Derivative Financial Instruments and Hedging Activities

3 Months Ended

Mar. 31, 2024

Derivative Financial Instruments and Hedging Activities

Derivative Financial Instruments and Hedging Activities

NOTE 9. Derivative Financial Instruments and Hedging Activities

Derivative Financial Instruments

The Company has derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s Balance Sheet as “Prepaid expenses and other assets” or “Accrued expenses and other liabilities”.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to any derivative agreement. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.

Derivative instruments are generally either negotiated via over the counter (“OTC”) contracts or standardized contracts executed on a recognized exchange. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.

Risk Management Policies – Hedging Instruments

The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company evaluates the effectiveness of entering into any derivative agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates.

Interest Rate Risk Management – Cash Flow Hedging Instruments

The Company has variable rate debt as a source of funds for use in the Company’s lending and investment activities and for other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore hedges its variable-rate interest payments. To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.

A summary of the Company’s outstanding interest rate swap agreements used to hedge variable rate debt at March 31, 2024 and December 31, 2023, respectively is as follows:

(In thousands, except percentages and years)	March 31, 2024			December 31, 2023
Notional amount	$	20,000		$	20,000
Fair value	$	805		$	918
Weighted average pay rate		0.83	%		0.83	%
Weighted average receive rate		5.62	%		5.27	%
Weighted average maturity in years		0.94			1.57
Number of contracts		1			1

During the three months ended March 31, 2024, the Company received variable rate Secured Overnight Financing Rate ("SOFR") payments from and paid fixed rates in accordance with its interest rate swap agreements. At March 31, 2024, the unrealized gain relating to interest rate swaps was recorded as a derivative asset and is included in “Prepaid expenses and other assets” on the Company’s Balance Sheet. Changes in the fair value of the interest rate swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive income. The following table presents the net gains and losses recorded in other comprehensive income and the consolidated financial statements relating to the cash flow derivative instruments at March 31, 2024 and 2023, respectively:

	For the three months ended March 31,
(In thousands)	2024		2023
Loss recognized in OCI
Gross of tax	$	(113)	$	(235)
Net of tax		(81)		(185)
Gain reclassified from AOCI into net income
Gross of tax		238		198
Net of tax		170		156