COMMITMENTS, CONTINGENCIES AND DERIVATIVES

Legal Contingencies

In the normal course of business, the Company and its subsidiaries are subject to pending and threatened legal actions. Although the Company is not able to predict the outcome of such actions, after reviewing pending and threatened actions with counsel, management believes that based on the information currently available the outcome of such actions, individually or in the aggregate, will not have a material adverse effect on the Company’s consolidated financial position as a whole.

Reserves are established for legal claims only when losses associated with the claims are judged to be probable and the loss can be reasonably estimated. In many lawsuits and arbitrations, it is not possible to determine whether a liability has been incurred or to estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case a reserve will not be recognized until that time.

As of June 30, 2016 and December 31, 2015, the Company did not have any material loss contingencies for which accruals were provided for and/or disclosure was deemed necessary.

Financial Instruments

In the normal course of business, the Company is a party to both on- and off-balance sheet financial instruments involving, to varying degrees, elements of credit risk and interest rate risk in addition to the amounts recognized in the consolidated statements of condition.

The following is a summary of the contractual and notional amounts of the Company’s financial instruments:



	June 30, 2016		December 31, 2015
Lending-Related Instruments:
Loan origination commitments and unadvanced lines of credit:
Home equity	$	464,991	$	464,701
Commercial and commercial real estate	52,268		94,791
Residential	28,809		16,256
Letters of credit	3,009		4,468
Other commitments	442		433
Derivative Financial Instruments:
Customer loan swaps	$	464,514	$	285,888
FHLBB advance interest rate swaps	50,000		50,000
Junior subordinated debt interest rate swaps	43,000		43,000
Interest rate lock commitments	49,113		20,735

Lending-Related Instruments

The contractual amounts of the Company’s lending-related financial instruments do not necessarily represent future cash requirements since certain of these instruments may expire without being funded and others may not be fully drawn upon. These instruments are subject to the Company’s credit approval process, including an evaluation of the customer’s creditworthiness and related collateral requirements. Commitments generally have fixed expiration dates or other termination clauses.

Derivative Financial Instruments

The Company uses derivative financial instruments for risk management purposes (primarily interest rate risk) and not for trading or speculative purposes. The Company controls the credit risk of these instruments through collateral, credit approvals and monitoring procedures. Additionally, as part of Company's normal mortgage origination process, it provides the borrower with the option to lock their interest rate based on current market prices. During the period from commitment date to the loan closing date, the Company is subject to the risk of interest rate change. In an effort to mitigate such risk the Company may enter into forward delivery sales commitments, typically on a "best-efforts" basis, with certain approved investors.

Derivative instruments are carried at fair value in the Company’s financial statements. The accounting for changes in the fair value of a derivative instrument is dependent upon whether or not it qualifies and has been designated as a hedge for accounting purposes, and further, by the type of hedging relationship.

The Company has designated its interest rate swaps on its junior subordinated debentures and its interest rate swaps on forecasted 30-day FHLBB borrowings as cash flow hedges. The change in the fair value of the Company's cash flow hedges is accounted within OCI, net of tax. Quarterly, in conjunction with financial reporting, the Company assesses each cash flow hedge for ineffectiveness. To the extent any significant ineffectiveness is identified, this amount is recorded within the consolidated statements of income. Furthermore, the Company will reclassify the gain or loss on the effective portion of the cash flow hedge from OCI into interest within the consolidated statements of income in the period the hedged transaction affects earnings.

The change in fair value of the Company's other derivative instruments, not designated and qualifying as hedges, are accounted for within the consolidated statements of income.

