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 September 30, 2015 and December 31, 2014 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. 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. 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 $10.0 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 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, there was no hedge ineffectiveness identified for the three and nine months ended September 30, 2015 and 2014. At December 31, 2014 there was $6,000 of hedge ineffectiveness identified for this interest rate swap.

The amounts included in accumulated other comprehensive income (loss) as unrealized losses (market value net of tax) were $318,000 and $185,000 as of September 30, 2015 and December 31, 2014, respectively.

Information concerning the derivatives designated as a cash flow hedges at September 30, 2015 and December 31, 2014 is presented in the following tables:



	September 30, 2015
	Positions (#)	Notional Amount (in thousands)		Asset (in thousands)		Liability (in thousands)		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	5,155	$	—	$	312	0.29	%	2.59	%	4.9
Pay fixed - receive floating interest rate swap	1	$	10,000	$	—	$	171	0.20	%	1.43	%	3.1



	December 31, 2014
	Positions (#)	Notional Amount (in thousands)		Asset (in thousands)		Liability (in thousands)		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

Derivatives not designated as hedging instruments

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 September 30, 2015 and December 31, 2014.

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:



	September 30, 2015
	Positions (#)	Notional Amount (in thousands)		Asset (in thousands)		Liability (in thousands)		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	3,821	$	—	$	62	1 month LIBOR plus 200 BP		3.90	%	12.0
Pay fixed - receive floating interest rate swap	1	1,716		—		74		1 month LIBOR plus 180 BP		4.09	%	9.0
Pay floating - receive fixed interest rate swap	1	3,821		62		—		3.90	%	1 month LIBOR plus 200 BP		12.0
Pay floating - receive fixed interest rate swap	1	1,716		74		—		4.09	%	1 month LIBOR plus 180 BP		9.0
Total derivatives not designated		$	11,074	$	136	$	136



	December 31, 2014
	Positions (#)	Notional Amount (in thousands)		Asset (in thousands)		Liability (in thousands)		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

Rate Cap Transaction

At September 30, 2015, the Company had one derivative instrument in the form of an interest rate cap agreement with a notional amount of $10.0 million. The notional amount of the financial derivative instrument does not represent exposure to credit loss. The Company is exposed to credit loss only to the extent the counter-party defaults in its responsibility to pay interest under the terms of the agreement. The credit risk in derivative instruments is mitigated by entering into transactions with highly-rated counterparties that management believes to be creditworthy and by limiting the amount of exposure to each counter-party. We do not expect any counterparty to fail to meet its obligations.

The details of the interest rate cap agreement as of September 30, 2015 is summarized below:



September 30, 2015
(Dollars in thousands)
Notional Amount		Termination Date	3-Month LIBOR Strike Rate		Premium Paid		Unamortized Premium at September 30, 2015		Fair Value September 30, 2015		Cumulative Cash Flows Received
$	10,000	September 8, 2018	2.00	%	$	70	$	70	$	35	$	—

In the third quarter of 2015, the interest rate cap agreement was purchased to limit the Company's exposure to rising interest rates. Under the terms of the agreement, the Company paid a premium of $70,000 for the right to receive cash flow payments if 3-month LIBOR rises above the cap of 2.00%, thus effectively ensuring interest expense is capped at a maximum rate of 2.00% for the duration of the agreement. The interest rate cap agreement is a derivative not designated as a hedging instrument.

At September 30, 2015, the total fair value of the interest rate cap agreement was $35,000. The fair value of the interest rate cap agreement is included in other assets on the Company's consolidated balance sheets. Changes in fair value are recorded in earnings in other operating expenses. At September 30, 2015, $35,000 was recognized in other operating expenses.

The premium paid on the interest rate cap agreement is recognized as an increase in interest expense over the duration of the agreement using the caplet method. For the three and nine months ended September 30, 2015, no premium amortization was required.