Derivative Instruments and Hedging Activities

12 Months Ended

Dec. 31, 2013

Derivative Instruments And Hedging Activities

Derivative Instruments and Hedging Activities

NOTE 14 Derivative Instruments and Hedging Activities

PSB is exposed to certain risks relating to its ongoing business operations. The primary risk managed by using derivative instruments is interest rate risk. Interest rate swaps are entered into to manage interest rate risk associated with PSB's variable rate junior subordinated debentures. Accounting standards require PSB to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. PSB designates its interest rate swap associated with the junior subordinated debentures as a cash flow hedge of variable-rate debt. For derivative financial instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative instrument representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

From time to time, PSB will also enter into fixed interest rate swaps with customers in connection with their floating rate loans to PSB. When fixed rate swaps are originated with customers, an identical offsetting swap is also entered into by PSB with a correspondent bank. These swap arrangements are intended to offset each other as “back to back” swaps and allow PSB’s loan customer to obtain fixed rate loan financing via the swap while PSB exchanges these fixed payments with a correspondent bank. In these arrangements, PSB’s net cash flows and interest income are equal to the floating rate loan originated in connection with the swap. These customer swaps are not designated as hedging instruments and are accounted for at fair value with changes in fair value recognized in the income statement during the current period.

PSB is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. PSB 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. PSB enters into agreements only with primary dealers. These derivative instruments are negotiated over-the-counter (OTC) contracts. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amounts, exercise prices, and maturity.

As of December 31, PSB had the following outstanding interest rate swap that was entered into to hedge variable-rate debt:

	2013	2012
Notional amount	$7,500	$7,500
Pay fixed rate	2.72%	2.72%
Receive variable rate	0.24%	0.31%
Maturity	9/15/2017	9/15/2017
Unrealized loss (fair value)	$438	$699

This agreement provides for PSB to receive payments at a variable rate determined by the three-month LIBOR in exchange for making payments at a fixed rate. Actual maturities may differ from scheduled maturities due to call options and/or early termination provisions. No interest rate swap agreements were terminated prior to maturity in 2013 or 2012. Risk management results for the year ended December 31, 2013, related to the balance sheet hedging of variable rate debt indicates that the hedge was 100% effective, and no component of the derivative instrument’s gain or loss was excluded from the assessment of hedge effectiveness. At December 31, 2013, the fair value of the interest rate swap of $438 was recorded in other liabilities. Net unrealized gain on the derivative instrument recognized in other comprehensive income during the year ended December 31, 2013, totaled $46, net of tax. The net amount of other comprehensive loss reclassified into interest expense during the year ended December 31, 2013 was $113, net of tax. As of December 31, 2013, approximately $184 of losses reported in other comprehensive income related to the interest rate swap ($111 after tax benefits) are expected to be reclassified into interest expense as a yield adjustment of the hedged borrowings during the 12-month period ending December 31, 2014. The interest rate swap agreement was secured by cash and cash equivalents of $570 and $850 at December 31, 2013 and 2012, respectively.

During 2013, PSB reclassified $186 ($113 after tax impacts) of interest rate swap settlements which increased comprehensive income. The increase to comprehensive net income was recognized as a $186 ($113 after tax impacts) increase to interest expense on junior subordinated debentures on the statement of income during the year.

As of December 31, 2013 and 2012, PSB had a number of outstanding interest rate swaps with customers and correspondent banks associated with its lending activities that are not designed as hedges.

At December 31, the following floating interest rate swaps were outstanding with customers:

	2013	2012
Notional amount	$14,323	$	14,979
Receive fixed rate (average)	2.00%		1.99%
Pay variable rate (average)	0.17%		0.21%
Maturity	3/2015-10/2021		3/2015-10/2021
Weighted average remaining term	2.9 years		3.9 years
Unrealized gain fair value	$276	$	673

At December 31, the following offsetting fixed interest rate swaps were outstanding with correspondent banks:

	2013	2012
Notional amount	$14,323	$14,979
Pay fixed rate (average)	2.00%	1.99%
Receive variable rate (average)	0.17%	0.21%
Maturity	3/2015-10/2021	3/2015-10/2021
Weighted average remaining term	2.9 years	3.9 years
Unrealized loss fair value	($276)	($673)