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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2025-02-27 compared with 2024-02-29 · 60 added, 51 removed, 74 unchanged (60% of the section changed)

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Asset/Liability Management of Interest Rate Risk

A fundamental risk in banking is exposure to market risk, or interest rate risk, since a bank’s net income is largely dependent on net interest income.

The Bank’s ALCO formulates and monitors the management of interest rate risk through policies and guidelines established by it and overseen by the Audit Committee and the full Board and through review of detailed reports discussed quarterly.

A fundamental risk in banking is exposure to market risk, specifically interest rate risk, since a bank’s earnings are largely dependent on net interest income.

The Bank’s ALCO formulates and monitors the management of interest rate risk through policies and guidelines established by it and overseen by the Audit Committee and the full Board of Directors and through review of detailed reports discussed quarterly.

In its consideration of risk limits, the ALCO considers the impact on earnings and capital, the level and direction of interest rates, liquidity, local economic conditions, outside threats and other factors.

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

During the year ended December 31, 2023, the Company was able to produce a net interest margin of 2.53% as compared to 2.93% during the same period in 2022 and continues to manage its overall interest rate risk position.

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

During the year ended December 31, 2024, the Company produced a net interest margin of 2.37% as compared to 2.53% during the same period in 2023 and continues to manage its overall interest rate risk position.

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.

During 2023, average market interest rates were increased across the yield curve as compared to the 2022 year end.

During 2024, the yield curve normalized and became less inverted as the short end of the curve came down as the long end increased as compared to the 2023 year end.

As compared to the year 2023, the average two year U.S.

Treasury rate in 2023 increased by 159 basis points from 2.99% to 4.58%.

Treasury rate in 2024 decreased by 21 basis points from 4.58% to 4.37%.

The average five year U.S.

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Treasury rate increased by 25 basis points from 3.96% to 4.21%.

The Company’s cost of interest bearing deposits increased by 96 basis points across its interest-bearing deposits, which comprise 74% of its total deposits, at December 31, 2023.

In that environment, the Company's result for net interest spread in 2023 was 1.28% compared to 2.33% for the year of 2022.

The decline in the net interest spread was due primarily to an increase in the rate on funding costs, of which lower average liquidity was a factor in ultimately reducing the net interest spread.

The Company believes that the change in the net interest spread for the full year 2023 has been consistent with its risk analysis at December 31, 2022 when accounting for balance sheet volume and mix changes.

The Company’s cost of interest bearing deposits decreased by 14 basis points across its interest-bearing deposits, which comprise 83% of its total deposits, at December 31, 2024.

The Company's result for net interest spread in 2024 was 1.28% unchanged from 2023.

Net interest spread was unchanged with offsetting decreases to interest earning assets and interest bearing liabilities.

The Company believes that the stable net interest spread for the full year 2024 has been consistent with its risk analysis at December 31, 2023 when accounting for balance sheet volume and mix changes.

On an annual basis, the Company back-tests the actual change in its net interest spread against expected change and actual market interest rate movements and other factors impacting actual as compared to projected results.

Although the Company has experienced net interest margin compression during the year ended December 31, 2023, the Company's interest rate risk modeling shows net interest margin expansion in an increasing rate environment.

The model's prediction is the result of increases in both interest income on variable and adjustable rate loans and interest expense on its deposit liabilities, based on our funding needs, market conditions and certain contractual obligations but with no changes in the mix of assets or liabilities or the spreads we are able to earn.

The model also assumes a stable interest rate environment after the programmed rate change, allowing assets and liabilities to reprice at their schedule in a stable environment, which may be quite different than real world conditions.

Interest rate floors on certain of the Company's variable and adjustable rate loans may provide asset yield protection in a low-interest rate environment;

however, they are also expected to delay the impact of increases to market rates on interest income until such floors have been exceeded, although this is not relevant for the current rate environment with most variable rate loans well above their floor rate.

The weighted average rate of the Company's variable rate loans increased by approximately 85 basis points from December 31, 2022 to December 31, 2023 in connection with the increase in 100 basis points for the same period in Fed Funds rate hikes caused by actions taken by the Federal Reserve Bank.

At December 31, 2023, the Company had a portfolio of $3.0 billion of variable and adjustable rate loans that were subject to interest rate floors with a weighted average rate of 7.99%.

