Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Asset and Liability Management and Market Risk
The rates of interest the Bank earns on its assets and pays on its liabilities are generally established contractually for a period of time. Fluctuations in interest rates have a significant impact not only upon our net income, but also upon the cash flows and market values of our financial assets and liabilities. Our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our interest-earning assets and interest-bearing liabilities. Risk associated with changes in interest rates on the earnings of the Bank and the market value of its financial assets and liabilities is known as interest rate risk. Interest rate risk is our most significant market risk, and our ability to adapt to changes in interest rates is known as interest rate risk management.
The general objective of our interest rate risk management program is to determine and manage an appropriate level of interest rate risk while maximizing net interest income in a manner consistent with our policy to manage, to the extent practicable, the exposure of net interest income to changes in market interest rates. The Board of Directors and Asset and Liability Management Committee ("ALCO") regularly review the Bank's interest rate risk exposure by forecasting the impact of hypothetical, alternative interest rate environments on net interest income and the market value of portfolio equity ("MVPE") at various dates. The MVPE is defined as the net of the present value of cash flows from existing assets, liabilities, and off-balance sheet instruments. The present values are determined based upon market conditions as of the date of the analysis, as well as in alternative interest rate environments providing potential changes in the MVPE under those alternative interest rate environments. Net interest income is projected in the same alternative interest rate environments with both a static balance sheet and with management strategies considered. The MVPE and net interest income analyses are also conducted to estimate our sensitivity to rates for future time horizons based upon market conditions as of the date of the analysis. The MVPE ratio continues to be an important measurement for management as we consider the changes in market interest rates, liquidity needs and portfolio balances. MVPE represents a long-term view of the interest sensitivity of the Bank's balance sheet while our net interest income projections inform management of the short-term impacts of pricing decisions. In addition to the interest rate environments presented below, management also reviews the impact of non-parallel rate shock scenarios on a quarterly basis. These scenarios consist of flattening and steepening the yield curve by changing short-term and long-term interest rates independent of each other, and simulating cash flows and determining valuations as a result of these hypothetical changes in interest rates to identify rate environments that pose the greatest risk to the Bank. This analysis helps management quantify the Bank's exposure to changes in the shape of the yield curve.
General assumptions used by management to evaluate the sensitivity of our financial performance to changes in interest rates presented in the tables below are utilized in, and set forth under, the gap table and related notes. Although management finds these assumptions reasonable, the interest rate sensitivity of our assets and liabilities and the estimated effects of changes in interest rates on our net interest income and MVPE indicated in the below tables could vary substantially if different assumptions were used or actual experience differs from these assumptions. To illustrate this point, the projected cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities within the next 12 months as a percent of total assets ("one-year gap") is also provided for an up 200 basis point scenario, as of September 30, 2023.
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Qualitative Disclosure about Market Risk
Gap Table. 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. Cash flow projections for mortgage-related assets are calculated based in part on prepayment assumptions at current and projected interest rates. Prepayment projections are subjective in nature, involve uncertainties and assumptions and, therefore, cannot be determined with a high degree of accuracy. Although certain assets and liabilities may have similar maturities or periods to repricing, they may react differently to changes in market interest rates. Assumptions may not reflect how actual yields and costs respond to market interest rate changes. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment rates would likely deviate significantly from those assumed in calculating the gap table below. A positive gap generally means more cash flows from assets are expected to reprice than cash flows from liabilities and suggests in a rising rate environment, that net interest income should increase. A negative gap generally means more cash flows from liabilities are expected to reprice than cash flows from assets and suggests, in a rising rate environment, that net interest income should decrease. 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.
