What changed in this filing

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2021-03-01 compared with 2020-03-02 · 53 added, 38 removed, 111 unchanged (45% of the section changed)

5 unchanged sentences

Banking is generally a business of managing the maturity and repricing mismatch inherent in its asset and liability cash flows and to provide net interest income growth consistent with the Company’s profit objectives.

During the year ended December 31, 2019, the Company was able to increase its net interest income by 2% while continuing to manage its overall interest rate risk position to a moderate level.

During the year ended December 31, 2020, the Company's net interest income decreased by 1%, as a result of compression in the net interest margin largely offset by growth in average earnings assets.

The Company believes it is able to continue to manage its overall interest rate risk position to a moderate level.

The Company, through its ALCO and ongoing financial management practices, monitors the interest rate environment in which it operates and adjusts the rates and maturities of its assets and liabilities to remain competitive and to achieve its overall financial objectives subject to established risk limits.

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agency investment portfolio.

During the year ended December 31, 2019, the average investment portfolio balances increased by 15% as compared to balances at December 31, 2018, in the effort to maintain the overall proportion of AFS securities to total assets, while also prudently managing deposit growth that outpaced loan growth.

During the year ended December 31, 2020, the average investment portfolio balances increased by 17% as compared to balances at December 31, 2019, in the effort to maintain the overall proportion of AFS securities to total assets, while also prudently managing significant deposit growth that outpaced loan growth.

Cash flows from mortgage backed securities and sales of U.S.

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agency investments decreased from 22% to 16%.

During 2019, the bank held 4% of its investment portfolio in US Treasury securities.

Shorter duration floating rate corporate bonds were 3% of total investments at December 31, 2020 and SBA bonds, which are included in mortgage backed securities, were 6% of total investments at December 31, 2020.

The duration of the investment portfolio was 3.4 years at December 31, 2019 and 3.6 at December 31, 2018, and was due primarily to the passage of time and maturity of the bond portfolio mitigated by purchases of a higher mix and dollar amount of longer duration mortgage backed securities and municipal bonds.

The duration of the investment portfolio was 3.2 years at December 31, 2020 and 3.4 at December 31, 2019.

The lower duration was due to the passage of time and maturity of the bond portfolio and the faster mortgage prepayment environment, mitigated by purchases of a higher mix and dollar amount of longer duration mortgage backed securities and municipal bonds.

In the loan portfolio, the repricing duration was 21 months at December 31, 2020 and 20 months at December 31, 2019, with fixed rate loans amounting to 45% of total loans at December 31, 2020 and 41% at December 31, 2019.

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The duration of the deposit portfolio lengthened to 42 months at December 31, 2020 from 27 months at December 31, 2019.

The change since December 31, 2018 was due to a planned increase in the amount of term deposits as a percentage of total deposits in an effort to add balance sheet liquidity.

The Company experienced $250.1 million in total deposit growth for the year ended December 31, 2019 as compared to total loan growth of $554.3 million.

The Company has continued its emphasis on funding loans in its marketplace, and has been able to achieve favorable loan pricing, although competition for new loans persists.

The change since December 31, 2019 was due to measured nonmaturity deposit decay rates extending due to an economic slowdown and a resulting lack of deposit competition as rates fell.

The Company experienced $2.0 billion in total deposit growth for the year ended December 31, 2020 as compared to total loan growth of $214.5 million.

While loan growth was impacted in 2020 due to the COVID-19 pandemic, the Company has continued its emphasis on funding loans in its marketplace, and has continued to achieve discplined loan pricing, even at the expense of growing new loans.

A disciplined approach to loan pricing has resulted in a loan portfolio yield of 4.66% for the year ended December 31, 2020 as compared to 5.45% for the same period in 2019.

In the competitive interest rate environment of 2019, the interest rates on new loan originations have been less than the rates of loan paydowns and payoffs.

In the competitive interest rate environment of 2020, the interest rates on new loan originations have been well below the rates of loan paydowns and payoffs.

Additionally, significant amounts of variable and adjustable rate loans have repriced down as market interest rates decreased.

The net unrealized gain before income tax on the investment portfolio was $4.2 million at December 31, 2019 as compared to a net unrealized loss before tax of $9.5 million at December 31, 2018, with $1.5 million of realized net gains recorded during the year ended December 31, 2019.