At December 31, 2023, only $183.9 million of loans held by the Company were earning interest at their floor rate, as compared to $241.0 million at December 31, 2022.

The majority of those loans are expected to reset at rates higher than their floor at their next rate reset date.

The loan portfolio increased throughout 2023.

The re-pricing duration on the loan portfolio was 12 months at December 31, 2023 and 13 months at December 31, 2022, with fixed-rate loans amounting to 38% of total loans at December 31, 2023 and 2022.

Variable and adjustable rate loans comprised 62% of total loans at December 31, 2023 and 2022.

Variable rate loans are generally indexed to either the one-month London Interbank Offered Rate (“LIBOR”) (prior to the June 30, 2023 LIBOR cessation date), with fallback language to reference the Secured Overnight Funding Rate ("SOFR"), or the Wall Street Journal prime interest rate, while adjustable rate loans are indexed primarily to the five year U.S.

The loan portfolio remained relatively flat throughout 2024.

The re-pricing duration on the loan portfolio was 10.6 months at December 31, 2024 and 12 months at December 31, 2023, with fixed-rate loans amounting to 38.1% and 38.2% of total loans at December 31, 2024 and 2023, respectively.

Variable and adjustable rate loans comprised 61.9% and 61.8% of total loans at December 31, 2024 and 2023, respectively.

Variable rate loans are generally indexed to the Secured Overnight Funding Rate ("SOFR") or the Wall Street Journal prime interest rate, while adjustable rate loans are indexed primarily to the five year U.S.

Treasury interest rate.

The few remaining loans that were still tied to LIBOR based rates on June 30, 2023 were transitioned to their appropriate fallback rate on July 3, 2023.

In the current and expected future interest rate environment, the Company has been maintaining its investment portfolio with the goal of managing the balance between yield and risk in its portfolio of MBS.

In the current and expected future interest rate environment, the Company has been maintaining its investment portfolio to manage the balance between yield and risk in its portfolio of MBS.

Further, the Company has been principally collecting cash flows from the investment portfolio to provide liquidity.

Additionally, the Company has limited call risk in its U.S.

agency investment portfolio.

At December 31, 2024, the amortized cost less allowance of the investment portfolio decreased by $336.5 million, or 12.5%, as compared to the balance at December 31, 2023.

The percentage mix of municipal securities was 5% of total investments at December 31, 2023 and 2022.

Based on amortized cost basis, the percentage mix of municipal securities was 6% of total investments at December 31, 2024 and 2023.

The portion of the portfolio invested in MBS was 62% and 61% at December 31, 2024 and 2023.

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Corporate bonds generally, and subordinated debt in particular, pose credit risk such that if any of these issuers were to enter bankruptcy or insolvency proceedings, we could experience losses that may be material to operating results and our financial condition.

We may also experience increases in provisions for credit losses, adversely affecting our net income, if the creditworthiness of the issuers declines, whether due to idiosyncratic factors, economic conditions generally or otherwise.

We may also experience increases in provisions for credit losses, adversely affecting our earnings, if the creditworthiness of the issuers declines, whether due to idiosyncratic factors, economic conditions generally or other unforeseen factors or events.

The Company has credit Risk Participation Agreements ("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.

The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure.

Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities.

Total expected exposure incorporates

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both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities.

These derivatives are not designated as hedges, are not speculative and have an asset position with a notional value of $49.5 million as of December 31, 2024.

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The duration of the deposit portfolio decreased to 11 months at December 31, 2024 from 28 months at December 31, 2023.

The Company experienced a total deposit increase of $94.9 million for the year ended December 31, 2023 as compared to a total loan increase of $333.1 million for the same period.

The shortfall was funded by increased borrowings, primarily with BTFP borrowings during the year ended December 31, 2023.

The funding mix has continued to change throughout the year ended December 31, 2023.

This decline is attributable to a shift in deposit mix, lower short term interest rates, and modeling assumption updates.

The Company experienced a total deposit increase of $323.0 million for the year ended December 31, 2024 as compared to a total loan decrease of $33.8 million for the same period.

The funding mix changed throughout the year ended December 31, 2024.

Deposits at year end were $9.1 billion and $8.8 billion at December 31, 2024 and 2023, respectively.