Junior Subordinated Debt Interest Rate Swaps:

The Company, from time to time, will enter into an interest rate swap agreement with a counterparty to manage interest rate risk associated with its variable rate borrowings. The Company’s interest rate swap arrangements contain provisions that require the Company to post cash collateral with the counterparty for contracts that are in a net liability position based on their fair values and the Company’s credit rating. If the interest rate swaps are in a net asset position based on their fair value, the counterparty is required to post collateral to the Company. The collateral posted by the Company (or counterparty) is not readily available and has been presented within cash and due from banks on the consolidated statements of condition. At June 30, 2016 and December 31, 2015, the Company had a notional amount of $43.0 million in variable-for-fixed interest rate swap agreements on its junior subordinated debentures and $13.8 million of cash as collateral to the counterparty at June 30, 2016.

The details of the interest rate swap agreements are as follows:



						June 30, 2016			December 31, 2015
Notional Amount		Trade Date	Maturity Date	Variable Index Received	Fixed Rate Paid	Fair Value⁽¹⁾			Fair Value⁽¹⁾
$	10,000	3/18/2009	6/30/2021	3-Month USD LIBOR	5.09%	$	(1,354	)	$	(1,038	)
10,000		7/8/2009	6/30/2029	3-Month USD LIBOR	5.84%	(3,583		)	(2,537		)
10,000		5/6/2010	6/30/2030	3-Month USD LIBOR	5.71%	(3,604		)	(2,477		)
5,000		3/14/2011	3/30/2031	3-Month USD LIBOR	4.35%	(1,893		)	(1,301		)
8,000		5/4/2011	7/7/2031	3-Month USD LIBOR	4.14%	(2,831		)	(1,876		)
$	43,000					$	(13,265	)	$	(9,229	)
(1) Presented within accrued interest and other liabilities on the consolidated statements of condition.

For the three and six months ended June 30, 2016 or 2015, the Company did not record any ineffectiveness on these cash flow hedges within the consolidated statements of income.

Net payments to the counterparty for the six months ended June 30, 2016 and 2015 were $782,000 and $501,000 and have been classified as cash flows from operating activities in the consolidated statements of cash flows.

FHLBB Advance Interest Rate Swaps:

The Bank has two interest rate swap arrangements with a counterparty on two tranches of 30-day FHLBB advances with a total notional amount of $50.0 million. Each derivative arrangement commenced on February 25, 2016, with one contract set to expire on February 25, 2018 and the other on February 25, 2019. The Bank entered into these interest rate swaps to mitigate its interest rate exposure on borrowings in a rising interest rate environment. The Bank has designated each arrangement as a cash flow hedge in accordance with GAAP, and, therefore, the change in unrealized gains or losses on the derivative instruments is recorded within AOCI, net of tax. Also, quarterly, in conjunction with financial reporting, the Company assesses each derivative instrument for ineffectiveness. To the extent any significant ineffectiveness is identified this amount would be recorded within the consolidated statements of income. For the three and six months ended June 30, 2016, the Company did not record any ineffectiveness within the consolidated statements of income.

The Bank's arrangement with the counterparty requires it to post cash collateral for contracts in a net liability position based on their fair values and the Bank's credit rating. If the interest rate swaps are in a net asset position based on their fair value, the counterparty is required to post collateral to the Company. The collateral posted by the Company (or counterparty) is not readily available and is presented within cash and due from banks on the consolidated statements of condition. At June 30, 2016, the Bank posted cash collateral with the counterparty of $1.2 million to the counterparty.

The details of the interest rate swap agreements are as follows:



						June 30, 2016			December 31, 2015
Notional Amount		Trade Date	Maturity Date	Variable Index Received	Fixed Rate Paid	Fair Value⁽¹⁾			Fair Value⁽¹⁾
$	25,000	2/25/2015	2/25/2018	1-Month USD LIBOR	1.54%	$	(421	)	$	(230	)
25,000		2/25/2015	2/25/2019	1-Month USD LIBOR	1.74%	(751		)	(346		)
$	50,000					$	(1,172	)	$	(576	)
(1) Presented within accrued interest and other liabilities on the consolidated statements of condition.

Net payments to the counterparty for the six months ended June 30, 2016 were $205,000 and have been classified as cash flows from operating activities in the consolidated statements of cash flows.

