DERIVATIVES AND HEDGING ACTIVITIES

The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally to manage the Company’s interest rate risk. Additionally, the Company enters into interest rate derivatives and foreign exchange contracts to accommodate the business requirements of its customers (“customer related positions”). The Company minimizes the market and liquidity risks of customer related positions by entering into similar offsetting positions with broker-dealers. 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 as a hedge for accounting purposes, and further, by the type of hedging relationship.

The Company does not enter into proprietary trading positions for any derivatives.

Interest Rate Positions

The Company currently utilizes interest rate swap agreements as hedging instruments against interest rate risk associated with the Company’s borrowings. An interest rate swap is an agreement whereby one party agrees to pay a floating rate of interest on a notional principal amount in exchange for receiving a fixed rate of interest on the same notional amount, for a predetermined period of time, from a second party. The amounts relating to the notional principal amount are not actually exchanged. The maximum length of time over which the Company is currently hedging its exposure to the variability in future cash flows for forecasted transactions related to the payment of variable interest on existing financial instruments is six years.

The following table reflects the Company’s derivative positions for the periods indicated below for interest rate swaps which qualify as cash flow hedges for accounting purposes:



June 30, 2013
Notional Amount		Trade Date	Effective Date	Maturity Date	Receive (Variable) Index	Current Rate Received		Pay Fixed Swap Rate		Fair Value
(Dollars in thousands)
$	25,000	16-Feb-06	28-Dec-06	28-Dec-16	3 Month LIBOR	0.27	%	5.04	%	$	(3,562	)
25,000		16-Feb-06	28-Dec-06	28-Dec-16	3 Month LIBOR	0.27	%	5.04	%	(3,563		)
25,000		8-Dec-08	10-Dec-08	10-Dec-13	3 Month LIBOR	0.27	%	2.65	%	(264		)
25,000		9-Dec-08	10-Dec-08	10-Dec-13	3 Month LIBOR	0.27	%	2.59	%	(258		)
25,000		9-Dec-08	10-Dec-08	10-Dec-18	3 Month LIBOR	0.27	%	2.94	%	(1,719		)
50,000		17-Nov-09	20-Dec-10	20-Dec-14	3 Month LIBOR	0.27	%	3.04	%	(1,955		)
25,000		5-May-11	10-Jun-11	10-Jun-15	3 Month LIBOR	0.27	%	1.71	%	(600		)
$	200,000									$	(11,921	)
December 31, 2012
Notional Amount		Trade Date	Effective Date	Maturity Date	Receive (Variable) Index	Current Rate Received		Pay Fixed Swap Rate		Fair Value
				(Dollars in thousands)
$	25,000	16-Feb-06	28-Dec-06	28-Dec-16	3 Month LIBOR	0.31	%	5.04	%	$	(4,416	)
25,000		16-Feb-06	28-Dec-06	28-Dec-16	3 Month LIBOR	0.31	%	5.04	%	(4,417		)
25,000		8-Dec-08	10-Dec-08	10-Dec-13	3 Month LIBOR	0.31	%	2.65	%	(553		)
25,000		9-Dec-08	10-Dec-08	10-Dec-13	3 Month LIBOR	0.31	%	2.59	%	(539		)
25,000		9-Dec-08	10-Dec-08	10-Dec-18	3 Month LIBOR	0.31	%	2.94	%	(2,819		)
50,000		17-Nov-09	20-Dec-10	20-Dec-14	3 Month LIBOR	0.31	%	3.04	%	(2,647		)
25,000		5-May-11	10-Jun-11	10-Jun-15	3 Month LIBOR	0.31	%	1.71	%	(798		)
$	200,000									$	(16,189	)

For derivative instruments that are designated and qualify as hedging instruments, the effective portion of the gains or losses is reported as a component of OCI, and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The Company expects approximately $5.0 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, 2013.

The Company had no fair value hedges as of June 30, 2013 or December 31, 2012.

The table below presents the net amortization income recognized as an offset to interest expense related to previously terminated swaps for the periods indicated:



	Three Months Ended				Six Months Ended
	June 30				June 30
	2013		2012		2013		2012
	(Dollars in thousands)				(Dollars in thousands)
Net amortization income	$	61	$	61	$	122	$	122

Customer Related Positions

Interest rate derivatives, primarily interest rate swaps, offered to commercial borrowers through the Bank’s loan level derivative program do not qualify as hedges for accounting purposes. The Bank believes that its exposure to commercial customer derivatives is limited because these contracts are simultaneously matched at inception with an offsetting dealer transaction. The commercial customer derivative program allows the Bank to retain variable-rate commercial loans while allowing the customer to synthetically fix the loan rate by entering into a variable-to-fixed interest rate swap.

