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Net interest income is our most significant component of earnings and we consider interest rate risk to be our most significant market risk.
+Added: Our net interest income results from the difference between the yields we earn on our interest-earning assets, primarily loans and investments, and the rates that we pay on our interest-bearing liabilities, primarily deposits and borrowings.
+Added: When interest rates change, the yields we earn on our interest-earning assets and the rates we pay on our interest-bearing liabilities do not necessarily move in tandem with each other because of the difference between their maturities and repricing characteristics and which can negatively impact net interest income.
+Added: Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve.
+Added: Changes in monetary policy, including changes in interest rates, influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but such changes could also affect the average duration of our mortgage portfolio, investment securities and other interest-earning assets.
Our goal is to structure our asset/liability composition to maximize net interest income while managing interest rate risk so as to minimize the adverse impact of changes in interest rates on net interest income and capital in either a rising or declining interest rate environment.
Profitability is affected by fluctuations in interest rates.
−Removed: A sudden and substantial change in interest rates may adversely impact our earnings because the interest rates of the underlying assets and liabilities do not change at the same speed, to the same extent or on the same basis.
−Removed: Interest rate risk is monitored through the use of three complementary modeling tools:
−Removed: static gap analysis, earnings simulation modeling, and economic value simulation (net present value estimation).
−Removed: Each of these models measures changes in a variety of interest rate scenarios.
−Removed: While each of the interest rate risk models has limitations, taken together they represent a reasonably comprehensive view of the magnitude of our interest rate risk, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships.
−Removed: Static gap, which measures aggregate repricing values, is less utilized because it only measures the magnitude of the timing differences and does not address repricing lags, market influences, or management actions.
−Removed: Earnings simulation and economic value models, which more effectively measure the cash flow and optionality impacts, are utilized by management on a regular basis and are discussed further below.
−Removed: From the various model results and our
−Removed: expectations regarding future interest rate movements, the national, regional and local economies, and other financial and business risk factors, we quantify the overall magnitude of interest sensitivity risk and then determine appropriate strategies and practices governing asset growth and pricing, funding sources and pricing, and off-balance sheet commitments.
+Added: A sudden and substantial change in interest rates will generally impact our earnings adversely because the interest rates of the underlying assets and liabilities do not change at the same speed, to the same extent or on the same basis.
+Added: Interest rate risk is monitored through the use of several complementary modeling tools, primarily earnings simulation modeling, and economic value simulation (net present value estimation).
+Added: These models measure changes in a variety of interest rate scenarios.
+Added: While interest rate risk models have limitations, taken together they represent a reasonably comprehensive view of the magnitude of our interest rate risk, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships.
+Added: Earnings simulation and economic value models are utilized by management on a regular basis as they more effectively measure the cash flow and optionality impacts than does a static gap analysis.
+Added: From the various model results and our expectations regarding future interest rate movements, the national, regional and local economies, and other financial and business risk factors, we quantify the overall magnitude of interest sensitivity risk and then determine appropriate strategies and practices governing asset growth and pricing, funding sources and pricing, and off-balance sheet commitments.
Earnings Simulation Analysis
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From a net interest income perspective, the Company has been fairly neutral historically with no significant change in the short-term (within a twelve-month period) and within the lower ranges (+ - 100-200 basis points) of interest rate changes.
−Removed: Starting in 2022, the Company's sensitivity position shifted somewhat such that, in the short-term it is projected that net interest income will likely fall in both a rising and falling rate environment.
+Added: Starting in 2022 and continuing through 2023, the Company's sensitivity position shifted somewhat such that, in the short-term it is projected that net interest income will likely fall in both a rising and falling rate environment.
This position is due in part to the changing market characteristics of certain loan and deposit products as well as to the current shape of the yield curve.
−Removed: The rapid rate increases in 2022 resulted in a steepening of the yield curve on the short end (within one year), while the longer end of the curve has inverted between one and ten years, meaning that the yield on short-term instruments (less than one year) are higher than longer-term instruments (ten years).
+Added: The Company's current position is now more liability-sensitive which generally implies that net interest income would be expected to rise in a falling rate environment and fall in a rising rate environment.
