of income. Changes in the fair value of IRLCs subsequent to inception are based on changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and changes in the probability that the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time.