DERIVATIVES AND HEDGING ACTIVITIES

3 Months Ended

Mar. 31, 2022

DERIVATIVES AND HEDGING ACTIVITIES

DERIVATIVES AND HEDGING ACTIVITIES

NOTE 16: DERIVATIVES AND HEDGING ACTIVITIES

Risk Management Objective of Using Derivatives

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of its assets and liabilities. In the normal course of business, the Company may use derivative financial instruments (primarily interest rate swaps) from time to time to assist in its interest rate risk management. The Company has interest rate derivatives that result from a service provided to certain qualifying loan customers that are not used to manage interest rate risk in the Company’s assets or liabilities and are not designated in a qualifying hedging relationship. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions. In addition, the Company has interest rate derivatives that are designated in a qualified hedging relationship.

Nondesignated Hedges

The Company has interest rate swaps that are not designated as qualifying hedging relationships. Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain loan customers, which the Company began offering during 2011. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.

As part of the Valley Bank FDIC-assisted acquisition, the Company acquired seven loans with related interest rate swaps. Valley’s swap program differed from the Company’s in that Valley did not have back to back swaps with the customer and a counterparty. Six of the seven acquired loans with interest rate swaps have paid off. The aggregate notional amount of the remaining Valley swaps was $468,000 and $482,000 at March 31, 2022 and December 31, 2021, respectively. At March 31, 2022, excluding the Valley Bank swaps, the Company had nine interest rate swaps and one interest rate cap totaling $94.2 million in notional amount with commercial customers, and nine interest rate swaps and one interest rate cap with the same aggregate notional amount with third parties related to its program. In addition, the Company has four participation loans purchased totaling $27.1 million, in which the lead institution has an interest rate swap with its customer and the economics of the counterparty swap are passed along to the Company through the loan participation. At December 31, 2021, excluding the Valley Bank swaps, the Company had 11 interest rate swaps and one interest rate cap totaling $93.9 million in notional amount with commercial customers, and 11 interest rate swaps and one interest rate cap with the same notional amount with third parties related to its program. During the three months ended March 31, 2022, the Company recognized net gains of $152,000, compared to net gains of $474,000 during the three months ended March 31, 2021, in noninterest income related to changes in the fair value of these swaps.

Cash Flow Hedges

Interest Rate Swap. As a strategy to maintain acceptable levels of exposure to the risk of changes in future cash flows due to interest rate fluctuations, in October 2018, the Company entered into an interest rate swap transaction as part of its ongoing interest rate management strategies to hedge the risk of its floating rate loans. The notional amount of the swap was $400 million with a termination date of October 6, 2025. Under the terms of the swap, the Company received a fixed rate of interest of 3.018% and paid a floating rate of interest equal to one-month USD-LIBOR. The floating rate was reset monthly and net settlements of interest due to/from the counterparty also occurred monthly. To the extent that the fixed rate of interest exceeded one-month USD-LIBOR, the Company received net interest settlements which were recorded as loan interest income. If USD-LIBOR exceeded the fixed rate of interest, the Company was required to pay net settlements to the counterparty and record those net payments as a reduction of interest income on loans.

In March 2020, the Company and its swap counterparty mutually agreed to terminate the $400 million interest rate swap prior to its contractual maturity. The Company received a payment of $45.9 million from its swap counterparty as a result of this termination. This $45.9 million, less the accrued interest portion and net of deferred income taxes, is reflected in the Company’s stockholders’ equity as Accumulated Other Comprehensive Income and a portion of it will be accreted to interest income on loans monthly through the original contractual termination date of October 6, 2025. This has the effect of reducing Accumulated Other Comprehensive Income and increasing Net Interest Income and Retained Earnings over the period. The Company currently expects to have a sufficient amount of eligible variable rate loans to continue to accrete this interest income in future periods. If this expectation changes and the amount of eligible variable rate loans decreases significantly, the Company may be required to recognize this interest income more rapidly.

In February 2022, the Company entered into an interest rate swap transaction as part of its ongoing interest rate management strategies to hedge the risk of its floating rate loans. The notional amount of the swap is $300 million with an effective date of March 1, 2022 and a termination date of March 1, 2024. Under the terms of the swap, the Company will receive a fixed rate of interest of 1.6725% and will pay a floating rate of interest equal to one-month USD-LIBOR (or the equivalent replacement rate if USD-LIBOR rate is not available). The floating rate will be reset monthly and net settlements of interest due to/from the counterparty will also occur monthly. The floating rate of interest was 0.2414% as of March 31, 2022. Therefore, in the near term, the Company will receive net interest settlements which will be recorded as loan interest income, to the extent that the fixed rate of interest continues to exceed one-month USD-LIBOR. If USD-LIBOR exceeds the fixed rate of interest in future periods, the Company will be required to pay net settlements to the counterparty and will record those net payments as a reduction of interest income on loans.

