NOTE 6 – DERIVATIVES

Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers.  The Company executes interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with a correspondent bank to offset the impact of the interest rate swaps with the commercial banking customers.  The net result is the desired floating rate loans and a minimization of the risk exposure of the interest rate swap transactions.  As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent bank are recognized directly to earnings.  Since they offset perfectly, there is no net impact to earnings.

The fair value of derivative instruments as of December 31, 2022 and 2021 are reflected in the following table (dollars in thousands):

The fair value of interest rate swaps in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $6.5 million and $3.3 million as of December 31, 2022 and 2021, respectively. The Bank has a master netting arrangement with the correspondent bank and has the right to offset, however it has elected to present the assets and liabilities gross. The Bank is required to pledge collateral to the correspondent bank equal to or in excess of the net liability position. The Bank’s derivative liability with the correspondent bank was $0 and $1.0 milllion at December 31, 2022 and 2021, respectively. Securities pledged as collateral totaling $1.7 million and $3.0 million was provided to the counterparty correspondent bank as of December 31, 2022 and 2021, respectively.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $62.7 million as of December 31, 2022 and $70.4 million at December 31, 2021. Associated credit exposure is generally mitigated by securing the interest rate swaps with the underlying collateral of the loan instrument that has been hedged.