Table o f Contents

The net unrealized gain before income tax on the investment portfolio was $22.0 million at December 31, 2020 as compared to a net unrealized gain before tax of $4.2 million at December 31, 2019, with $1.8 million of realized net gains recorded during the year ended December 31, 2020.

The higher net unrealized gain on the investment portfolio was due primarily to lower interest rates at year end 2020 as compared to year end 2019.

1 unchanged sentence

The Company is a party to interest rate swaps as part of its interest rate risk management strategy intended to mitigate the potential risk of rising interest rates on the Bank’s cost of funds.

As of December 31, 2019, the Company had one interest rate swap transactions outstanding that had a notional amount of $100.0 million associated with the Company’s variable rate deposits as compared to three designated cash flow hedge notional interest rate swap transactions outstanding as of December 31, 2018 amounting to $250.0 million associated with the Company’s variable rate deposits.

The decline in the amount of hedged variable rate deposits was due to a reduction in such variable rate deposits.

The interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed payments that began in April 2016.

The net unrealized loss before income tax on the interest rate swaps was $202 thousand at December 31, 2019 as compared to a net unrealized gain before income tax of $3.7 million at December 31, 2018, and is included in accumulated other comprehensive income (net of taxes) on the Consolidated Balance Sheet.

The unrealized loss in value since year end 2018 was due to the termination of two of the interest rate swap transactions as part of the Company’s asset liability strategy as well as declines in market interest rates.

As a result of the swap terminations, the Company recognized $829 thousand in noninterest income during March 2019.

Additionally, the Company will amortize $123 thousand of realized gain as a reduction to interest expense through the swap’s original maturity date of March 31, 2020.

As of both December 31, 2020 and 2019, the Company had one interest rate swap transaction outstanding that had a notional amount of $100.0 million associated with the Company’s variable rate deposits.

The interest rate swap is designated as a cash flow hedge and involves the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed payments that began in April 2016.

The net unrealized loss before income tax on the interest rate swap was $516 thousand at December 31, 2020 as compared to a net unrealized loss before income tax of $202 thousand at December 31, 2019, and is included in accumulated other comprehensive income (net of taxes) on the Consolidated Balance Sheet.

The increased unrealized gain in value since year end 2019 was due to the declines in market interest rates.

During the third quarter of 2018, the Company entered into credit RPAs with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts.

9 unchanged sentences

The results are analyzed as to the impact on net interest income, net income and the market equity over the next twelve and twenty-four month periods from December 31, 2020.

In addition to analysis of simultaneous changes in interest rates along the yield curve, changes based on interest rate “ramps” is also performed.

This analysis represents the impact of a more gradual change in interest rates, as well as yield curve shape changes.

In addition to analysis of simultaneous changes in interest rates along the yield curve, changes based on interest rate “ramps” is also performed and reviewed by ALCO, but is not herein disclosed.

Such analysis represents the impact of a more gradual change in interest rates, as well as yield curve shape changes.

For the analysis presented below, at December 31, 2020, the simulation assumes a 50 basis point change in interest rates on money market and interest bearing transaction deposits for each 100 basis point change in market interest rates in a decreasing interest rate shock scenario with a floor of 10 basis points, and assumes a 70 basis point change in interest rates on money market and interest bearing transaction deposits for each 100 basis point change in market interest rates in an increasing interest rate shock scenario.

2 unchanged sentences

The repricing duration of the investment portfolio at December 31, 2020 is 3.2 years, the loan portfolio 1.7 years, the interest bearing deposit portfolio 2.65 years and the borrowed funds portfolio 5.8 years.

Table o f Contents

The following table reflects the result of simulation analysis on the December 31, 2020 asset and liability balances:

Percentage change in

Change in interest

Percentage change in net

Percentage change in

rates (basis points) Percentage change in net

interest income Percentage change in

net income Percentage change in

market value of portfolio

rates (basis points)

interest income

+400 +14.0 +23.8 +8.1

+300 +9.4 +16.0 +6.4

+200 +5.0 +8.5 +4.7

+100 +1.6 +2.8 +2.8

(100) (1.6) (2.6) (11.3)

(200) (1.9) (3.2) (23.6)

The results of simulation analysis are within the relevant policy limits adopted by the Company except for the negative 200 basis point scenario for the market value of portfolio equity, which becomes harder to interpret as assets and liabilities go down to the zero lower bound in the simulation.