More Than More Than
Within One Year to Three Years Over
One Year Three Years to Five Years Five Years Total
Interest-earning assets: (Dollars in thousands)
Loans receivable (1)
$ 1,432,766 $ 1,764,668 $ 1,405,268 $ 3,383,068 $ 7,985,770
Securities (2)
341,362 648,456 195,313 200,861 1,385,992
Other interest-earning assets 213,967 — — — 213,967
Total interest-earning assets 1,988,095 2,413,124 1,600,581 3,583,929 9,585,729
Interest-bearing liabilities:
Non-maturity deposits (3)
653,670 407,782 351,235 1,991,741 3,404,428
Certificates of deposit 1,499,018 1,037,730 193,262 182 2,730,192
Borrowings (4)
1,021,214 1,287,580 582,261 26,046 2,917,101
Total interest-bearing liabilities 3,173,902 2,733,092 1,126,758 2,017,969 9,051,721
Excess (deficiency) of interest-earning assets over
interest-bearing liabilities $ (1,185,807) $ (319,968) $ 473,823 $ 1,565,960 $ 534,008
Cumulative excess (deficiency) of interest-earning assets over
interest-bearing liabilities $ (1,185,807) $ (1,505,775) $ (1,031,952) $ 534,008
Cumulative excess (deficiency) of interest-earning assets over interest-bearing
liabilities as a percent of total Bank assets at:
September 30, 2023 (11.7) % (14.8) % (10.1) % 5.3 %
September 30, 2022 (11.9)
Cumulative one-year gap - interest rates +200 bps at:
September 30, 2023 (11.9)
September 30, 2022 (12.1)
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(1) Adjustable-rate loans are included in the period in which the rate is next scheduled to adjust or in the period in which repayments are expected to occur, or prepayments are expected to be received, prior to their next rate adjustment, rather than in the period in which the loans are due. Fixed-rate loans are included in the periods in which they are scheduled to be repaid, based on scheduled amortization and prepayment assumptions. Balances are net of undisbursed amounts and deferred fees and exclude loans 90 or more days delinquent or in foreclosure.
(2) MBS reflect projected prepayments at amortized cost. All other securities are presented based on contractual maturities, term to call dates or pre-refunding dates as of September 30, 2023, at amortized cost.
(3) Although the Bank's checking, savings, and money market accounts are subject to immediate withdrawal, management considers a substantial amount of these accounts to be core deposits having significantly longer effective maturities. The decay rates (the assumed rates at which the balances of existing accounts decline) used on these accounts is based on assumptions developed from our actual experiences with these accounts. If all of the Bank's checking, savings, and money market accounts had been assumed to be subject to repricing within one year, interest-bearing liabilities which were estimated to mature or reprice within one year would have exceeded interest-earning assets with comparable characteristics by $3.94 billion, for a cumulative one-year gap of (38.7)% of total assets.
(4) Borrowings exclude deferred prepayment penalty costs. Included in this line item are $365.0 million of FHLB adjustable-rate advances tied to interest rate swaps. The repricing for these liabilities is projected to occur at the maturity date of each interest rate swap.
At September 30, 2023, the Bank's gap between the amount of interest-earning assets and interest-bearing liabilities projected to reprice within one year was $(1.19) billion, or (11.7)% of total assets, compared to $(1.14) billion, or (11.9)% of total assets, at September 30, 2022. The change in the one-year gap amount was due primarily to an increase in the amount of liability cash flows coming due in one year at September 30, 2023 compared to September 30, 2022, partially offset by an increase in the amount of asset cash flows coming due for the same time period. This was due primarily to an increase in the amount of certificates of deposit and borrowings scheduled to mature within one year as of September 30, 2023 compared to September 30, 2022.
The majority of interest-earning assets anticipated to reprice in the coming year are repayments and prepayments on one- to four-family loans and MBS, both of which include the option to prepay without a fee being paid by the contract holder. The amount of interest-bearing liabilities expected to reprice in a given period is not typically impacted significantly by changes in interest rates, because the Bank's borrowings and certificate of deposit portfolios have contractual maturities and generally cannot be terminated early without a prepayment penalty. If interest rates were to increase 200 basis points, as of September 30, 2023, the Bank's one-year gap is projected to be $(1.21) billion, or (11.9)% of total assets. This compares to a one-year gap of $(1.17) billion, or (12.1)% of total assets, if interest rates were to have increased 200 basis points as of September 30, 2022.
Change in Net Interest Income. The Bank's net interest income projections are a reflection of the response to interest rates of assets and liabilities that are expected to mature or reprice over the next year. Repricing occurs as a result of cash flows that are received or paid on assets or due on liabilities which would be replaced at then current market interest rates or on adjustable-rate products that reset during the next year. The Bank's borrowings and certificate of deposit portfolios have stated maturities and the cash flows related to the Bank's liabilities do not generally fluctuate as a result of changes in interest rates. Cash flows from mortgage-related assets and callable agency debentures can vary significantly as a result of changes in interest rates. As interest rates decrease, borrowers have an economic incentive to lower their cost of debt by refinancing or endorsing their mortgage to a lower interest rate. 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. The change in each interest rate environment represents the difference between estimated net interest income in the zero 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 in an effort to model anticipated customer behavior changes as market rates change. 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. The estimation of net interest income does not include any projected gains or losses related to the sale of loans or securities, or income derived from non-interest income sources, but does include the use of different prepayment assumptions in the alternative interest rate
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environments. It is important to consider that estimated changes in net interest income are for a cumulative four-quarter period. These do not reflect the earnings expectations of management.