Customer Loan Swaps:

The Company will enter into interest rate swaps with its commercial customers, from time to time, to provide them with a means to lock into a long-term fixed rate, while simultaneously the Company enters into an arrangement with a counterparty to swap the fixed rate to a variable rate to allow it to effectively manage its interest rate exposure.

The Company's customer loan level derivative program is not designated as a hedge for accounting purposes. As the interest rate swap agreements have substantially equivalent and offsetting terms, they do not materially change the Company’s interest rate risk or present any material exposure to the Company's consolidated statements of income. The Company records its customer loan swaps at fair value and presents such on a gross basis within other assets and accrued interest and other liabilities on the consolidated statements of condition.

The following table presents the total positions, notional and fair value of the Company's customer loans swaps with its commercial customers and the corresponding interest rate swap agreements with counterparty for the periods indicated:



	June 30, 2016						December 31, 2015
	Number of Positions	Notional		Fair Value			Number of Positions	Notional		Fair Value
Receive fixed, pay variable⁽¹⁾	44	$	232,257	$	15,001		28	$	142,944	$	3,166
Pay fixed, received variable⁽²⁾	44	232,257		(15,001		)	28	142,944		(3,166		)
(1) Presented within other assets on the consolidated statements of condition.
(2) Presented within accrued interest and other liabilities on the consolidated statements of condition.

The Company seeks to mitigate its customer counterparty credit risk exposure through its loan policy and underwriting process, which includes credit approval limits, monitoring procedures, and obtaining collateral, where appropriate. The Company seeks to mitigate its institutional counterparty credit risk exposure by limiting the institutions for which it will enter into interest swap arrangements through an approved listing by the Company's board of directors. The Company's arrangement with an institutional counterparty requires it to post collateral for contracts in a net liability position based on their fair values and the Bank's credit rating or receive collateral for contracts in a net asset position. At June 30, 2016, the Company posted cash collateral with the counterparty of $15.5 million. The collateral posted by the Company (or counterparty) is not readily available and is presented within cash and due from banks on the consolidated statements of condition.

Interest Rate Locks Commitments:

As part of originating residential and commercial loans, the Company may enter into rate lock agreements with customers and may issue commitment letters to customers, which are considered interest rate lock commitments. At June 30, 2016 and December 31, 2015, our pipeline of mortgage loans with interest rate lock commitments were as follows:



	June 30, 2016				December 31, 2015
	Notional		Fair Value		Notional		Fair Value
Mortgage interest rate locks⁽¹⁾	$	49,113	$	523	$	20,735	$	139
(1) Presented within other assets on the consolidated statements of condition.

For the three months ended June 30, 2016 and 2015, the unrealized gains from the change in fair value on the Company's mortgage interest rate locks reported within mortgage banking income, net, on the consolidated statements of income were $92,000 and $18,000, respectively. For the six months ended June 30, 2016 and 2015, the unrealized gains from the change in fair value on the Company's mortgage interest rate locks were $384,000 and $14,000, respectively.

The table below presents the effect of the Company’s derivative financial instruments included in OCI and current earnings for the periods indicated:



	For The Three Months Ended June 30,						For The Six Months Ended June 30,
	2016			2015			2016			2015
Derivatives designated as cash flow hedges
Net change in unrealized losses on cash flow hedging derivatives, net of tax (effective portion)	$	(905	)	$	1,694		$	(3,010	)	$	522
Net reclassification adjustment for effective portion of cash flow hedges included in interest expense (effective portion), gross	$	(622	)	$	(158	)	$	(987	)	$	(501	)

The Company expects approximately $2.1 million (pre-tax) to be reclassified to interest expense from OCI, related to the Company’s cash flow hedges, in the next twelve months. This reclassification is due to anticipated payments that will be made and/or received on the swaps based upon the forward curve as of June 30, 2016.