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, and based on the information currently available, management believes that 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 June 30, 2019 and December 31, 2018, the Company did not have any material loss contingencies for which accruals were provided for and/or that were required to be disclosed.

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 off-balance sheet financial instruments:



(In thousands)	June 30, 2019		December 31, 2018
Lending-Related Instruments:
Commitments to extend credit	$	737,371	$	654,575
Standby letters of credit	5,887		3,063
Derivative Financial Instruments:
Customer loan swaps	$	818,514	$	833,030
Interest rate swap on loans	100,000		—
Junior subordinated debt interest rate swaps	43,000		43,000
Fixed-rate mortgage interest rate lock commitments	34,814		12,077
Forward delivery commitments	13,088		4,315
FHLBB advance interest rate swaps	—		25,000

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. Of the total commitments to extend credit, $285.0 million and $270.8 million were unconditionally cancellable by the Company at June 30, 2019 and December 31, 2018, respectively.

Standby letters of credit are conditional commitments issued to guarantee the performance of a borrower to a third party. In the event of nonperformance by the borrower, the Company would be required to fund the commitment and would be entitled to the underlying collateral, if applicable, which generally consists of pledges of business assets including, but not limited to, accounts receivable, inventory, plant and equipment, and/or real estate. The maximum potential future payments are limited to the contractual amount of the commitment.

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 effort" basis, with certain approved investors. The Company accounts for its interest rate lock commitments on loans that will be held for sale as derivative instruments. 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 as a derivative upon execution of the mandatory delivery 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.

At June 30, 2019, the Company designated its interest rate swaps on its junior subordinated debentures and its interest rate swap on loans as cash flow hedges. The change in the fair value for cash flow hedges is accounted for within AOCI, net of tax. Quarterly, in conjunction with financial reporting, each cash flow hedge is assessed for ineffectiveness. To the extent any significant ineffectiveness is identified, this amount is recorded within the consolidated statements of income. The gain or loss on the effective portion of the cash flow hedge is reclassified from AOCI into interest within the consolidated statements of income in the period the hedged transaction affects earnings.

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

Customer Loan Swaps:

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

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 them 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 dates indicated:



(In thousands, except number of positions)		June 30, 2019						December 31, 2018
(In thousands, except number of positions)	Presentation on Consolidated Statements of Condition	Number of Positions	Notional Amount		Fair Value			Number of Positions	Notional Amount		Fair Value
Receive fixed, pay variable	Accrued interest and other liabilities	12	$	42,916	$	(541	)	57	$	297,624	$	(7,841	)
Receive fixed, pay variable	Other assets	72	366,341		17,143			25	118,891		3,467
Pay fixed, receive variable	(Accrued interest and other liabilities) / other assets	84	409,257		(16,602		)	82	416,515		4,374
Total		168	$	818,514	$	—		164	$	833,030	$	—

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 as necessary. The Bank's arrangement with its institutional counterparty requires it to post cash or other assets as collateral for its customer loan swap contracts in a net liability position based on their fair values and the Bank's credit rating or receive cash collateral for contracts in a net asset position as requested. At June 30, 2019, the Bank posted to the counterparty $17.8 million of cash as collateral on its customer loan swap contracts which was presented within other assets on the consolidated statements of condition. Refer to Note 9 for further discussion of master netting arrangements and presentation within the Company's consolidated financial statements.

Interest Rate Swap on Loans:

On June 12, 2019, the Bank entered into a $100.0 million interest rate swap contract with a counterparty to manage interest rate risk associated with its variable-rate loans. The Company has entered into a master netting arrangement with the counterparty and settles payments monthly on a net basis. The Bank's arrangement with the counterparty requires it to post collateral for its interest rate swap on loans that is in a net liability position based on its fair value. If the interest rate swap is in a net asset position based on its fair value, the counterparty will post collateral to the Bank as requested. At June 30, 2019, neither the Bank nor the counterparty had posted any collateral. Refer to Note 9 for further discussion of master netting arrangements and presentation within the Company's consolidated financial statements.

The details of the interest rate swap for the date indicated was as follows:

(Dollars in thousands)

June 30, 2019

Trade
Date

Maturity Date

Variable Index
Paid

Fixed Rate
Received

Presentation on Consolidated Statements of Condition

Notional
Amount

Fair

Value

6/12/2019

6/10/2024

1-Month

USD LIBOR

1.693%

Other assets

100,000

262

For the three and six months ended June 30, 2019, the Company did not record any ineffectiveness within the consolidated statements of income.

Net payments paid to the counterparty for the six months ended June 30, 2019 were $34,000 and were classified as cash flows from operating activities in the Company's consolidated statements of cash flows.

Junior Subordinated Debt Interest Rate Swaps:

The Company entered into five interest rate swap agreements with a counterparty to manage interest rate risk associated with the Company's variable rate borrowings. Each interest rate swap was designated as a cash flow hedge. The Company 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 will post collateral to the Company as requested. At June 30, 2019, the Company posted $8.7 million of cash as collateral to the counterparty and was presented within other assets on the consolidated statements of financial condition. Refer to Note 9 for further discussion of master netting arrangements and presentation within the Company's consolidated financial statements.

