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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2020-11-25 compared with 2019-11-27 · 58 added, 35 removed, 164 unchanged (36% of the section changed)

36 unchanged sentences

At September 30, 2020, the Bank's gap between the amount of interest-earning assets and interest-bearing liabilities projected to reprice within one year was $435.0 million, or 4.58% of total assets, compared to $487.4 million, or 5.22% of total assets, at September 30, 2019.

The increase in the one-year gap amount was due primarily to lower interest rates as of September 30, 2019 compared to September 30, 2018, as well as an increase in the amount of cash held at September 30, 2019 compared to September 30, 2018.

The decrease in the one-year gap amount was due to a shift in the cash flow projections on the Bank's non-maturity deposits compared to the prior year, related to the implementation of a new interest rate risk model.

This change shortened the life of these liabilities and thus increased the amount of projected cash flows in the 12-month horizon compared to the previous model.

This change was largely offset by lower interest rates as of September 30, 2020 compared to September 30, 2019, which increased the cash flow projections related to the Bank's mortgage-related assets.

As interest rates fall, borrowers have more economic incentive to refinance their mortgages and agency debt issuers have more economic incentive or opportunity to exercise their call options in order to issue new debt at lower interest rates, resulting in higher projected cash flows on these assets.

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The majority of these cash flows were reinvested into new loans and securities at current market interest rates.

Total cash flows from term liabilities that matured and repriced into current market interest rates during the current fiscal year were $2.28 billion, including $875.0 million in FHLB borrowings.

Total cash flows from term liabilities that matured and/or repriced into current market interest rates during the current fiscal year were $2.97 billion, including $1.16 billion in term borrowings, of which $640.0 million was tied to interest rate swaps.

These offsetting cash flows allow the Bank to manage its interest rate risk and gap position more precisely than if the Bank did not have offsetting cash flows due to its mix of assets or maturity structure of liabilities.

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The interest rate swaps effectively convert the adjustable-rate borrowings into long-term, fixed-rate liabilities.

The Bank uses the securities portfolio to shorten the average life of the Bank's assets.

Security purchases over the past few years have primarily been focused on callable agency debentures with maturities no longer than five years, shorter duration MBS, and adjustable-rate MBS.

These securities have a shorter average life and provide a steady source of cash flow that can be reinvested as interest rates rise into higher-yielding assets.

In addition to these wholesale strategies, the Bank has sought to increase non-maturity deposits.

Non-maturity deposits are expected to reduce the risk of higher interest rates because their interest rates are not expected to increase significantly as market interest rates rise.

In addition to these wholesale strategies, the Bank has benefited from an increase in non-maturity deposits.

Rates paid on non-maturity deposits are not expected to increase as market interest rates rise.

Specifically, checking accounts and savings accounts have had minimal interest rate fluctuations throughout historical interest rate cycles, though no assurance can be given that this will be the case in future interest rate cycles.

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The Bank uses historical data pertaining to these accounts to estimate their future balances.

Over the last few years, the Bank has priced long-term certificates of deposit more aggressively than short-term certificates of deposit with the goal of giving customers incentive to move funds into longer-term certificates of deposit when interest rates were lower.

Like non-maturity deposits, longer-term certificates of deposit are expected to reduce the risk of higher interest rates when market interest rates rise.

More recently, the Bank began pricing short-term certificates of deposit more aggressively as the Bank reduces its usage of public unit certificates of deposit, which are generally large dollar, short-term funds.

This strategy is intended to allow the Bank to more quickly reprice certificate of deposit funds lower, as it has been management's expectation that short-term interest rates would decrease.

Additionally, as we expand the commercial banking business, we expect to have the ability to obtain lower-costing commercial deposits, which could be used to reduce the cost of funds by replacing FHLB borrowings and wholesale deposits.

With the significant decrease in interest rates during the current year, the Bank has decreased the rates on certificates of deposit and money market accounts on pace with competitors in its market areas.

The Bank will continue to adjust rates as market conditions allow.

The following gap table summarizes the anticipated maturities or repricing periods of the Bank's interest-earning assets and interest-bearing liabilities based on the information and assumptions set forth in the notes below.

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For additional information regarding the impact of changes in interest rates, see the following Change in Net Interest Income and Change in MVPE discussions and tables.

to Five Years

More Than More Than

Within One Year to Three Years Over

One Year Three Years to Five Years Five Years Total

Interest-earning assets:

1 unchanged sentence

Loans receivable (1)

$ 2,180,950 $ 2,209,189 $ 1,087,823 $ 1,745,032 $ 7,222,994

Securities (2)

618,869 513,172 178,157 219,407 1,529,605

Other interest-earning assets 172,286 — — — 172,286

2 unchanged sentences

Non-maturity deposits (3)

752,147 379,065 410,930 1,710,488 3,252,630

Certificates of deposit 1,505,599 1,199,700 315,477 468 3,021,244

Borrowings (4)

279,401 702,940 618,134 231,139 1,831,614

Total interest-bearing liabilities 2,537,147 2,281,705 1,344,541 1,942,095 8,105,488

3 unchanged sentences

interest-bearing liabilities $ 434,958 $ 875,614 $ 797,053 $ 819,397

Cumulative (deficiency) excess of interest-earning assets over interest-bearing

More Than More Than

Within One Year to Three Years Over

One Year Three Years to Five Years Five Years Total

Cumulative excess of interest-earning assets over interest-bearing

liabilities as a percent of total Bank assets at:

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(4) Borrowings exclude deferred prepayment penalty costs.