The increase was primarily attributable to a $1.4 billion increase in interest bearing time deposits, offset by a $871.7 million reduction in noninterest bearing deposits and a $326.7 million reduction in savings and money market accounts as a result of an increase of disintermediation driven primarily by an increase in interest rates.

The growth in interest bearing deposits was driven by the increased utilization of brokered deposits, particularly brokered time deposits, during the year ended December 31, 2023, as discussed in "Deposits and Other Borrowings" above.

Additionally, the Company’s cost of interest increased by 269 basis points across its interest-bearing deposits, which comprise 74.12% of its total deposits, at December 31, 2022.

The net unrealized loss before income tax on the investment securities available-for-sale portfolio was $162.0 million and $205.3 million at December 31, 2023 and 2022, respectively.

The increase in deposits was primarily attributable to a $558.2 million decrease in noninterest bearing demand deposits, offset by a $734.7 million increase in time deposits.

Refer to the "Deposits and Other Borrowings" section below for further discussion of deposits and borrowings.

The net unrealized loss before income tax on the AFS securities portfolio was $141.5 million and $162.0 million at December 31, 2024 and 2023, respectively.

At December 31, 2024, the net unrealized loss position represented 10.04% of the investment portfolio's book value.

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There can be no assurance that the Company will be able to successfully achieve its optimal asset liability mix, given competitive pressures, customer preferences and the inability to forecast future interest rates and movements with complete accuracy.

The Company employs an earnings simulation model (immediate parallel shifts along the yield curve) on a quarterly basis to monitor its interest rate sensitivity and risk and to model its balance sheet cash flows and the related income statement effects in different interest rate scenarios.

In the year ended December 31, 2024, the Federal Reserve instituted 100 basis points of interest rate cuts.

Yields on interest-earning assets and interest bearing deposits decreased as a result of the Federal Reserve rate cuts.

However a decrease in non-interest bearing deposits replaced with an increase in interest bearing deposits resulted in a decrease in net interest margin as compared to the prior year-end.

Our rate risk modeling showed very modest net interest margin compression in an increased interest rate environment while showing modest net interest margin expansion in a declining interest rate environment.

The model's prediction in a rising rate environment is the result of increases in both interest income on variable and adjustable rate loans and interest expense on its deposit liabilities, based on our funding needs, market conditions and certain contractual obligations but with no changes in the mix of assets or liabilities or the spreads we are able to earn.

The opposite is true in a falling interest rate environment as decreases in both interest income on variable and adjustable rate loans and interest expense on deposit liabilities drive modest margin expansion.

The model also assumes a stable interest rate environment after the programmed changes in the yields, which assumes repricing of assets and liabilities as scheduled in a stable environment, which may be quite different than real world conditions.

Interest rate floors on certain of the Company's variable and adjustable rate loans may provide asset yield protection in a low-interest rate environment;

however, they are also expected to delay the impact of increases to market rates on interest income until such floors have been exceeded.

In 2024, interest rate floors have not been relevant in the current interest rate environment since most variable rate loans are well above their floor rate.

The weighted average rate of the Company's variable rate loans decreased by approximately 76 basis points from December 31, 2023 to December 31, 2024 in connection with the decrease of 100 basis points for the same period in Fed Funds rate.

The most recent interest rate cuts of 100 basis points instituted by the Federal Reserve at the end of September 2024, and in the fourth quarter of 2024 were signs of improvements in the economic outlook.

In 2025, the economic outlook continues to evolve and any additional adjustments to interest rates are uncertain.

At December 31, 2024, the Company had a portfolio of $3.0 billion of variable and adjustable rate loans that were subject to interest rate floors with a weighted average rate of 7.24%, which was a 75 bps decrease from December 31, 2023.

At December 31, 2024, only $123.6 million or 1.56% of loans held by the Company were earning interest at their floor rate, as compared to $183.9 million or 2.31% at December 31, 2023.

The majority of those loans are expected to reset at rates higher than their floor at their next rate reset date.

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The Company employs an earnings simulation model (immediate parallel shifts along the yield curve) on a quarterly basis to monitor its interest rate sensitivity and risk and to model its balance sheet cash flows and the related statement of operations effects in different interest rate scenarios.

