Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is defined as the risk of loss arising from an adverse change in the market value (or prices) of financial instruments. A significant component of market risk is interest rate risk, which is inherent in our lending, investment, borrowing, and deposit gathering activities. The Bank manages interest rate sensitivity to minimize the exposure of our net interest margin, earnings, and capital to changes in interest rates. Interest rate changes can create fluctuations in the net interest margin due to an imbalance in the timing of repricing, or maturity of assets or liabilities. Interest rate changes can also affect the market value of our financial instruments, such as available-for-sale securities and the related unrealized gains or losses, which affect our equity value.
To mitigate interest rate risk, the structure of our assets and liabilities is managed with the objective of correlating the effects of interest rate changes on loans and investments with those of deposits and borrowings. The Asset/Liability Management Policy sets limits on the acceptable amount of change to net interest income and the economic value of equity in different interest rate environments.
From time to time, we enter into interest rate swap contracts to mitigate the changes in the fair value of selected investment securities and specified long-term fixed-rate loans and firm commitments to enter into long-term fixed-rate loans caused by changes in interest rates. Refer to Note 15 in the Consolidated Financial Statements in ITEM 8 of this report.
57
ALCO and the Board of Directors review our exposure to interest rate risk at least quarterly. We use simulation models to measure interest rate risk and to evaluate strategies to improve profitability in the context of policy guidelines. A simplified statement of condition is prepared on a quarterly basis as a starting point, using instrument level data of our actual loans, investments, borrowings and deposits as inputs. If potential changes to net equity value and net interest income resulting from hypothetical interest rate changes are not within the limits established by the Board of Directors, management may adjust the asset and liability mix to bring the risk position within approved limits or take other actions. Governing policies are subject to review by regulators and are updated to incorporate their observations and adapt to changes in idiosyncratic and systemic risks. As of December 31, 2025, interest rate risk was within the policy guidelines established by ALCO and the Board.
Immediate Changes in Interest Rates (in basis points) Estimated Change in Net Interest Income in Year 1, as Percent of Net Interest Income Estimated Change in Net Interest Income in Year 2, as Percent of Net Interest Income
As of December 31, 2025, our interest rate risk position was within the policy guidelines established by ALCO and the Board based on an assessment that was completed before the reclassification of certain reciprocal network deposits from noninterest-bearing to interest-bearing. The results from an updated assessment, which will include the reclassification, are expected to be released in late April 2026 as part of our first quarter earnings release materials and preliminary calculations suggest that we should remain in compliance with policy guidelines.
58