+Added: However, the rapid rate increases in 2022 and into 2023 resulted in a steepening of the yield curve on the short end (within one year), while the longer end of the curve has inverted between one and ten years, meaning that the yield on short-term instruments (less than one year) are higher than longer-term instruments (ten years).
A flat or inverted interest rate curve is an unfavorable interest rate environment for many financial institutions, including the Bank, as short-term interest rates generally drive our deposit pricing and longer-term interest rates generally drive loan pricing.
When these rates converge or invert, the profit spread we realize between loan yields and deposit rates narrows, which pressures our NIM.
−Removed: With regard to rising rates, with an immediate increase or shock in market rates over the short-term (twelve month horizon), we would expect to realize a decline in net interest income, although not to the extent projected in a declining rate environment.
+Added: With regard to rising rates, with an immediate increase or shock in market rates over the short-term (twelve month horizon), we would expect to realize a decline in net interest income.
This is due in part to the composition of our loan portfolio which is comprised of approximately 20% variable rate loans which could immediately reprice, thus limiting the magnitude of the impact of rate increases given that the majority of our portfolio is at fixed rates.
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As previously noted, these assumptions are inherently uncertain, and actual results may differ from simulated results.
−Removed: While we believe rates may increase again moderately in the remainder of 2023, the consensus is that the market rates may begin to stabilize and there is a possibility that the Federal Reserve may start to reduce rates in 2024.
+Added: The current indication is that the market rates may begin to stabilize.
+Added: However, the consensus is that the Federal Reserve will not start to reduce rates until late 2024 or into 2025.
We would expect net interest income to decline somewhat in a decreasing interest rate environment, as interest-earning assets reprice to lower rates and interest-bearing deposits repricing may lag given continued market competition for deposits.
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Economic values are calculated based on discounted cash flow analysis.
−Removed: The net economic
−Removed: value of equity is the economic value of all assets minus the economic value of all liabilities assuming a liquidation of the current balance sheet.
+Added: The net economic value of equity is the economic value of all assets minus the economic value of all liabilities assuming a liquidation of the current balance sheet.
The change in net economic value over different rate environments is an indication of the longer-term earnings capability of the balance sheet.
−Removed: The same assumptions are generally used in the economic value simulation as in the earnings simulation, including immediate and parallel rate shocks and static assumptions for deposit average decay rate and average lives.
−Removed: As of December 31, 2022, the Company’s economic value of equity ("EVE") was generally liability sensitive in a rising interest rate environment, such that the value of EVE would decline in rising rates.
−Removed: The effect is similar in a falling rate scenario, although to a lower degree.
−Removed: The increase in EVE exposure to rising rates which occurred starting in 2022 was primarily due to the composition of the consolidated balance sheets combined with the pricing characteristics and assumptions of certain deposits.
−Removed: Specifically, starting in 2022, non-maturity deposits, generally with lower betas, have decreased and were replaced with short-term FHLB advances.
−Removed: There has been no material change to the composition of the balance sheet or our deposits and funding mix since year end as such, no significant change to Company's estimated EVE position.
+Added: The same assumptions are generally used in the
+Added: economic value simulation as in the earnings simulation, including immediate and parallel rate shocks and static assumptions for deposit average decay rate and average lives.
+Added: As of December 31, 2023, the Company’s economic value of equity ("EVE") was generally liability sensitive in both a rising and falling interest rate environment, which continues to be the case.
+Added: The decline in EVE under a rising rate environment is driven by the composition of the loans and investment portfolios, primarily related to CRE fixed rate loans and fixed rate mortgage-back securities.
+Added: In a rising rate environment, these portfolios tend to extend due to slower prepayments, thus lowering their relative valuation in the EVE calculation.
+Added: With regard to the falling rate scenario, the non-maturity deposits, generally with lower betas, continue to be at or near floor rates assumed in the model, thus within the -200 shocked interest rate scenario, essentially all of the non-maturity deposits are at or near their floor thus negatively impacting their value in the EVE calculation while variable rate assets continue to price downward in all falling rate scenarios.
Additional discussion concerning our exposure to interest rate risk is presented in Item 7A of the 2023 Annual Report on Form 10-K filed with the SEC.
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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.