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Table of Contents
Index to Financial Statements
Hedge Ineffectiveness
In accordance with SFAS No. 133, the Company recognizes hedge ineffectiveness on both fair value and cash flow hedge relationships.
These amounts are reflected in the consolidated statements of operations in other income (expense) as the fair value adjustments of financial
derivatives. The following table summarizes the income (expense) recognized by the Company as fair value and cash flow hedge
ineffectiveness (in thousands):
Mortgage Banking Activities
Year Ended December 31,
2003
2002
2001
Fair value hedges
$
(19,711
)
$
(22,379
)
$
(5,791
)
Cash flow hedges
4,374
10,717
2,679
Total fair value adjustments of financial derivatives
$
(15,337
)
$
(11,662
)
$
(3,112
)
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding; these
commitments are referred to as Interest Rate Lock Commitments, (“IRLCs”). IRLCs on loans the Bank intends to sell are considered to be
derivatives and are, therefore, recorded at fair value with changes in fair value recorded in earnings. For purposes of determining their fair
value, the Company performs a net present value analysis of the anticipated cash flows associated with these IRLCs. The net present value
analysis performed excludes the market value associated with the anticipated sale of servicing rights related to each loan commitment. IRLCs
expose the Company to interest rate risk. At December 31, 2003, the fair value of these IRLCs was $2.0 million. The Company manages this
risk by selling mortgages or mortgage-backed securities on a forward basis referred to as Forward Sale Agreements. Changes in the fair value
of these derivatives are included in the consolidated statements of operations as gain on sales of loans held-for-sale and securities, net or gain
on sales of originated loans based on whether the loan was purchased or originated. The net change in the IRLCs and the related hedging
instruments resulted in net losses of $3.0 million in 2003 and $2.6 million in 2002.
The Company also designates fair value hedge relationships of closed loans held-for-
sale against a combination of mortgage forwards and
short treasury positions. The marks-to-market of the mortgage forwards are included in the net change of the IRLC’s and the related hedging
instruments disclosed above. The marks-to-market of the closed loans recorded for 2003 was $4.1 million. Changes in the fair value of these
closed loans are included in the consolidated statements of operations as gain on sales of loans held-for-sale and securities, net or gain on sales
of originated loans based on whether the loan was purchased or originated.
Credit risk is managed by limiting activity to approved counterparties and setting aggregate exposure limits for each approved
counterparty. The credit risk that results from interest rate swaps and purchased options is represented by the fair value of contracts that have
2003. These agreements required the Company to pledge approximately $85.4 million of its mortgage-backed and investment securities as
collateral.
While the Company does not expect that any counterparty will fail to perform, the following table shows the maximum exposure, or net
credit risk, associated with each counterparty to interest rate swaps and purchased interest rate options. At December 31, 2003 are as follows
(in thousands):
100
Counterparty
Credit Risk
Salomon Brothers
$
9,101
Deutsche Bank
6,816
Bank of America
4,091
Total
$
20,008