Note 9 - Derivatives and Hedging Activities

6 Months Ended

Mar. 31, 2023

Derivative Instruments and Hedging Activities Disclosure [Text Block]

Note 9 – Derivatives and Hedging Activities

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future uncertain cash amounts, the value of which are determined by interest rates.

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (loss) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. At March 31, 2023, such derivatives were used to hedge the variable cash flows associated with advances from the Federal Home Loan Bank of Pittsburgh.

Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next 12 months, the Company estimates approximately $2.3 million to be reclassified to earnings as a decrease to interest expense. The Company is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 20 months (excluding forecasted transactions related to the payment of variable interest on existing financial instruments).

The Company also 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 the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. These derivatives are not designated as hedges and are not speculative. Rather, these derivatives result from a service the Company provides to certain customers. As the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.

The tables below present the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Statements of Financial Condition as of March 31, 2023 and September 30, 2022:

	*March 31, 2023*
	*Asset derivatives*					*Liability derivatives*
					*Statement of*					*Statement of*
	*Notional*				*Financial Condition*	*Notional*				*Financial Condition*
	*Amount*		*Fair Value*		*Location*	*Amount*		*Fair Value*		*Location*
	*(In thousands)*
Derivatives designated as a hedging instrument:
Interest rate swap agreements	$	60,000	$	3,023	Other assets	$	—	$	—	Other liabilities
Derivatives not designated as a hedging instrument:
Interest rate swap agreements	$	43,727	$	2,393	Other assets	$	43,727	$	2,394	Other liabilities

	*September 30, 2022*
	*Asset derivatives*					*Liability derivatives*
					*Statement of*					*Statement of*
	*Notional*				*Financial Condition*	*Notional*				*Financial Condition*
	*Amount*		*Fair Value*		*Location*	*Amount*		*Fair Value*		*Location*
	*(In thousands)*
Derivatives designated as a hedging instrument:
Interest rate swap agreements	$	60,000	$	4,017	Other assets	$	—	$	—	Other liabilities
Derivatives not designated as a hedging instrument:
Interest rate swap agreements	$	44,132	$	3,711	Other assets	$	44,132	$	3,712	Other liabilities

The tables below present the derivative assets and liabilities offsetting as of March 31, 2023 and September 30, 2022:

Offsetting of Derivative Assets

(In thousands)

as of March 31, 2023

Gross Amounts Not Offset in the Statements of

Financial Condition

Gross

Net Amounts

Amounts

of Assets

Gross

Offset in the

presented in

Amounts

Statement of

the Statement

Cash

of Recognized

Financial

of Financial

Financial

Collateral

Assets

Condition

Instruments

Received

Net Amount

Derivatives

5,416

—

5,416

—

3,670

1,746

Offsetting of Derivative Liabilities

(In thousands)

as of March 31, 2023

Gross Amounts Not Offset in the Statements of

Financial Condition

Gross

Net Amounts

Amounts

of Liabilities

Gross

Offset in the

presented in

Amounts

Statement of

the Statement

Cash

of Recognized

Financial

of Financial

Financial

Collateral

Liabilities

Condition

Instruments

Posted

Net Amount

Derivatives

2,394

—

2,394

—

2,394

Offsetting of Derivative Assets

(In thousands)

as of September 30, 2022

Gross Amounts Not Offset in the Statements of

Financial Condition

Gross

Net Amounts

Amounts

of Assets

Gross

Offset in the

presented in

Amounts

Statement of

the Statement

Cash

of Recognized

Financial

of Financial

Financial

Collateral

Assets

Condition

Instruments

Received

Net Amount

Derivatives

7,728

—

4,210

3,518

Offsetting of Derivative Liabilities

(In thousands)

as of September 30, 2022

Gross Amounts Not Offset in the Statements of

Financial Condition

Gross

Net Amounts

Amounts

of Liabilities

Gross

Offset in the

presented in

Amounts

Statement of

the Statement

Cash

of Recognized

Financial

of Financial

Financial

Collateral

Liabilities

Condition

Instruments

Posted

Net Amount

Derivatives

3,712

—

3,712

The tables below present the net gains (losses) recorded in accumulated other comprehensive income (loss) and the Consolidated Statements of Net Income relating to the cash flow derivative instruments for the three and six months ended March 31, 2023 and 2022:

	*Three Months Ended March 31, 2023*
	*Amount of Gain (Loss) Recognized*			*Amount of Gain Reclassified from OCI to*
	*in OCI on Derivative*			*Interest Expense*
	(In thousands)
Interest rate swap agreements	$	(182	)	$	565
Total derivatives	$	(182	)	$	565

	*Three Months Ended March 31, 2022*
	*Amount of Loss Recognized*		*Amount of Loss Reclassified from OCI to*
	*in OCI on Derivative*		*Interest Expense*
	(In thousands)
Interest rate swap agreements	$	1,748	$	(26	)
Total derivatives	$	1,748	$	(26	)

	*Six Months Ended March 31, 2023*
	*Amount of Loss Recognized*		*Amount of Gain Reclassified from OCI to*
	*in OCI on Derivative*		*Interest Expense*
	(In thousands)
Interest rate swap agreements	$	22	$	1,016
Total derivatives	$	22	$	1,016

	*Six Months Ended March 31, 2022*
	*Amount of Loss Recognized*		*Amount of Loss Reclassified from OCI to*
	*in OCI on Derivative*		*Interest Expense*
	(In thousands)
Interest rate swap agreements	$	2,142	$	(111	)
Total derivatives	$	2,142	$	(111	)

The tables below present the effect of the Company’s derivative financial instruments on the Consolidated Statements of net Income for the three and six months ended March 31, 2023 and 2022:

	*Six Months Ended March 31, 2023*
	*Consolidated Statements of Income*	*Amount of Loss Recognized in Income on derivatives*
	(In thousands)
Derivatives not designated as a hedging instrument:
Interest rate swap agreement	Other income	$	—
Total		$	—

	*Six Months Ended March 31, 2022*
	*Consolidated Statements of Income*	*Amount of Loss Recognized in Income on derivatives*
	(In thousands)
Derivatives not designated as a hedging instrument:
Interest rate swap agreement	Other income	$	2
Total		$	2

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

At March 31, 2023 and September 30, 2022, the fair value of derivatives was in a net asset position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements. There were no adjustments for nonperformance risk at March 31, 2023 and September 30, 2022. At March 31, 2023 and September 30, 2022, the Company had no collateral posting requirement against its obligations under these agreements. If the Company had breached any of these provisions of its contracts, 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.

Three Months Ended March 31, 2023

Consolidated Statements of Net Income

Amount of Gain Recognized in Income on derivatives

(In thousands)

Derivatives not designated as a hedging instrument:

Interest rate swap agreement

Other income

MALVERN BANCORP, INC. 10-Q