1 unchanged sentence

For the market value of equity, the Company has adopted a policy limit of 12% for a 100 basis point change, 15% for a 200 basis point change, 25% for a 300 basis point change and 30% for a 400 basis point change.

Due to the level of market rates at December 31, 2019, interest rate shocks of -200, -300 and -400 basis points leave the Bank with zero and negative rate instruments and are not considered practical or informative.

Due to the level of market rates at December 31, 2020, all down interest rate shocks (-100, -200, -300 and -400 basis points) leave the Bank with zero and negative rate instruments and are not considered practical or informative.

The changes in net interest income, net income and the economic value of equity in both a higher and lower interest rate shock scenario at December 31, 2020 are not considered to be excessive.

The positive impact of +5.1% in net interest income and +8.8% in net income given a 100 basis point increase in market interest rates at December 31, 2019 compares to +4.8% in net interest income and +7.9 in net income for the same period in 2018 and reflects in large measure the impact of variable and adjustable rate loans that are at or above floor rates at December 31, 2019 as compared to December 31, 2018.

The positive impact of +1.6% in net interest income and +2.8% in net income given a 100 basis point increase in market interest rates at December 31, 2020 compares to +5.1% in net interest income and +8.8 in net income for the same period in 2019 and reflects in large measure the impact of variable and adjustable rate loans that are at floor rates at December 31, 2020 and won’t reprice above floors without more significant rate movements as compared to December 31, 2019.

Generally speaking, the loss of economic value of portfolio equity in a lower interest rate environment is due to lower values of core deposits more than offsetting the gains in loan and investment values;

1 unchanged sentence

The Company believes its balance sheet is well positioned in the current interest rate environment.

During 2019, the Company continued to manage its interest rate sensitivity position to moderate levels of risk, as indicated in the simulation results above.

The interest rate risk position at December 31, 2019 was similar to the interest rate risk position at December 31, 2018.

As compared to December 31, 2018, the sum of federal funds sold, interest bearing deposits with banks and other short-term investments and loans held for sale decreased by $43.2 million at December 31, 2019.

During 2020, largely as a result of the COVID-19 pandemic, the Company experienced sharply lower market interest rates together with significantly higher levels of deposit growth as compared to loan growth.

This resulted in extraordinary levels of liquidity which was able to be invested in overnight funds which yielded a weighted average rate over the course of the year of just 0.22%.

This event resulted in a decline in the net interest spread.

Additionally, while a significant mix of the deposit growth was in noninterest bearing funds, the value of these interest free funds decreased in the lower market rate environment.

In this challenging interest rate environment in 2020, the Company continued to manage its interest rate sensitivity position to moderate levels of risk, as indicated in the simulation results above.

The interest rate risk position at December 31, 2020 was dissimilar to the interest rate risk position at December 31, 2019.

As compared to December 31, 2019, the sum of federal funds sold, interest bearing deposits with banks and other short-term investments and loans held for sale increased by $1.5 billion at December 31, 2020, and as noted above, significant amounts of variable rate loans were below floor levels at December 31, 2020.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table.

4 unchanged sentences

Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase.

During 2019, average market interest rates resulted in a flattening of the yield curve.

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During 2020, average market interest rates declined sharply, and resulted in a flattening of the yield curve.

As compared to the year 2019, the average two year U.S.

4 unchanged sentences

In that environment, the Company was able to achieve a net interest spread for 2020 of 2.81% compared to 3.05% for the year of 2019.

The decline was due primarily to an increase in the cost of interest bearing liabilities.

The decline was due primarily to a decrease in the yield on earnings assets, of which higher average liquidity was a significant factor.

The Company believes that the change in the net interest spread for the full year 2020 has been consistent with its risk analysis at December 31, 2019.

1 unchanged sentence

Banks and other financial institutions earnings are significantly dependent upon net interest income, which is the difference between interest earned on earning assets and interest expense on interest bearing liabilities.

Net interest income represented 92% and

93% of the Company’s revenue for the years ended December 31, 2019 and December 31, 2018, respectively.

