Derivatives

The Company utilizes derivative instruments as a part of its asset-liability management program to control fluctuation of market values and cash flows to changes in interest rates associated with certain financial instruments. The Company accounts for derivatives in accordance with ASC 815, "Derivatives and Hedging". Under current guidance, derivative transactions are classified as either cash flow hedges or fair value hedges or they are not designated as hedging instruments. The Company designates each derivative instrument at the inception of the derivative transaction in accordance with this guidance. Information concerning each of the Company's categories of derivatives as of December 31, 2014 and 2013 is presented below.

Derivatives designated as cash flow hedges

During 2010, the Company entered into an interest rate swap agreement as part of the interest rate risk management process. The swap was designated as a cash flow hedge intended to hedge the variability of cash flows associated with the Company’s trust preferred capital securities described in Note 19, “Subordinated Notes”. The swap hedges the cash flow associated with the trust preferred capital notes wherein the Company receives a floating rate based on LIBOR from a counterparty and pays a fixed rate of 2.59% to the same counterparty. The swap is calculated on a notional amount of $5.2 million. The term of the swap is 10 years and commenced on October 23, 2010. The swap was entered into with a counterparty that met the Company’s credit standards and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant.

During 2013, the Company entered into an interest rate swap agreement as part of the interest rate risk management process. The swap has been designated as a cash flow hedge intended to hedge the variability of cash flows associated with the Company’s FHLB borrowings described in Note 7, “Borrowings”. The swap hedges the cash flows associated with the FHLB borrowings wherein the Company receives a floating rate based on LIBOR from a counterparty and pays a fixed rate of 1.43% to the same counterparty. The swap is calculated on a notional amount of $10 million. The term of the swap is 5 years and commenced on November 25, 2013. The swap was entered into with a counterparty that met the Company’s credit standards and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant.

Amounts receivable or payable are recognized as accrued under the terms of the agreement, with the effective portion of the derivative’s unrealized gain or loss recorded as a component of other comprehensive income. The ineffective portion of the unrealized gain or loss, if any, would be recorded in other income or other expense. The Company has assessed the effectiveness of the hedging relationship by comparing the changes in cash flows on the designated hedged item. As a result of this assessment, hedge ineffectiveness for this interest rate swap of $6,000 was identified during 2014 and is classified as other operating expenses on the consolidated statements of income.

The amounts included in accumulated other comprehensive income (loss) as unrealized losses (market value net of tax) were $185,000 and $29,000 as of December 31, 2014 and 2013, respectively.

Information concerning the derivative designated as a cash flow hedge at December 31, 2014 and 2013 is presented in the following tables:



	December 31, 2014
(Dollars in thousands)	Positions (#)	Notional Amount		Asset		Liability		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	5,155	$	—	$	213	0.23	%	2.59	%	5.8
Pay fixed - receive floating interest rate swap	1	$	10,000	$	—	$	74	0.16	%	1.43	%	4.0



	December 31, 2013
(Dollars in thousands)	Positions (#)	Notional Amount		Asset		Liability		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	5,155	$	—	$	72	0.23	%	2.59	%	6.8
Pay fixed - receive floating interest rate swap	1	$	10,000	$	102	$	—	0.17	%	1.43	%	5.0

Derivatives designated as fair value hedges

The Company will from time to time utilize derivatives to limit exposure to the variability of fair market values of certain financial instruments. Information below is presented on derivatives designated as fair value hedges as of December 31, 2014 and 2013.

Mortgage banking activities

As a result of the Company's affiliation with Southern Trust Mortgage, and as part of the related mortgage banking activities, Southern Trust Mortgage entered into interest rate lock commitments which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding and the customers have locked the interest rate. The period of time between the origination of a loan commitment and closing and sale of the loan generally ranges from 60 to 120 days. Southern Trust Mortgage either locked the loan and associated rate in with an investor and committed to deliver the loan only if settlement occurs ("best efforts delivery") or it committed to deliver the locked loan in a binding ("mandatory") delivery program with an investor. Because of the high correlation between best efforts delivery contracts and interest rate lock commitments, no gain or loss was recognized on best efforts contracts and any resulting interest rate risk associated with these transactions was borne by the ultimate purchaser of the loan. Accordingly, as of December 31, 2013, the Company did not designate best efforts delivery contracts and the related interest rate lock commitments as hedging instruments (See discussion below under "Derivatives not designated as hedging instruments"). On May 15, 2014, the Company sold all of its majority interest in Southern Trust Mortgage and as a result, on this date, this activity ceased.