Included in this line are $640.0 million of FHLB adjustable-rate advances with interest rate swaps.

Included in this line item are $640.0 million of FHLB adjustable-rate advances with interest rate swaps.

The repricing for these liabilities is projected to occur at the maturity date of each interest rate swap.

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Similarly, agency debt issuers are more likely to exercise embedded call options for agency securities and issue new securities at a lower interest rate.

For each date presented in the following table, the estimated change in the Bank's net interest income is based on the indicated instantaneous, parallel and permanent change in interest rates is presented.

For each date presented in the following table, the estimated change in the Bank's net interest income is based on the indicated instantaneous, parallel and permanent change in interest rates.

The change in each interest rate environment represents the difference between estimated net interest income in the 0 basis point interest rate environment ("base case," assumes the forward market and product interest rates implied by the yield curve are realized) and the estimated net interest income in each alternative interest rate environment (assumes market and product interest rates have a parallel shift in rates across all maturities by the indicated change in rates).

Projected cash flows for each scenario are based upon varying prepayment assumptions to model likely customer behavior changes as market rates change.

For the current year, multiple yields along the yield curve were less than one percent, so the -100 basis points scenario was not applicable.

Estimations of net interest income used in preparing the table below were based upon the assumptions that the total composition of interest-earning assets and interest-bearing liabilities does not change materially and that any repricing of assets or liabilities occurs at anticipated product and market rates for the alternative rate environments as of the dates presented.

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These do not reflect the earnings expectations of management.

Net Interest Income At September 30,

Change Net Interest Income At September 30,

(in Basis Points) 2020 2019

in Interest Rates (1)

Amount ($) Change ($) Change (%) Amount ($) Change ($) Change (%)

(Dollars in thousands)

000 bp $ 183,596 $ — — % $ 193,329 $ — — %

+100 bp 188,084 4,488 2.44 194,093 764 0.40

+200 bp 188,417 4,821 2.63 192,111 (1,218) (0.63)

+300 bp 186,441 2,845 1.55 188,752 (4,577) (2.37)

(1) Assumes an instantaneous, parallel, and permanent change in interest rates at all maturities.

The net interest income projection was lower in the base case scenario at September 30, 2019 compared to September 30, 2018 due mainly to lower market interest rates at September 30, 2019 as assets are expected to reprice lower at a faster pace than liabilities over the one-year horizon.

The Bank's one-year gap amount was positive at September 30, 2019.

Therefore, as market interest rates rise in the +100 basis point scenario, the Bank's assets are projected to reprice higher at a faster pace than liabilities, resulting in a higher net interest income projection in this scenario.

However, as interest rates rise, the one-year gap will eventually become negative due to a reduction in cash flows from the Bank's mortgage-related assets and callable agency debentures.

Therefore, as interest rates move higher in the +200 and +300 basis point scenarios, liabilities are projected to reprice to higher interest rates at a faster pace than assets and have a negative impact to the Bank's net interest income projection.

The net interest income projection was lower in the base case scenario at September 30, 2020 compared to September 30, 2019 due to lower interest rates at September 30, 2020 compared to September 30, 2019.

Because the Bank's gap was positive during the current year, assets have repriced downward at a faster pace than liabilities, resulting in a lower base case net interest income projection at September 30, 2020.

The net interest income projections increase from the base case in all rising interest rate scenarios at September 30, 2020.

The net interest income projection was more adversely impacted in the rising interest rate scenarios at September 30, 2019 compared to September 30, 2020, due primarily to higher interest rates at September 30, 2019.

The positive impact of rising interest rates is diminished as interest rates increase.

Higher interest rates decreased the projected cash flows from the Bank's mortgage-related assets, thus decreasing the positive impact of rising interest rates compared to the base case.

Change in MVPE.

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Projected cash flows for each scenario are based upon varying prepayment assumptions to model likely customer behavior as market rates change.

For the current year, multiple yields along the yield curve were less than one percent, so the -100 basis points scenario was not applicable.

The estimations of the MVPE used in preparing the table below were based upon the assumptions that the total composition of interest-earning assets and interest-bearing liabilities does not change, that any repricing of assets or liabilities occurs at current product or market rates for the alternative rate environments as of the dates presented, and that different prepayment rates were used in each alternative interest rate environment.

1 unchanged sentence

The table below presents the effects of the changes in interest rates on our assets and liabilities as they mature, repay, or reprice, as shown by the change in the MVPE for alternative interest rates.