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



(Dollars in thousands)					June 30, 2019					December 31, 2018
Trade Date	Maturity Date	Variable Index Received	Fixed Rate Paid	Presentation on Consolidated Statements of Condition	Notional Amount		Fair Value			Notional Amount		Fair Value
3/18/2009	6/30/2021	3-Month USD LIBOR	5.09%	Accrued interest and other liabilities	$	10,000	$	(383	)	$	10,000	$	(272	)
7/8/2009	6/30/2029	3-Month USD LIBOR	5.84%	Accrued interest and other liabilities	10,000		(2,353		)	10,000		(1,655		)
5/6/2010	6/30/2030	3-Month USD LIBOR	5.71%	Accrued interest and other liabilities	10,000		(2,396		)	10,000		(1,636		)
3/14/2011	3/30/2031	3-Month USD LIBOR	4.35%	Accrued interest and other liabilities	5,000		(1,279		)	5,000		(877		)
5/4/2011	7/7/2031	3-Month USD LIBOR	4.14%	Accrued interest and other liabilities	8,000		(1,895		)	8,000		(1,242		)
					$	43,000	$	(8,306	)	$	43,000	$	(5,682	)

For the three and six months ended June 30, 2019 and 2018, 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, 2019 and 2018 were $318,000 and $489,000, respectively, and were classified as cash flows from operating activities in the Company's consolidated statements of cash flows.

Fixed-Rate Mortgage Interest Rate Lock 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. The Company's pipeline of mortgage loans with fixed-rate interest rate lock commitments for which it intends to sell the loan upon origination were as follows for the dates indicated:



		June 30, 2019					December 31, 2018
(In thousands)	Presentation on Consolidated Statements of Condition	Notional Amount		Fair Value			Notional Amount		Fair Value
Fixed-rate mortgage interest rate locks	Other assets	$	31,100	$	516		$	8,239	$	95
Fixed-rate mortgage interest rate locks	Accrued interest and other liabilities	3,714		(45		)	3,838		(28		)
Total		$	34,814	$	471		$	12,077	$	67

For the three months ended June 30, 2019 and 2018, the net unrealized gain from the change in fair value on the Company's fixed-rate mortgage rate locks reported within mortgage banking income, net, on the consolidated statements of income was $223,000 and $4,000, respectively. For the six months ended June 30, 2019 and 2018, the net unrealized gain (loss) from the change in fair value on the Company's fixed-rate mortgage rate locks reported within mortgage banking income, net, on the consolidated statements of income was $404,000 and ($8,000), 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 typically to 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 it as a hedge) upon origination of a loan identified as held for sale.

The Company's forward delivery commitments on loans held for sale for the dates indicated were as follows:



		June 30, 2019					December 31, 2018
(In thousands)	Balance Sheet Location	Notional		Fair Value			Notional		Fair Value
Forward delivery commitments ("best effort")	Other Assets	$	11,559	$	272		$	2,593	$	32
Forward delivery commitments ("best effort")	Accrued interest and other liabilities	1,529		(15		)	1,722		(17		)
Total		$	13,088	$	257		$	4,315	$	15

For the three months ended June 30, 2019 and 2018, the net unrealized 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 was $159,000 and $69,000, respectively. For the six months ended June 30, 2019 and 2018, the net unrealized 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 was $242,000 and $50,000, respectively.

FHLBB Advance Interest Rate Swaps:

On February 25, 2015, the Bank entered into two $25.0 million one-year forward-starting interest rate swap arrangements with a counterparty to mitigate short-term interest rate risk. On February 25, 2019, the last $25.0 million tranche matured.

The details of the Company's FHLBB advance interest rate swaps for the dates indicated were as follows:

(Dollars in thousands)

June 30, 2019

December 31, 2018

Trade
Date

Maturity Date

Variable Index
Received

Fixed Rate
Paid

Presentation on Consolidated Statements of Condition

Notional
Amount

Fair

Value

Notional
Amount

Fair

Value

2/25/2015

2/25/2019

1-Month

USD LIBOR

1.74%

Other assets

—

25,000

Net payments received from the counterparty for the six months ended June 30, 2019 and 2018 were $32,000 and $2,000, respectively, and were classified as cash flows from operating activities in the consolidated statements of cash flows.

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,
(In thousands)	2019			2018		2019			2018
Derivatives designated as cash flow hedges:
Effective portion of unrealized (losses) gains recognized within OCI during the period, net of tax	$	(1,203	)	$	414	$	(2,128	)	$	1,570
Net reclassification adjustment for effective portion of cash flow hedges included in interest expense, gross	$	201		$	203	$	320		$	487

The Company expects approximately $1.3 million (pre-tax) to be reclassified to interest expense from AOCI, related to the Company’s cash flow hedges, in the next 12 months. This reclassification is due to anticipated payments that will be made on the swaps based upon the forward curve as of June 30, 2019.