Change Net Interest Income At September 30,
(in Basis Points) 2023 2022
in Interest Rates (1)
Amount ($) Change ($) Change (%) Amount ($) Change ($) Change (%)
(Dollars in thousands)
-200 bp $ 126,495 $ (6,963) (5.2) % $ 182,458 $ (775) (0.4) %
-100 bp 130,374 (3,084) (2.3) 183,363 130 0.1
000 bp 133,458 — — 183,233 — —
+100 bp 136,147 2,689 2.0 182,737 (496) (0.3)
+200 bp 138,804 5,346 4.0 182,081 (1,152) (0.6)
+300 bp 141,494 8,036 6.0 181,394 (1,839) (1.0)
(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, 2023 compared to September 30, 2022 due primarily to higher interest expense projections on the Bank's liabilities compared to the increase in the interest income projections on the Bank's assets. This was primarily driven by faster increases in the cost of liabilities during fiscal year 2023, compared to the increase in asset yields. The increase in the cost of liabilities was due mainly to an increase in the balance and rate of the certificate of deposit portfolio, an increase in the rates paid on money market accounts, and an increase in the balance of higher-costing borrowings during the current year. This was partially offset by higher projected income on loans receivable due to a higher balance and yield on the portfolio compared to September 30, 2022.
In the rising and declining interest rate scenarios, the variability of net interest income projections has become more significant due to the composition of the balance sheet and the elevated interest rate environment. At September 30, 2023, the Bank's balance of cash and cash equivalents was $245.6 million with an average yield of 4.70% compared to a balance of $49.2 million with an average yield of 1.75% at September 30, 2022. As a result, in each interest rate scenario, there was a greater impact on net interest income at September 30, 2023 compared to September 30, 2022 due to the higher cash balance. Additionally, due to compositional changes in the Bank's deposit portfolio between periods (increase in certificates of deposit and decrease in non-maturity deposits), the impact from instantaneous, parallel and permanent changes in the various interest rate scenarios was less pronounced at September 30, 2023. More generally, however, increases in net interest income in the rising rate scenarios are due to the degree to which loan repayments that are projected to reprice upward are greater than the projected increase in deposit rates in the next 12 months. In the declining rate scenarios, loan repayments are repriced at rates that do not fully offset the higher cost of liabilities that are expected to reprice in the next 12 months.
Change in MVPE. Changes in the estimated market values of our financial assets and liabilities drive changes in estimates of MVPE. The market value of an asset or liability reflects the present value of all the projected cash flows over its remaining life, discounted at market interest rates. As interest rates rise, generally the market value for both financial assets and liabilities decrease. The opposite is generally true as interest rates fall. The MVPE represents the theoretical market value of capital that is calculated by netting the market value of assets, liabilities, and off-balance sheet instruments. If the market values of financial assets increase at a faster pace than the market values of financial liabilities, or if the market values of financial liabilities decrease at a faster pace than the market values of financial assets, the MVPE will increase. The market value of shorter term-to-maturity financial instruments is less sensitive to changes in interest rates than are longer term-to-maturity financial instruments. Because of this, the market values of our certificates of deposit (which generally have relatively shorter average lives) tend to display less sensitivity to changes in interest rates than do our mortgage-related assets (which generally have relatively longer average lives). The average life expected on our mortgage-related assets varies under different interest rate environments because borrowers have the ability to prepay their mortgage loans. Therefore, as interest rates decrease, the WAL of mortgage-related assets decrease as well. As interest rates increase, the WAL would be expected to increase, as well as increasing the sensitivity of these assets in higher rate environments.
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The following table sets forth the estimated change in the MVPE for each date presented based on the indicated instantaneous, parallel, and permanent change in interest rates. The change in each interest rate environment represents the difference between the MVPE in the base case (assumes the forward market interest rates implied by the yield curve are realized) and the MVPE in each alternative interest rate environment (assumes market interest rates have a parallel shift in rates). Projected cash flows for each scenario are based upon varying prepayment assumptions to model anticipated customer behavior as market rates change. 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. The estimated MVPE results from the valuation of cash flows from financial assets and liabilities over the anticipated lives of each for each interest rate environment. 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.
