BANNER CORP 10-Q

ITEM 3 – Quantitative and Qualitative Disclosures About Market Risk Market Risk and Asset/Liability Management Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. Our profitability is dependent, to a large extent, on our net interest income, which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing liabilities. Our activities, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on the institution’s earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of an institution’s assets, liabilities and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk affecting our financial performance. 63 Table of Contents For Banner, the greatest source of interest rate risk results from the mismatch of maturities or repricing intervals for rate sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets, although our floating-rate assets tend to be more immediately responsive to changes in market rates than most deposit liabilities. Additional interest rate risk results from mismatched repricing indices and formula (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to clients than to us. An exception to this generalization is the beneficial effect of interest rate floors on a portion of our performing floating-rate loans, which help us maintain higher loan yields in periods when market interest rates decline significantly. However, in a declining interest rate environment, as loans with floors are repaid they generally are replaced with new loans which have lower interest rate floors. As of June 30, 2024, our loans with interest rate floors totaled $5.05 billion and had a weighted average floor rate of 4.59%, compared to a current average note rate of 6.73%. Our loans with interest rates at their floors at June 30, 2024, totaled $1.29 billion and had a weighted average note rate of 4.14%. The Company actively manages its exposure to interest rate risk through on-going adjustments to the mix of interest-earning assets and funding sources that affect the repricing speeds of loans, investments, interest-bearing deposits and borrowings. The principal objectives of asset/liability management are to evaluate the interest rate risk exposure; to determine the appropriate level of risk given our operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability allocation alternatives; and to manage our interest rate risk consistent with regulatory guidelines and policies approved by the Board of Directors. Through such management, we seek to reduce the vulnerability of our earnings and capital position to changes in the level of interest rates. Our actions in this regard are taken under the guidance of the Asset/Liability Management Committee, which is comprised of members of our senior management. The Committee closely monitors our interest sensitivity exposure, asset and liability allocation decisions, liquidity and capital positions, and local and national economic conditions and attempts to structure the loan and investment portfolios and funding sources to maximize earnings within acceptable risk tolerances. Sensitivity Analysis Our primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income resulting from those movements under different rate environments. The sensitivity of net interest income to changes in the modeled interest rate environments provides a measurement of interest rate risk. We also utilize economic value analysis, which addresses changes in estimated net economic value of equity arising from changes in the level of interest rates. The net economic value of equity is estimated by separately valuing our assets and liabilities under varying interest rate environments. The extent to which assets gain or lose value in relation to the gains or losses of liability values under the various interest rate assumptions determines the sensitivity of net economic value to changes in interest rates and provides an additional measure of interest rate risk. The interest rate sensitivity analysis performed by us incorporates beginning-of-the-period rate, balance and maturity data, using various levels of aggregation of that data, as well as certain assumptions concerning the maturity, repricing, amortization and prepayment characteristics of loans and other interest-earning assets and the repricing and withdrawal of deposits and other interest-bearing liabilities into an asset/liability simulation model. The interest rate sensitivity analysis includes a rate ramp sensitivity scenario, which assumes a gradual change in market interest rates at all maturities during the first year, as well as a rate shock interest rate sensitivity scenario, which assumes an instantaneous and sustained uniform change in market interest rates at all maturities. We update and prepare simulation modeling at least quarterly for review by senior management and oversight by the directors. We believe the data and assumptions are realistic representations of our portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of our net interest income and net economic value of equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used. 64 Table of Contents The following tables set forth, as of June 30, 2024, the estimated changes in our net interest income over one-year and two-year time horizons for our rate ramp and rate shock interest rate sensitivity scenarios, and the estimated changes in economic value of equity for our rate shock interest rate sensitivity scenario based on the indicated interest rate environments (dollars in thousands): Interest Rate Risk Indicators - Rate Ramp June 30, 2024 Estimated Increase (Decrease) in Change (in Basis Points) in Interest Rates (1) Net Interest Income Next 12 Months Net Interest Income Next 24 Months +300 $ (3,505) (0.6) % $ (8,895) (0.7) % +200 644 0.1 7,771 0.6 +100 1,927 0.3 11,571 1.0 0 — — — — -100 (6,226) (1.1) (27,919) (2.3) -200 (12,003) (2.1) (58,644) (4.8) -300 (18,065) (3.1) (91,870) (7.6) (1) Assumes a gradual change in market interest rates at all maturities during the first year; however, no rates are allowed to go below zero. The targeted Federal Funds Rate was between 5.25% and 5.50% at June 30, 2024. Interest Rate Risk Indicators - Rate Shock June 30, 2024 Estimated Increase (Decrease) in Change (in Basis Points) in Interest Rates (1) Net Interest Income Next 12 Months Net Interest Income Next 24 Months Economic Value of Equity +300 $ (16,680) (2.9) % $ 2,845 0.2 % $ (304,269) (11.9) % +200 (1,655) (0.3) 22,286 1.8 (176,488) (6.9) +100 4,196 0.7 22,157 1.8 (77,734) (3.0) 0 — — — — — — -100 (17,096) (3.0) (48,558) (4.0) 43,457 1.7 -200 (34,753) (6.0) (102,020) (8.4) 37,917 1.5 -300 (53,170) (9.2) (161,168) (13.3) (46,514) (1.8) (1) Assumes an instantaneous and sustained uniform change in market interest rates at all maturities; however, no rates are allowed to go below zero. The targeted Federal Funds Rate was between 5.25% and 5.50% at June 30, 2024. Another monitoring tool for assessing interest rate risk is gap analysis. The matching of the repricing characteristics of assets and liabilities may be analyzed by examining the extent to which assets and liabilities are interest sensitive and by monitoring an institution’s interest sensitivity gap. An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated to mature or reprice, based upon certain assumptions, within that same time period. A gap is considered positive when the amount of interest-sensitive assets exceeds the amount of interest-sensitive liabilities. A gap is considered negative when the amount of interest-sensitive liabilities exceeds the amount of interest-sensitive assets. Generally, during a period of rising rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income. Certain shortcomings are inherent in gap analysis. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of some borrowers to service their debt may decrease in the event of a severe change in market rates. 65 Table of Contents The following table presents our interest sensitivity gap between interest-earning assets and interest-bearing liabilities at June 30, 2024 (dollars in thousands), based on the amounts of interest-earning assets and interest-bearing liabilities which are anticipated by us, based upon certain assumptions, to reprice or mature in each of the future periods shown. At June 30, 2024, total interest-earning assets maturing or repricing within one year exceeded total interest-bearing liabilities maturing or repricing in the same time period by $1.72 billion, representing a one-year cumulative gap to total assets ratio of 10.85%. The interest rate risk indicators and interest sensitivity gaps as of June 30, 2024 are within our internal policy guidelines and management considers that our current level of interest rate risk is reasonable. Within 6 Months After 6 Months Within 1 Year After 1 Year Within 3 Years After 3 Years Within 5 Years After 5 Years Within 10 Years Over 10 Years Total Interest-earning assets: (1) Construction loans $ 1,161,882 $ 46,459 $ 145,717 $ 31,834 $ 36,099 $ 1,616 $ 1,423,607 Fixed-rate mortgage loans 243,940 216,767 792,366 602,369 716,569 257,886 2,829,897 Adjustable-rate mortgage loans 1,065,358 421,588 1,628,005 749,524 421,404 7,021 4,292,900 Fixed-rate mortgage-backed securities 101,968 90,394 366,361 378,197 828,426 846,405 2,611,751 Adjustable-rate mortgage-backed securities 249,861 45 194 210 3,883 — 254,193 Fixed-rate commercial/agricultural loans 96,532 101,060 263,646 143,988 135,670 21,315 762,211 Adjustable-rate commercial/agricultural loans 932,280 24,819 85,586 72,485 2,910 — 1,118,080 Consumer and other loans 527,676 47,080 48,417 33,163 25,446 44,082 725,864 Investment securities and interest-earning deposits 86,545 15,175 43,102 34,480 101,790 544,282 825,374 Total rate sensitive assets 4,466,042 963,387 3,373,394 2,046,250 2,272,197 1,722,607 14,843,877 Interest-bearing liabilities: (2) Regular savings 601,533 136,511 463,633 358,113 593,807 1,038,440 3,192,037 Interest checking accounts 353,443 108,148 368,789 285,500 467,812 625,051 2,208,743 Money market deposit accounts 205,587 114,118 369,283 261,444 368,269 296,847 1,615,548 Certificates of deposit 1,087,900 363,636 65,985 6,992 620 — 1,525,133 FHLB advances 398,000 — — — — — 398,000 Subordinated notes — 90,000 — — — — 90,000 Junior subordinated debentures 89,178 — — — — — 89,178 Retail repurchase agreements 165,956 — — — — — 165,956 Total rate sensitive liabilities 2,901,597 812,413 1,267,690 912,049 1,430,508 1,960,338 9,284,595 Excess of interest-sensitive assets over interest-sensitive liabilities $ 1,564,445 $ 150,974 $ 2,105,704 $ 1,134,201 $ 841,689 $ (237,731) $ 5,559,282 Cumulative excess of interest-sensitive assets $ 1,564,445 $ 1,715,419 $ 3,821,123 $ 4,955,324 $ 5,797,013 $ 5,559,282 $ 5,559,282 Cumulative ratio of interest-earning assets to interest-bearing liabilities 153.92 % 146.19 % 176.70 % 184.08 % 179.15 % 159.88 % 159.88 % Interest sensitivity gap to total assets 9.89 0.95 13.31 7.17 5.32 (1.50) 35.15 Ratio of cumulative gap to total assets 9.89 10.85 24.16 31.33 36.65 35.15 35.15 (Footnotes on following page) 66 Table of Contents Footnotes for Table of Interest Sensitivity Gap (1) Adjustable-rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due to mature, and fixed-rate assets are included in the period in which they are scheduled to be repaid based upon scheduled amortization, in each case adjusted to take into account estimated prepayments. Mortgage loans and other loans are not reduced for allowances for credit losses and non-performing loans. Mortgage loans, mortgage-backed securities, other loans and investment securities are not adjusted for deferred fees or unamortized acquisition premiums and discounts. (2) Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in the period they are due to mature. Although regular savings, demand, interest checking, and money market deposit accounts are subject to immediate withdrawal, based on historical experience management considers a substantial amount of such accounts to be core deposits having significantly longer maturities. For the purpose of the gap analysis, these accounts have been assigned decay rates to reflect their longer effective maturities. If all of these accounts had been assumed to be short-term, the one-year cumulative gap of interest-sensitive assets would have been a negative $3.8 billion, or negative 23.91% of total assets, at June 30, 2024.