The model utilizes current balance sheet data and attributes and is adjusted for assumptions as to investment maturities (including prepayments), loan prepayments, interest rates, deposit decay rates, and the level of noninterest income and noninterest expense.

Further discussion of the limitations of this analysis are listed below and in Item 1A.

Risk Factors.

Risk Factors, and in other periodic and current reports filed by the Company with the SEC.

The data is then subjected to a “shock test” which assumes a simultaneous change in interest rates up 100, 200, 300 and 400 basis points or down 100, 200 and 300 basis points, along the entire yield curve, but not below zero.

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For the analysis presented below, at December 31, 2024, the simulation assumes a 100 basis point change in interest rates on interest bearing 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 100 basis point change in interest rates on interest bearing deposits for each 100 basis point change in market interest rates in an increasing interest rate shock scenario.

The Bank does have deposits with contractual terms which means these deposits will change 100 basis points for every 100 basis points change in market rates.

The Bank does have deposits with contractual rate terms which means these deposits will change 100 basis points for every 100 basis points change in market rates.

Thus, the overall measure of the correlation between deposit costs and market rate changes is modeled at 100%.

At December 31, 2022, the Company assumed a 70 basis point change in interest rates on interest bearing deposits for each 100 basis point change in market interest rates, with a floor of 10 basis points and 0 basis points on decreasing and increasing rate shock scenarios, respectively.

The Company utilized the same assumptions for its analysis at December 31, 2023.

Because competitive market behavior does not necessarily track the trend of interest rates but at times moves ahead of financial market influences, the change in the cost of liabilities may be different than anticipated by the interest rate risk model.

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This moderate impact is due substantially to the significant level of variable rate and repriceable assets and liabilities and related shorter relative durations.

The repricing duration of the investment portfolio at December 31, 2023 is 4.4 years, the loan portfolio 1.0 years, the interest bearing deposit portfolio 1.2 years, and the borrowed funds portfolio 0.3 years.

At December 31, 2024, the repricing duration of (a) the investment portfolio was 4.2 years, (b) the loan portfolio 0.9 years, (c) the interest bearing deposit portfolio was 0.2 years, and (d) the borrowed funds portfolio was 0.5 years.

The following table reflects the result of the simulation analysis on the December 31, 2024 asset and liability balances:

Change in interest

rates (basis points) Percentage change in net

interest income Percentage change in

net income Percentage change in

market value of portfolio

rates (basis points) Percentage change in 12-month net

interest income

Percentage change in 12-month net income

Percentage change in

economic value of

+400 (2.9)% (6.3)% (14.1)%

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For net interest income, the Company has adopted a policy limit of -10% for a 100 basis point change, -12% for a 200 basis point change, -18% for a 300 basis point change and -24% for a 400 basis point change.

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.

The impact of (0.4)% in net interest income and (0.9)% in net income given a 100 basis point increase in market interest rates at December 31, 2023 compares to 9.9% in net interest income and 16.4% in net income for the same period in 2022 and reflects in large measure the beta factor discussion above.

At the end of 2023 compared in the end of 2022, increasing rates do not lead to increased income because we model that rate increases pass through to our borrowers basis point for basis point as opposed to the prior year where our model suggested rising rates would not be fully passed on to depositors.

The changes in net interest income, net income and the economic value of equity in higher interest rate shock scenarios at December 31, 2023 are not believed to be excessive.

For the economic 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.

The increase in 12-month net interest income and net income of 0.9% and 2.0%, respectively, given a 100 basis point decrease in market interest rates at December 31, 2024 compares to (0.4)% and (0.9)%, respectively, for the same period in 2023.

The analysis at the end of 2024 consistent with the analysis at the end of 2023, showed that in an environment of increasing rates, income decreases.

The changes in net interest income, net income and the economic value of equity in higher interest rate shock scenarios at December 31, 2024 are not believed to be excessive and are within policy limits.

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

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The projected impact on net interest income in the table above also assumes a "through-the-cycle" non-maturity deposit beta which may not be an accurate predictor of actual deposit rate changes realized in scenarios of smaller and/or non-parallel interest rate movements.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by current and future changes in interest rates.

Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates.

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ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios as part of its responsibility to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing and capital policies.

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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