NOTE 5. DERIVATIVES AND HEDGING ACTIVITIES

Risk Management Objective of Using Derivatives

WesBanco is exposed to certain risks arising from both its business operations and economic conditions. WesBanco principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. WesBanco manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities. WesBanco’s existing interest rate derivatives result from a service provided to certain qualifying customers and, therefore, are not used to manage interest rate risk in WesBanco’s assets or liabilities. WesBanco manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions. A matched book is when the Bank’s assets and liabilities are equally distributed but also have similar maturities.

Loan Swaps

WesBanco executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that WesBanco executes with a third party, such that WesBanco minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements of FASB ASC 815, changes in the fair value of both the customer swaps and the offsetting third-party swaps are recognized directly in earnings. As of March 31, 2018 and December 31, 2017, WesBanco had 43 and 39, respectively, interest rate swaps with an aggregate notional amount of $309.2 million and $298.2 million, respectively, related to this program. During the three months ended March 31, 2018 and 2017, WesBanco recognized net gains (net losses) of $0.2 million and $(0.2) million, respectively, related to the changes in fair value of these swaps. Additionally, WesBanco recognized $0.4 million and $1.0 million of income for the related swap fees for the three months ended March 31, 2018 and 2017, respectively.

Mortgage Loans Held for Sale and Loan Commitments

Certain residential mortgage loans are originated for sale in the secondary mortgage loan market. These loans are classified as held for sale and carried at fair value as WesBanco has elected the fair value option. Fair value is determined based on rates obtained from the secondary market for loans with similar characteristics. WesBanco sells loans to the secondary market on a mandatory or best efforts basis. The loans sold on a mandatory basis are not committed to an investor until the loan is closed with the borrower. WesBanco enters into forward TBA contracts to manage the interest rate risk between the loan commitment and the closing of the loan. The loans sold on a best efforts basis are committed to an investor simultaneous to the interest rate commitment with the borrower.

 

Fair Values of Derivative Instruments on the Balance Sheet

All derivatives are carried on the consolidated balance sheet at fair value. Derivative assets are classified in the consolidated balance sheet under other assets, and derivative liabilities are classified in the consolidated balance sheet under other liabilities. Changes in fair value are recognized in earnings. None of WesBanco’s derivatives are designated in qualifying hedging relationships under ASC 815.

The table below presents the fair value of WesBanco’s derivative financial instruments as well as their classification on the Balance Sheet as of March 31, 2018 and December 31, 2017:

 

		March 31, 2018												December 31, 2017
(unaudited, in thousands)		Notional or Contractual Amount				Asset Derivatives				Liability Derivatives				Notional or Contractual Amount				Asset Derivatives				Liability Derivatives
Derivatives
Loan Swaps:
Interest rate swaps		$	309,242			$	9,257			$	9,083			$	298,223			$	7,351			$	7,345
Other contracts:
Interest rate loan commitments			24,730				147				—				20,319				49				—
Best efforts forward delivery commitments			3,941				—				11				2,905				—				6
Forward TBA contracts			36,500				—				3				31,750				—				23
Total derivatives						$	9,404			$	9,097							$	7,400			$	7,374

Effect of Derivative Instruments on the Income Statement

The table below presents the change in the fair value of the Company’s derivative financial instruments reflected within the other non-interest income line item of the consolidated income statement for the three months ended March 31, 2018 and 2017, respectively.

 

				For the Three Months Ended
		Location of Gain/(Loss)		March 31,
(unaudited, in thousands)				2018				2017
Interest rate swaps		Other income		$	(167	)		$	195
Interest rate loan commitments		Mortgage banking income			98				—
Best efforts forward sales contracts		Mortgage banking income			(5	)			—
Forward TBA contracts		Mortgage banking income			410				—
Total				$	336			$	195

Credit-risk-related Contingent Features

WesBanco has agreements with its derivative counterparties that contain a provision where if WesBanco defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then WesBanco could also be declared in default on its derivative obligations.

WesBanco also has agreements with certain of its derivative counterparties that contain a provision where if WesBanco fails to maintain its status as either a well or adequately capitalized institution, then the counterparty could terminate the derivative positions and WesBanco would be required to settle its obligations under the agreements.

WesBanco has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral with a market value of $2.9 million as of March 31, 2018. If WesBanco had breached any of these provisions at March 31, 2018, it could have been required to settle its obligations under the agreements at the termination value and would have been required to pay any additional amounts due in excess of amounts previously posted as collateral with the respective counterparty.