Note 13 – Financial Instruments with Off-balance Sheet Risk and Derivatives

The Company is a party to interest rate derivatives that are not designated as hedging instruments. The Company has entered into these interest rate derivatives to facilitate customer transactions and meet their financing needs. These derivatives are interest rate swaps that the Company entered into with loan customers to allow the customers to convert variable rate loans to a fixed rate. Interest is paid to the customer at a floating rate based on the notional amount and the Company receives interest from the customer at a fixed rate for the same notional amount. Concurrent with the customer transaction, the Company enters into an offsetting interest rate swap with another financial institution. The Company pays the other financial institution at the same fixed rate on the same notional amount as the swap entered into with the customer, and receives interest from the financial institution for the same floating rate on the same notional amount. The changes in the fair value of the swaps offset each other. When the fair value of a derivative instrument contract is positive, this generally indicates that the counterparty or customer owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument contract is negative, the Company owes the customer or counterparty and therefore, has no credit risk to the Company. The notional value of commercial loan interest rate swaps outstanding was $46.8 million with a fair value of $1.9 million as of September 30, 2013 compared to $35.9 million with a fair value of $1.3 million as of December 31, 2012. The offsetting nature of the interest rate swaps results in a neutral effect on the Company’s operations. Fair values of the interest rate swaps are carried as both gross assets and gross liabilities in the condensed consolidated statements of condition. The associated net gains and losses on the interest rate swaps are recorded in other non-interest income.