Item 3. Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (continued)
suspended the + 300 and + 400 basis point rate shock analyses. Due to Federal Open Market Committee’s slowing future rate increase projections coupled with the recent increase in the Fed Funds Target Rate of 5.00% since March 17, 2022, we believe the impact to NII income when evaluating the + 300 and +400 basis point rate shock scenarios do not provide meaningful insight into our interest rate risk position nor does it project a probably interest rate environment for the foreseeable future.
To monitor interest rate risk beyond the 24-month time horizon of rate shocks, we also perform EVE rate shock simulations using the same assumptions used in the NII rate shock simulations discussed above. EVE represents the present value of all asset cash flows discounted with related market interest rates minus the present value of all liability cash flows which are also discounted with related market interest rates. The impact of a changing interest rate environment on the Company’s projected EVE is analyzed by shocking market interest rates, then modeling the impact of the rate shock on both the cash flow of assets and liabilities, and the underlying discount rate utilized in the present value calculation of the assets and liabilities. Market rate shock results are then compared to base case simulation results to determine the impact that market rate changes may have on our EVE. As with NII rate shock analyses, EVE rate shock analyses incorporate management’s assumptions regarding prepayment behavior of fixed rate loans and securities with embedded optionality and the behavior and value of non-maturity deposit products. Our policy guidelines limit the change in EVE given changes in rates of +/- 100, 200, 300, and 400 basis points. We have temporarily suspended the + 300 and + 400 basis point rate shock analyses. Due to Federal Open Market Committee’s slowing future rate increase projections coupled with the recent increase in the Fed Funds Target Rate of 5.00% since March 17, 2022. We believe the impact to NII income when evaluating the + 300 and +400 basis point rate shock scenarios do not provide meaningful insight into our interest rate risk position nor does it project a probably interest rate environment for the foreseeable future.
The following tables reflect the NII rate shock analyses and EVE analyses results for the periods presented utilizing a forecasted static balance sheet over the next twelve months. All percentage changes presented are within prescribed ranges set by management.
June 30, 2023 December 31, 2022
Change in Interest Rate (basis points) % Change in Pretax Net Interest Income % Change in Economic Value of Equity % Change in Pretax Net Interest Income % Change in Economic Value of Equity
200 5.5% (3.7)% 7.7% (0.2)%
100 2.7% (1.3)% 4.1% 0.8%
-100 (2.9)% (0.8)% (5.1)% (3.4)%
-200 (6.9)% (2.9)% (10.7)% (8.5)%
-300 (11.5)% (6.0)% (17.3)% (16.0)%
-400 (16.4)% (14.1)% (23.5)% (28.0)%
The results from the net interest income rate shock analysis are consistent with having an asset sensitive balance sheet when adjusted for repricing correlations (betas). The above table indicates that in a rising interest rate environment, the Company is positioned to have increased pretax net interest income for the same asset base due to the balance sheet composition, related maturity structures, and repricing correlations to market interest rates for assets and liabilities. Conversely, in a declining interest rate environment, we are positioned to have decreased pretax net interest income for the same reasons discussed above.
Based on the ALM results presented above for the quarters ending June 30, 2023 and December 31, 2022, the Company’s balance sheet is less asset sensitive at June 30, 2023 than it previously was at December 31, 2022. This migration in asset sensitivity is due to 1) lower yielding, floating rate excess cash positions held in federal reserve bank and interest-bearing deposits in other financial institutions that are more sensitive to future market interest rate changes which were deployed into higher yielding, fixed and floating rate securities and portfolio loans that are less sensitive to future market interest rate changes, 2) the addition of the Company’s largest lending relationship with an aggregate principal amount of $301.9 million being placed on nonaccrual status as of June 30, 2023, and 3) the recent shifts in the shape of the yield curve between the two periods presented above.
In addition to rate shocks and EVE analyses, sensitivity analyses are performed to help us identify which model assumptions are critical and cause the greatest impact on pretax NII. Sensitivity analyses include changing prepayment behavior of loans and securities with optionality, repricing correlations, and the impact of interest rate changes on non-maturity deposit products (decay rates).
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CARTER BANKSHARES, INC.
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