Net interest income represented 88% and 92% of the Company’s revenue for the years ended December 31, 2020 and December 31, 2019, respectively.

The Company’s net interest margin was 3.19% for the year ended December 31, 2020, as compared to 3.77% for the year ended December 31, 2019.

The decline in net interest margin for the year ended December 31, 2019 as compared to the year ended December 31, 2018, was due to increased funding costs from term deposits gathered early in the year, new loan and variable rate loans adjusting downward as market rates fell, exacerbated by a decrease in the average loan to deposit ratio, as the Bank rebuilt its liquidity position.

The decline in net interest margin for the year ended December 31, 2020 as compared to the year ended December 31, 2019, was due to increased funding costs from term deposits gathered early in the year, new loan and variable rate loans adjusting downward as market rates fell, exacerbated by a decrease in the average loan to deposit ratio, as the Bank experienced high levels of on balance sheet liquidity.

In falling interest rate environments, net interest income is maximized with longer term, higher yielding assets being funded by lower yielding short-term funds, or what is referred to as a negative mismatch or negative gap.

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If this were to occur, the effects of a declining interest rate environment may not be in accordance with management’s expectations.

Table o f Contents

December 31, 2020

1 unchanged sentence

Repricible in:

Over 60 months

Non Sensitive

0-3 months 4-12 months 13-36 months 37-60 months Over 60 months Total Rate

Sensitive Non Sensitive Total

RATE SENSITIVE ASSETS:

Investment securities $ 129,321 $ 146,042 $ 271,885 $ 183,583 $ 420,252 $ 1,151,083

3,805,449 588,026 1,873,182 739,945 841,815 $ 7,848,417

Fed funds and other short-term investments 1,780,619 — — — — $ 1,780,619

Other earning assets 76,729 — — — — $ 76,729

Total $ 5,792,118 $ 734,068 $ 2,145,067 $ 923,528 $ 1,262,067 $ 10,856,848 260,954 $ 11,117,802

RATE SENSITIVE LIABILITIES:

5 unchanged sentences

Other borrowings — 148,531 — 69,546 350,000 $ 568,077

Total $ 5,397,729 $ 746,198 $ 973,253 $ 586,629 $ 2,080,197 $ 9,784,006 92,904 $ 9,876,910

Gap $ 394,389 $ (12,130) $ 1,171,814 $ 336,899 $ (818,130) $ 1,072,842

Cumulative Gap $ 364,389 $ 352,259 $ 1,524,073 $ 1,860,972 $ 1,042,842

1 unchanged sentence

OFF BALANCE-SHEET:

Interest Rate Swaps - LIBOR based

Interest Rate Swaps - Fed Funds based 100,000 (100,000) $ —

Total $ 100,000 $ (100,000) $ — $ — $ — $ — $ — $ —

Gap $ 494,389 $ (112,130) $ 1,171,814 $ 336,899 $ (818,130) $ 1,072,842

Cumulative Gap $ 464,389 $ 352,259 $ 1,524,073 $ 1,860,972 $ 1,042,842

2 unchanged sentences

(2) Nonaccrual loans are included in the over 60 months category

The sum of federal funds sold, interest bearing deposits with banks and other short-term investments decreased by $43.2 million at December 31, 2019 as compared to December 31, 2018.

The Company was able to curtail some short term liabilities, namely Federal Home Loan Bank short term borrowings, at year end 2019 as compared to 2018, but was holding more time deposits that are due to mature and reprice in the 4-12 month time horizon.

The sum of federal funds sold, interest bearing deposits with banks and other short-term investments increased by $1.6 billion at December 31, 2020 as compared to December 31, 2019.

The Company was able to curtail some short term liabilities at year end 2020 as compared to 2019, but was holding more time deposits that are due to mature and reprice in the 4-12 month time horizon.

This change resulted in the cumulative gap position within 12 months decreasing to 3.2% of total assets at December 31, 2020 from 3% of total assets at December 31, 2019.

Although NOW and money market accounts are subject to immediate repricing, the Bank’s gap model has incorporated a repricing schedule to account for a lag in rate changes based on our experience, as measured by the amount of those deposit rate changes relative to the amount of rate change in assets.

Table o f Contents

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