8.DERIVATIVES

 

The Company has three interest rate swap agreements (the “trust swaps”) as part of the management of interest rate risk related to the trust preferred capital notes further described in Note 6 “Borrowings” in the “Notes to Consolidated Financial Statements”.  The Company designated the trust swaps as a cash flow hedge intended to protect against the variability of cash flows associated with the aforementioned preferred capital securities.  The trust swaps hedge the interest rate risk, wherein the Company receives interest of LIBOR from a counterparty and pays a weighted average fixed rate of 2.77% to the same counterparty calculated on a notional amount of $68.0 million.  The terms of the trust swaps range from three to six years. 

 

During the third quarter of 2013, the Company entered into eight interest rate swap agreements (the “prime loan swaps”) as part of the management of interest rate risk.  The Company designated the prime loan swaps as cash flow hedges intended to protect the Company against the variability in the expected future cash flows on the designated variable rate loan products.  During the first quarter of 2014, the Company discontinued four of the prime loan swaps with a total notional amount of $45.0 million, which were in place at December 31, 2013.  The unrealized gain reclassified to earnings related to these four prime loan swaps was not material to the Company’s consolidated financial statements.  The remaining four prime loan swaps hedge the underlying cash flows, wherein the Company receives a fixed interest rate ranging from 4.71% to 5.20% from the counterparty and pays interest based on the Wall Street Journal prime index, with a spread of up to 1.00%, to the same counterparty calculated on a notional amount of $55.0 million.  One of the four prime loan swaps contains a floor rate of 4.00%.  The terms of the four prime loan swaps is six years with a fixed rate that started September 17, 2013.

 

During 2014, the Company entered into four swaps (“FHLB advance swaps”) with a total notional amount of $140.0 million.  The Company designated the FHLB advance swaps as a cash flow hedge intended to protect against the variability in the expected future cash flows on the designated variable rate FHLB borrowings.  The FHLB advance swaps hedge the interest rate risk, wherein the Company will receive an interest rate based on the three month LIBOR from the counterparty and pays an interest rate ranging from 3.16% to 3.46% to the same counterparty calculated on the notional amount.  The swaps are deferred starting swaps with terms of six years and five years and effective dates of February 23, 2017 and February 23, 2018, respectively.    

 

All swaps were entered into with counterparties 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.  As of September 30, 2014, the Company had $5.7 million of cash pledged as collateral for the trust swaps and securities with a market value of $4.9 million pledged as collateral for the prime loan swaps and FHLB advance swaps.

 

Amounts receivable or payable are recognized as accrued under the terms of the agreements.  In accordance with ASC 815, Derivatives and Hedging, the Company has designated the trust swaps, prime loan swaps, and FHLB advance swaps as cash flow hedges, with the effective portions of the derivatives’ unrealized gains or losses recorded as a component of other comprehensive income.  The ineffective portions of the unrealized gains or losses, if any, would be recorded in “Other expense” in the Consolidated Statements of Income.  The Company has assessed the effectiveness of each hedging relationship by comparing the changes in cash flows on the designated hedged item.  The Company’s cash flow hedges are deemed to be effective.  At September 30, 2014, the fair value of the Company’s cash flow hedges was an unrealized loss of $5.0 million, the amount the Company would have expected to pay if the contract was terminated.  The liability is recorded as a component of other comprehensive income recorded in the Company’s Consolidated Statements of Comprehensive Income. 

Shown below is a summary of the derivatives designated as cash flow hedges at September 30, 2014 and December 31, 2013 (dollars in thousands):

 

 

 

 

During the normal course of business, the Company enters into interest rate swap loan relationships (“loan swaps”) with borrowers to meet their financing needs.  Upon entering into the loan swaps, the Company enters into offsetting positions with counterparties in order to minimize interest rate risk.  These back-to-back loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the Consolidated Balance Sheets.  As of September 30, 2014, the Company had securities with a market value of $2.0 million pledged as collateral for the loan swaps.  Shown below is a summary regarding loan swap derivative activities at September 30, 2014 and December 31, 2013 (dollars in thousands):

 

 

 

 

 

 

 

 

In the ordinary course of business, the Company enters into commitments to originate mortgage loans whereby the interest rate on the loan is determined prior to funding (“rate lock commitments”).  Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives.  The period of time between issuance of a loan commitment, closing, and sale of the loan generally ranges from 30 to 120 days.  The Company protects itself from changes in interest rates through the use of best efforts 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 buyer has assumed interest rate risk on the loan.  The correlation between the rate lock commitments and the best efforts contracts is high due to their similarity.

 

The market value of rate lock commitments and best efforts contracts is not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded in stand-alone markets.  The Company determines the fair value of rate lock commitments and best efforts contracts by measuring the change in the value of the underlying asset while taking into consideration the probability that the rate lock commitments will close. 

 

During the first quarter of 2014, and in connection with the acquisition of StellarOne, the Company began recording the rate lock commitments derivative on its balance sheet at fair value.  Because the amounts associated with the rate lock commitments were determined to be immaterial, the Company did not record the value of the rate locks in any period prior to January 1, 2014.  While the rate lock commitment derivative is still considered immaterial to the consolidated financial statements, the Company began recording this asset on its Consolidated Balance Sheets within “Loans held for sale, net” post-acquisition when integrating the acquired mortgage operations of StellarOne.  The Company’s derivative related to rate lock commitments had a notional amount of $70.3 million at September 30, 2014 with a fair value of $612,000.  This derivative instrument does not qualify for hedge accounting; as a result, changes in fair value are recognized in current period earnings as a component of “Gain on sale of mortgage loans, net of commissions.”