Market Value of Portfolio Equity At September 30,

Change Market Value of Portfolio Equity At September 30,

(in Basis Points) 2020 2019

in Interest Rates (1)

Amount ($) Change ($) Change (%) Amount ($) Change ($) Change (%)

(Dollars in thousands)

000 bp $ 1,301,409 $ — — % $ 1,283,429 $ — — %

+100 bp 1,290,877 (10,532) (0.81) 1,286,446 3,017 0.24

+200 bp 1,157,368 (144,041) (11.07) 1,162,151 (121,278) (9.45)

+300 bp 967,997 (333,412) (25.62) 992,060 (291,369) (22.70)

(1) Assumes an instantaneous, parallel, and permanent change in interest rates at all maturities.

At September 30, 2019, the average life of the Bank's mortgage-related assets was shorter than that of the Bank's long-term borrowings and core deposits due to the low level of interest rates.

Because of the low level of interest rates at September 30, 2019, prepayment projections for mortgage-related assets and call projections for callable agency debentures were high, thereby significantly reducing the average life of these assets by increasing near-term cash flows.

As interest rates rise, the market values of the Bank's financial liabilities decrease at a faster pace than those of its assets.

As a result, the Bank's MVPE increases in the +100 basis point interest rate environment.

As interest rates move higher in the +200 and +300 basis point interest rate environments, prepayment projections for mortgage-related assets, in general, are expected to decrease significantly and reduce near-term cash flows.

As interest rates rise to these levels, projected prepayments would likely only be realized through changes in borrowers' lives such as divorce, death, job-related relocations, or other life-changing events, resulting in an increase in the average life of these assets.

Call projections for the Bank's callable agency debentures would also decrease significantly as interest rates rise to these levels, which would cause the cash flows from these assets to move toward their contractual maturity dates.

The longer expected average lives of these assets, relative to the assumptions in the base case environment, increase their sensitivity to changes in interest rates.

As a result, the Bank's sensitivity to rising interest rates increases to such a point that that expected decrease in the market value of the Bank's financial assets more than

offsets the decrease in the market value of its financial liabilities, resulting in a decrease in the MVPE in these interest rate environments.

The percentage change in the Bank's MVPE at September 30, 2020 was negative in all scenarios.

At September 30, 2019 the percentage change in the Bank's MVPE was negative in the +200 and +300 basis point scenarios.

This change was due primarily to a change in the Bank's interest rate risk model, of which the most significant impact was on the valuation of the Bank's non-maturity deposit portfolio.

The model changes resulted in a shorter duration for these liabilities than was modeled at September 30, 2019, which reduced their sensitivity to changes in interest rates.

The Bank's MVPE decreases as interest rates rise, as the market value for assets decreases at a faster pace than these liabilities.

The negative impact to the MVPE in the rising interest rate scenarios is due to slower prepayment projections on the Bank's mortgage-related assets and investments.

As interest rates increase, borrowers have less economic incentive to refinance their mortgages and agency debt issuers have less economic incentive or opportunity to exercise their call options in order to issue new debt at lower interest rates, resulting in lower projected cash flows on these assets.

As interest rates increase in the rising rate scenarios, repayments on mortgage-related assets are more likely to decrease and only be realized through significant changes in borrowers' lives such as divorce, death, job-related relocations, or other events as there is less economic incentive for borrowers to prepay their debt, resulting in an increase in the average life of mortgage-related assets.

Similarly, call projections for the Bank's callable agency debentures decrease as interest rates rise, which results in cash flows related to these assets moving closer to the contractual maturity dates.

The higher expected average lives of these assets, relative to the assumptions in the base case interest rate environment, increases the sensitivity of their market value to changes in interest rates.

The following table presents the weighted average yields/rates and WALs (in years), after applying prepayment, call assumptions, and decay rates for our interest-earning assets and interest-bearing liabilities as of September 30, 2020.

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The maturity and repricing terms presented for one- to four-family loans represent the contractual terms of the loan.

% of Category

Amount Yield/Rate WAL % of Category % of Total

(Dollars in thousands)

Investment securities $ 380,147 0.65 % 1.0 24.3 % 4.2 %

MBS - fixed 970,369 1.82 3.3 62.2 10.7

MBS - adjustable 210,434 2.49 3.1 13.5 2.3

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Fixed-rate one- to four-family:

<= 15 years 1,130,538 2.98 3.1 15.6 % 12.5

> 15 years 4,287,229 3.67 4.2 59.3 47.3

Fixed-rate commercial 556,195 4.14 3.5 7.7 6.1

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Adjustable-rate one- to four-family:

<= 36 months 189,591 2.25 4.8 2.6 2.1

> 36 months 639,461 3.09 3.2 8.9 7.1

Adjustable-rate commercial 273,465 4.75 6.6 3.8 3.0

2 unchanged sentences

Total loans receivable 7,224,996 3.57 4.0 100.0 % 79.7

FHLB stock 93,862 4.64 1.9 1.0

Cash and cash equivalents 185,148 0.09 — 2.1

5 unchanged sentences

Term borrowings 1,793,000 2.31 3.0 22.5

FHLB line of credit

Total borrowings

Total interest-bearing liabilities $ 7,984,408 1.26 3.6 100.0 %

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7A. Quantitative and Qualitative Disclosures About Market Risk