Foreign exchange contracts offered to commercial borrowers through the Bank’s derivative program do not qualify as hedges for accounting purposes. The Bank acts as a seller and buyer of foreign exchange contracts to accommodate its customers. To mitigate the market and liquidity risk associated with these derivatives, the Bank enters into similar offsetting positions.

The following table reflects the Company’s customer related derivative positions for the periods indicated below for those derivatives not designated as hedging:



		Notional Amount Maturing
	# of Positions (1)	2013		2014	2015	2016	Thereafter	Total		Fair Value
	June 30, 2013
	(Dollars in thousands)
Loan level swaps
Receive fixed, pay variable	158	$	4,058	55,271	100,565	43,966	327,855	$	531,715	$	13,519
Pay fixed, receive variable	152	$	4,058	55,271	100,565	43,966	327,855	$	531,715	$	(13,543	)
Foreign exchange contracts
Buys foreign exchange, sells US currency	13	$	25,073	7,221	—	—	—	$	32,294	$	(64	)
Buys US currency, sells foreign exchange	13	$	25,073	7,221	—	—	—	$	32,294	$	78
	December 31, 2012
	(Dollars in thousands)
Loan level swaps
Receive fixed, pay variable	143	$	16,766	65,344	105,939	45,267	268,932	$	502,248	$	28,678
Pay fixed, receive variable	137	$	16,766	65,344	105,939	45,267	268,932	$	502,248	$	(28,663	)
Foreign exchange contracts
Buys foreign exchange, sells US currency	16	$	42,516	—	—	—	—	$	42,516	$	1,748
Buys US currency, sells foreign exchange	16	$	42,516	—	—	—	—	$	42,516	$	(1,718	)


(1)	The Company may enter into one swap agreement which offsets multiple reverse swap agreements. The positions will offset and the terms will be identical.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the balance sheet at the periods indicated:



	Asset Derivatives					Liability Derivatives
	Balance Sheet Location	Fair Value at June 30, 2013		Fair Value at December 31, 2012		Balance Sheet Location	Fair Value at June 30, 2013		Fair Value at December 31, 2012
	(Dollars in thousands)
Derivatives designated as hedges
Interest rate swaps	Other assets	$	—	$	—	Other liabilities	$	11,921	$	16,189
Derivatives not designated as hedges
Customer Related Positions:
Loan level swaps	Other assets	$	18,413	$	28,678	Other liabilities	$	18,437	$	28,663
Foreign exchange contracts	Other assets	291		1,748		Other liabilities	277		1,718
Total		$	18,704	$	30,426		$	18,714	$	30,381

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



	Three Months Ended						Six Months Ended
	June 30						June 30
	2013			2012			2013			2012
	(Dollars in thousands)						(Dollars in thousands)
Derivatives designated as hedges
Gain (loss) in OCI on derivatives (effective portion), net of tax	$	765		$	(1,227	)	$	763		$	(1,196	)
Loss reclassified from OCI into interest expense (effective portion)	$	(1,443	)	$	(1,346	)	$	(2,859	)	$	(2,638	)
Loss recognized in income on derivatives (ineffective portion & amount excluded from effectiveness testing)
Interest expense	$	—		$	—		$	—		$	—
Other expense	—			—			—			—
Total	$	—		$	—		$	—		$	—
Derivatives not designated as hedges
Changes in fair value of customer related positions
Other income	$	14		$	51		$	26		$	73
Other expense	(56		)	(9		)	(81		)	(19		)
Total	$	(42	)	$	42		$	(55	)	$	54

By using derivatives, the Company is exposed to credit risk to the extent that counterparties to the derivative contracts do not perform as required. Should a counterparty fail to perform under the terms of a derivative contract, the Company's credit exposure on interest rate swaps is limited to the net positive fair value and accrued interest of all swaps with each counterparty. The Company seeks to minimize counterparty credit risk through credit approvals, limits, monitoring procedures, and obtaining collateral, where appropriate. Institutional counterparties must have an investment grade credit rating and be approved by the Company's Board of Directors. As such, management believes the risk of incurring credit losses on derivative contracts with those counterparties is remote and losses, if any, would be immaterial. The Company had no exposure relating to interest rate swaps with institutional counterparties at June 30, 2013 and December 31, 2012, as all such swaps were in a liability position. The Company’s exposure relating to customer related positions was approximately $16.7 million and $31.0 million at June 30, 2013 and December 31, 2012, respectively. Credit exposure may be reduced by the amount of collateral pledged by the counterparty.

The Company does not offset fair value amounts recognized for derivative instruments. The Company does net the amount recognized for the right to reclaim cash collateral against the obligation to return cash collateral arising from derivative instruments executed with the same counterparty under a master netting arrangement. Collateral legally required to be maintained at dealer banks by the Company is monitored and adjusted as necessary. Per a review completed by management of these instruments at June 30, 2013 it was determined that no additional collateral would have to be posted to immediately settle these instruments.