Mandatory delivery of mortgage loans

For the portion of interest rate lock commitments that were designated to be delivered under a mandatory delivery method, the Company, through its affiliation with Southern Trust Mortgage, bore the risk of changes in value of the commitment from the time a rate was locked with the mortgage customer until a loan was closed and ultimately sold to an investor. To mitigate this risk, the Company entered into forward sales contracts of mortgage backed securities ("MBS") with similar characteristics to the rate lock commitments. Both the rate lock commitments and the associated forward sales contracts were designated as fair value hedges by the Company as of December 31, 2013. On May 15, 2014, the Company sold all of its ownership interest in Southern Trust Mortgage and as a result, on this date, this activity ceased. Until the sate of sale, rate lock commitments and forward sales contracts of MBS were recorded at fair value with changes in fair value recorded through non-interest income on the consolidated statements of income.

The notional amount of interest rate lock commitments related to mandatory delivery methods totaled $22.2 million at December 31, 2013. This represented a total of 110 open interest rate lock commitments under mandatory delivery at December 31, 2013. The fair value of the open interest rate lock commitments under mandatory delivery at December 31, 2013 were $16,000.

At December 31, 2013, Southern Trust Mortgage had 27 open forward sales contracts of MBS with a notional value of $33.0 million. The fair value of these open forward sales contracts was $202,000 at December 31, 2013. Certain additional risks could arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. At December 31, 2013, we did not expect any counterparty to fail to meet its obligations. Additional risks inherent in mandatory delivery programs include the risk that if Southern Trust Mortgage did not close the loans subject to interest rate lock commitments, they would be obligated to deliver MBS to the counterparty under the forward sales agreement. If this would have been required, Southern Trust Mortgage could have incurred significant costs in acquiring replacement loans or MBS. On May 15, 2014, the Company sold all of its majority interest in Southern Trust Mortgage and as a result, on this date, this activity ceased.

Derivatives not designated as hedging instruments

Best efforts delivery mortgage banking derivatives

Interest rate lock commitments under best efforts delivery and the resulting commitments to deliver loans to investors on a best efforts basis are considered derivatives. For loans to be delivered under a best efforts delivery method, the Company mitigates any risk from changes in interest rates through the use of best effort forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the investor has assumed interest rate risk on the loan. As a result, the Company is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates. The correlation between the rate lock commitment and the best efforts contracts is very high.

As of December 31, 2013, the notional amount of open best efforts interest rate lock commitments was $103.5 million. The related notional amounts of open forward sales commitments to investors as of December 31, 2013 was $114.4 million.

The market value of best effort rate lock commitments and best efforts forward delivery contracts is not readily ascertainable with

precision because the rate lock commitments and best efforts contracts are not actively traded in stand-alone markets. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments.

Since the time between when a loan is locked under a best efforts contract and delivery of that loan to an investor is short, and the investor has committed to purchase the loan at an agreed-upon price, if it settles, we have concluded that the difference between the fair value of the loans and the fair value of the best efforts commitments was not material.

On May 15, 2014, the Company sold all of its majority interest in Southern Trust Mortgage and as a result, on this date, this activity ceased.

Two-way client loan swaps

During the fourth quarter of 2014 and 2012, the Company entered into certain interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which we enter into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on an identical notional amount at a fixed interest rate. At the same time, the Company agrees to pay the counterparty the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows our clients to effectively convert a variable rate loan into a fixed rate loan. Because the Company acts as an intermediary for our customers, changes in the fair value of the underlying derivatives contracts offset each other and do not significantly impact our results of operations. The Company had no undesignated interest rate swaps at December 31, 2014 and December 31, 2013.

Certain additional risks arise from interest rate swap contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. We do not expect any counterparty to fail to meet its obligations.

Information concerning two-way client interest rate swaps not designated as either fair value or cash flow hedges is presented in the following table:



	December 31, 2014
(Dollars in thousands)	Positions (#)	Notional Amount		Asset		Liability		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	4,002	$	—	$	19	1 month LIBOR plus 200 BP		3.90	%	12.9
Pay fixed - receive floating interest rate swap	1	1,747		—		31		1 month LIBOR plus 180 BP		4.09	%	9.9
Pay floating - receive fixed interest rate swap	1	4,002		19		—		3.90	%	1 month LIBOR plus 200 BP		12.9
Pay floating - receive fixed interest rate swap	1	1,747		31		—		4.09	%	1 month LIBOR plus 180 BP		9.9
Total derivatives not designated		$	11,498	$	50	$	50



	December 31, 2013
(Dollars in thousands)	Positions (#)	Notional Amount (in thousands)		Asset		Liability		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	4,235	$	—	$	232	1 month LIBOR plus 200 BP		3.90	%	13.9
Pay floating - receive fixed interest rate swap	1	4,235		232		—		3.90	%	1 month LIBOR plus 200 BP		13.9
Total derivatives not designated		$	8,470	$	232	$	232