Change Market Value of Portfolio Equity At September 30,
(in Basis Points) 2023 2022
in Interest Rates (1)
Amount ($) Change ($) Change (%) Amount ($) Change ($) Change (%)
(Dollars in thousands)
-200 bp $ 1,302,781 $ 283,093 27.8 % $ 1,299,340 $ 404,353 45.2 %
-100 bp 1,145,404 125,716 12.3 1,024,167 129,180 14.4
000 bp 1,019,688 — — 894,987 — —
+100 bp 888,642 (131,046) (12.9) 759,165 (135,822) (15.2)
+200 bp 757,870 (261,818) (25.7) 625,864 (269,123) (30.1)
+300 bp 632,716 (386,972) (38.0) 500,730 (394,257) (44.1)
(1) Assumes an instantaneous, parallel, and permanent change in interest rates at all maturities.
The percentage change in the Bank's MVPE at both September 30, 2023 and September 30, 2022 was negative in all rising interest rate scenarios. The Bank's MVPE increased from $895.0 million at September 30, 2022 to $1.02 billion at September 30, 2023. The increase was primarily a result of refinements made during the current year in calculating the estimated fair value of the Bank's balance sheet; specifically, related to the treatment of unrealized gains and losses associated with its AFS securities portfolio. Previously, at September 30, 2022, net unrealized losses associated with the Bank's AFS securities portfolio were included in both the calculation of the estimated market value of assets and the estimated market value of securities. Unrealized gains and losses associated with the Bank's AFS securities portfolio are now only reflected in the estimated market value of its securities.
As interest rates increase, borrowers have less economic incentive to prepay or 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 interest rate scenarios, prepayments 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 longer expected average lives of these assets increases the sensitivity of their market value to changes in interest rates.
In the increasing rate scenarios, the sensitivity reflects the negative impacts of rates on the value of the Bank's loan and securities portfolios more so than on its deposit and borrowings portfolios. In the decreasing interest rate scenarios, the Bank's MVPE increased due to a larger increase in the market value of the Bank's assets than the Bank's liabilities. This is because the Bank's mortgage-related assets continue to have a longer duration in these interest rate scenarios which results in greater sensitivity in market value as interest rates change.
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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, 2023. Yields presented for interest-earning assets include the amortization of fees, costs, premiums and discounts, which are considered adjustments to the yield. The interest rate presented for term borrowings is the effective rate, which includes the impact of interest rate swaps and the amortization of deferred prepayment penalties resulting from FHLB advances previously prepaid. The WAL presented for term borrowings includes the effect of interest rate swaps.
Amount Yield/Rate WAL % of Category % of Total
(Dollars in thousands)
Securities $ 1,384,482 1.35 % 4.2 14.3 %
Loans receivable:
Fixed-rate one- to four-family 5,605,281 3.29 6.9 70.2 % 57.6
Fixed-rate commercial 456,087 4.44 3.1 5.7 4.7
All other fixed-rate loans 78,005 4.48 7.3 1.0 0.8
Total fixed-rate loans 6,139,373 3.39 6.7 76.9 63.1
Adjustable-rate one- to four-family 916,660 3.73 4.5 11.5 9.4
Adjustable-rate commercial 831,400 5.92 7.6 10.4 8.5
All other adjustable-rate loans 96,948 8.26 3.1 1.2 1.0
Total adjustable-rate loans 1,845,008 4.95 5.8 23.1 18.9
Total loans receivable 7,984,381 3.75 6.5 100.0 % 82.0
FHLB stock 110,714 9.22 2.1 1.2
Cash and cash equivalents 245,605 4.70 — 2.5
Total interest-earning assets $ 9,725,182 3.50 5.9 100.0 %
Non-maturity deposits $ 2,762,702 1.06 6.7 50.3 % 33.0 %
Retail certificates of deposit 2,533,954 3.47 1.3 46.1 30.2
Commercial certificates of deposit 48,751 3.56 1.0 0.9 0.6
Public unit certificates of deposit 147,487 4.44 0.6 2.7 1.8
Total interest-bearing deposits 5,492,894 2.28 4.0 100.0 % 65.6
Term borrowings 2,882,828 3.34 1.8 34.4
Total interest-bearing liabilities $ 8,375,722 2.65 3.2 100.0 %
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