COMMITMENTS, CONTINGENCIES AND DERIVATIVES

Legal Contingencies

In the normal course of business, the Company and its subsidiary 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 statements.

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 March 31, 2017 and December 31, 2016, 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:



	March 31, 2017		December 31, 2016
Lending-Related Instruments:
Loan origination commitments and unadvanced lines of credit:
Home equity	$	464,909	$	454,225
Commercial and commercial real estate	56,515		83,103
Residential	30,949		17,795
Letters of credit	2,858		2,580
Other commitments	428		432
Derivative Financial Instruments:
Customer loan swaps	$	557,798	$	532,526
FHLBB advance interest rate swaps	50,000		50,000
Junior subordinated debt interest rate swaps	43,000		43,000
Interest rate lock commitments	18,821		15,249
Forward delivery commitments	5,715		15,125

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. The Company accounts for its interest rate lock commitments on loans within the normal origination process for which it intends to sell as a derivative instrument. Furthermore, the Company records a derivative for its "best-effort" forward delivery commitments upon origination of a loan identified as held for sale. Should the Company enter into a forward delivery commitment on a mandatory delivery arrangement with an investor it accounts for the forward delivery commitment upon execution of the contract.

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 for 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 has entered into a master netting arrangement with its counterparty and settles payments with the counterparty quarterly on a net basis. The interest rate swap arrangements contain provisions that require the Company to post cash or other assets as 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. At March 31, 2017, the Company had $8.4 million of cash posted as collateral to the counterparty. The collateral posted by the Company was not readily available and has been presented within cash and due from banks on the consolidated statements of condition.

The details of the junior subordinated debt interest rate swaps for the periods indicated were as follows:



						March 31, 2017			December 31, 2016
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%	$	(733	)	$	(806	)
10,000		7/8/2009	6/30/2029	3-Month USD LIBOR	5.84%	(2,214		)	(2,321		)
10,000		5/6/2010	6/30/2030	3-Month USD LIBOR	5.71%	(2,186		)	(2,290		)
5,000		3/14/2011	3/30/2031	3-Month USD LIBOR	5.75%	(1,160		)	(1,211		)
8,000		5/4/2011	7/7/2031	3-Month USD LIBOR	5.56%	(1,665		)	(1,744		)
$	43,000					$	(7,958	)	$	(8,372	)


(1)	Presented within accrued interest and other liabilities on the consolidated statements of condition.

For the three months ended March 31, 2017 and 2016, 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 three months ended March 31, 2017 and 2016 were $346,000 and $316,000, respectively, and were classified as cash flows from operating activities in the Company's 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 months ended March 31, 2017 and 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 March 31, 2017, the Bank did not have any cash or other assets posted as collateral to the counterparty.

The details of the FHLBB advance interest rate swaps for the periods indicated were as follows:



						March 31, 2017			December 31, 2016
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%	$	(74	)	$	(152	)
25,000		2/25/2015	2/25/2019	1-Month USD LIBOR	1.74%	(134		)	(237		)
$	50,000					$	(208	)	$	(389	)


(1)	Presented within accrued interest and other liabilities on the consolidated statements of condition.

Net payments to the counterparty for the three months ended March 31, 2017 and 2016 were $109,000 and $49,000, respectively, and were classified as cash flows from operating activities in the consolidated statements of cash flows.

Customer Loan Swaps:

The Bank 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 Bank 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 Bank'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 Bank'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:



		March 31, 2017						December 31, 2016
	Balance Sheet Location	Number of Positions	Notional		Fair Value			Number of Positions	Notional		Fair Value
Receive fixed, pay variable	Other assets / (accrued interest and other liabilities)	31	$	157,291	$	(4,683	)	50	$	266,263	$	(1,945	)
Receive fixed, pay variable	Other assets / (accrued interest and other liabilities)	23	121,608		1,877			—	—		—
Pay fixed, receive variable	Other assets / (accrued interest and other liabilities)	54	278,899		2,806			50	266,263		1,945
Total		108	$	557,798	$	—		100	$	532,526	$	—

The Bank 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 Bank 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 has entered into a master netting arrangement with its counterparty and settles payments with the counterparty quarterly on a net basis. The Bank's arrangement with an institutional counterparty requires it to post cash or other assets as 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 March 31, 2017, the Company did not have any cash or other assets posted as collateral with the counterparty.

Interest Rate Locks Commitments:

As part of the origination process of a residential loan, the Company may enter into rate lock agreements with its borrower, which is considered an interest rate lock commitment. If the Company has the intention to sell the loan upon origination, it will account for the interest rate lock commitment as a derivative. Our pipeline of mortgage loans with fixed-rate interest rate lock commitments were as follows for the periods indicated:



		March 31, 2017					December 31, 2016
	Balance Sheet Location	Notional		Fair Value			Notional		Fair Value
Fixed-rate mortgage interest rate locks	Other Assets	$	14,342	$	219		$	12,310	$	202
Fixed-rate mortgage interest rate locks	Accrued interest and other liabilities	4,479		(44		)	2,939		(15		)
Total		$	18,821	$	175		$	15,249	$	187

For the three months ended March 31, 2017 and 2016, the net unrealized (loss) gain 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 $(12,000) and $292,000, respectively.

Forward Delivery Commitments:

The Company typically enters into a forward delivery commitment with a secondary market investor, which has been approved by the Company within its normal governance process, at the onset of the loan origination process. The Company may enter into these arrangements with the secondary market investors on a "best effort" or "mandatory delivery" basis. The Company's normal practice is to typically enter into these arrangements on a "best effort" basis. The Company enters into these arrangements with the secondary market investors to manage its interest rate exposure. The Company accounts for the forward delivery commitment as a derivative (but does not designate as a hedge) upon origination of a loan for which it intends to sell. The Company's forward delivery commitments on loans held for sale was as follows for the periods indicated:



		March 31, 2017				December 31, 2016
	Balance Sheet Location	Notional		Fair Value		Notional		Fair Value
Forward delivery commitments ("best-effort")	Other Assets	$	5,715	$	160	$	14,250	$	587
Forward delivery commitments ("best-effort")	Accrued interest and other liabilities	—		—		875		(309		)
Total		$	5,715	$	160	$	15,125	$	278

For the three months ended March 31, 2017 and 2016, the net unrealized (loss) gain from the change in fair value on the Company's forward delivery commitments reported within mortgage banking income, net on the consolidated statements of income were $(118,000) and $0, 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 March 31,
	2017		2016
Derivatives designated as cash flow hedges:
Effective portion of unrealized gains (losses) recognized within AOCI during the period, net of tax	$	90	$	(2,342	)
Net reclassification adjustment for effective portion of cash flow hedges included in interest expense, gross⁽¹⁾	$	455	$	365

(1) Reclassified into the consolidated statements of income within interest on subordinated debentures.

The Company expects approximately $1.4 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 March 31, 2017.