The Company recorded loan interest income of $2.0 million on the terminated interest rate swap during each of the three months ended March 31, 2022 and 2021. The Company recorded loan interest income of $370,000 on the active interest rate swap during the three months ended March 31, 2022.The effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affected earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. During each of the three months ended March 31, 2022 and 2021, the Company recognized no noninterest income related to changes in the fair value of these derivatives. The Company currently expects to have an amount of eligible variable rate loans to continue to accrete this interest income in future periods. If this expectation changes and the amount of eligible variable rate loans decreases significantly, the Company may be required to recognize this interest income more rapidly.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Statements of Financial Condition:

	Location in	Fair Value
	Consolidated Statements	March 31,		December 31,
	of Financial Condition	2022		2021
		(In Thousands)
Derivatives designated as hedging instruments
Active interest rate swap	Accrued expenses and other liabilities	$	3,994	$	—
Total derivates designated as hedging instruments		$	3,994	$	—
Derivatives not designated as hedging instruments
Asset Derivatives
Interest rate products	Prepaid expenses and other assets	$	5,191	$	2,816
Total derivatives not designated as hedging instruments		$	5,191	$	2,816
Liability Derivatives
Interest rate products	Accrued expenses and other liabilities	$	5,118	$	2,895
Total derivatives not designated as hedging instruments		$	5,118	$	2,895

The following table presents the effect of cash flow hedge accounting on the statements of comprehensive income:

	Amount of Gain (Loss)
	Recognized in AOCI
	Three Months Ended March 31,
Cash Flow Hedges	2022		2021
	(In Thousands)
Terminated interest rate swap, net of income taxes	$	(1,547)	$	(1,546)
Active interest rate swap, net of income taxes		(3,083)		—
	$	(4,630)	$	(1,546)

The following table presents the effect of cash flow hedge accounting on the statements of income:

	Three Months Ended March 31,
Cash Flow Hedges	2022				2021
	Interest		Interest		Interest		Interest
	Income		Expense		Income		Expense
	(In Thousands)
Total Interest Income	$	46,673	$	—	$	47,709	$	—
Total Interest Expense		—		3,407		—		6,544
	$	46,673	$	3,407	$	47,709	$	6,544
Terminated interest rate swap	$	2,003	$	—	$	2,003	$	—
Active interest rate swap		370		—		—		—
	$	2,373	$	—	$	2,003	$	—

Agreements with Derivative Counterparties

The Company has agreements with its derivative counterparties. If the Company defaults on any of its indebtedness, including a default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. If the Bank fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements. Similarly, the Company could be required to settle its obligations under certain of its agreements if certain regulatory events occur, such as the issuance of a formal directive, or if the Company’s credit rating is downgraded below a specified level.

At March 31, 2022, the termination value of derivatives with our derivative dealer counterparties (related to loan level swaps with commercial lending customers and an active interest rate swap to hedge risk related to the Company's variable rate loans) in an overall net liability position, which included accrued interest but excluded any adjustment for nonperformance risk, related to these agreements was $1.5 million. The Company has minimum collateral posting thresholds with its derivative dealer counterparties. At March 31, 2022, the Company had received cash collateral from another derivative counterparty of $1.8 million to cover its fair value position with us. At March 31, 2022, the Company did not have any activity with its derivative counterparties that met the level at which the Company’s minimum collateral posting thresholds take effect (requiring collateral to be given by the Company).

At December 31, 2021, the termination value of derivatives with our derivative dealer counterparties (related to loan level swaps with commercial lending customers) in a net liability position, which included accrued interest but excluded any adjustment for nonperformance risk, related to these agreements was $437,000. Additionally, the Company’s activity with one of its derivative counterparties met the level at which the Company’s minimum collateral posting thresholds take effect (requiring collateral to be given by the Company) and the Company posted collateral of $1.2 million to the derivative counterparty to satisfy the loan level agreements. Also at December 31, 2021, the Company had received cash collateral from another derivative counterparty of $390,000 to cover its fair value position with us.

If the Company had breached any of these provisions at March 31, 2022 or December 31, 2021, it could have been required to settle its obligations under the agreements at the termination value. Under the collateral agreements between the parties, either party may choose to provide cash or securities to satisfy its collateral requirements.