The following table presents the Company's asset derivative positions and the potential effect of netting arrangements on its financial position, as of the periods indicated:



							Gross Amounts Not Offset in the Statement of Financial Position
Description	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Statement of Financial Position		Net Amounts of Assets Presented in the Statement of Financial Position		Financial Instruments (1)		Cash Collateral Received		Net Amount
	(Dollars in thousands)
	June 30, 2013
Interest rate swaps	$	—	$	—	$	—	$	—	$	—	$	—
Loan level swaps	18,413		—		18,413		1,735		—		16,678
Customer foreign exchange contracts	291		—		291		108		—		183
	$	18,704	$	—	$	18,704	$	1,843	$	—	$	16,861

	December 31, 2012
Interest rate swaps	$	—	$	—	$	—	$	—	$	—	$	—
Loan level swaps	28,678		—		28,678		—		—		28,678
Customer foreign exchange contracts	1,748		—		1,748		—		—		1,748
	$	30,426	$	—	$	30,426	$	—	$	—	$	30,426


(1)	Includes loan level swaps with customers which are not subject to a master netting arrangement and thus are not offset in the statement of financial position.

The following table presents the Company's liability derivative positions and the potential effect of netting arrangements on its financial position, as of the periods indicated:



							Gross Amounts Not Offset in the Statement of Financial Position
Description	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Statement of Financial Position		Net Amounts of Liabilities Presented in the Statement of Financial Position		Financial Instruments (1)		Cash Collateral Pledged		Net Amount
	(Dollars in thousands)
	June 30, 2013
Interest rate swaps	$	11,921	$	—	$	11,921	$	—	$	15,774	$	(3,853	)
Loan level swaps	18,437		—		18,437		1,735		15,797		905
Customer foreign exchange contracts	277		—		277		108		—		169
	$	30,635	$	—	$	30,635	$	1,843	$	31,571	$	(2,779	)

	December 31, 2012
Interest rate swaps	$	16,189	$	—	$	16,189	$	—	$	19,185	$	(2,996	)
Loan level swaps	28,663		—		28,663		—		31,772		(3,109		)
Customer foreign exchange contracts	1,718		—		1,718		—		—		1,718
	$	46,570	$	—	$	46,570	$	—	$	50,957	$	(4,387	)


(1)	Includes loan level swaps with customers which are not subject to a master netting arrangement and thus are not offset in the statement of financial position.

The Company has agreements with certain of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well capitalized institution, then the Company could be required to terminate any outstanding derivatives with the counterparty. Included in the table above are derivative instruments that contain credit-risk related contingent features that are in a net liability position, which require the Company to assign collateral. All liability position interest rate swap and customer loan level swap counterparties have credit-risk contingent instruments as of the dates indicated in the table above.

Mortgage Derivatives

Forward sale contracts of residential mortgage loans, considered derivative instruments for accounting purposes, are utilized by the Company in its efforts to manage risk of loss associated with its mortgage loan commitments and mortgage loans intended for sale. Prior to closing and funding certain one-to-four family residential mortgage loans, an interest rate lock commitment is generally extended to the borrower. During the period from commitment date to closing date, the Company is subject to the risk that market rates of interest may change. If market rates rise, investors generally will pay less to purchase such loans resulting in a reduction in the gain on sale of the loans or, possibly, a loss. In an effort to mitigate such risk, forward delivery sales commitments are executed, under which the Company agrees to deliver whole mortgage loans to various investors. The interest rate lock commitments and forward sales commitments are recorded at fair value, with changes in fair value recorded in current period earnings as a component of mortgage banking income. The Company has elected the fair value option to carry these instruments at fair value. Changes in the fair value marks on loans held for sale offset changes in interest rate lock and forward sales commitments. The change in fair value of loans held for sale is recorded in current period earnings as a component of mortgage banking income in accordance with the Company's fair value election.

The table below summarizes the fair value of residential mortgage loans commitments, forward sales agreements, and loans held for sale at the periods indicated:



	June 30, 2013			December 31, 2012
	(Dollars in thousands)
Interest rate lock commitments	$	(866	)	$	102
Forward sales agreements	$	2,092		$	(223	)
Loans held for sale fair value adjustments	$	(1,214	)	$	121

The table below summarizes the changes in the fair value of residential mortgage loans commitments, forward sales agreements, and loans held for sale at the periods indicated:



	Three Months Ended						Six Months Ended
	June 30						June 30
	2013			2012			2013			2012
	(Dollars in thousands)						(Dollars in thousands)
Interest rate lock commitments	$	(997	)	$	385		$	(968	)	$	101
Forward sales agreements	2,204			(766		)	2,315			(213		)
Loans held for sale fair value adjustments	(1,195		)	381			(1,335		)	112
Total change in fair value	$	12		$	—		$	12		$	—