Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to economic loss that arises from changes in the values of certain financial instruments. The types of market risk exposures generally faced by financial institutions include interest rate risk, equity market price risk, debt security market price risk, foreign currency price risk and commodity price risk. Due to the nature of its operations, foreign currency price risk and commodity price risk are not significant to the Corporation.
Interest Rate Risk, Asset/Liability Management and Liquidity
Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Corporation's liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Corporation's net interest income and changes in its economic value of its equity.
The Corporation employs various management techniques to minimize its exposure to interest rate risk. The Corporation's ALCO is responsible for reviewing the interest rate sensitivity and liquidity positions of the Corporation, approving asset and liability management policies, and overseeing the formulation and implementation of strategies regarding balance sheet positions.
The Corporation uses two complementary methods to measure and manage interest rate risk. They are simulation of net interest income and estimates of economic value of equity. Using these measurements in tandem provides a reasonably comprehensive summary of the magnitude of the Corporation's interest rate risk, level of risk as time evolves, and exposure to changes in interest rates.
Simulation of net interest income is performed for the next 12-month period. A variety of interest rate scenarios are used to measure the effects of sudden and gradual movements upward and downward in the yield curve. These results are compared to the results obtained in a flat or unchanged interest rate scenario. Simulation of net interest income is used primarily to measure the Corporation's short-term earnings exposure to rate movements. The Corporation's policy limits the potential exposure of net interest income, in a non-parallel instantaneous shock, to 10% of the base case net interest income for a 100 bps shock in interest rates, 15% for a 200 bps shock, 20% for a 300 bps shock and 25% for a 400 bps shock . A "shock" is an immediate upward or downward movement of interest rates. The shocks do not take into account changes in customer behavior that could result in changes to mix and/or volumes in the balance sheet, nor does it take into account the potential effects of competition on the pricing of deposits and loans over the forward 12-month period.
Contractual maturities and repricing opportunities of loans are incorporated in the simulation model as are prepayment assumptions, maturity data and call options within the investment portfolio. Assumptions based on past experience are incorporated into the model for non-maturity deposit accounts. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model's simulated results due to timing, amount and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
The following table summarizes the expected impact of abrupt interest rate changes, i.e. a non-parallel instantaneous shock, on net interest income as of December 31, 2023:
Rate Shock (1)
Annual change
in net interest income % Change in net interest income
+400 bp +$38.1 million + 4.2%
+300 bp + $29.7 million + 3.3%
+200 bp + $22.5 million + 2.5%
+100 bp + $14.0 million + 1.6%
-100 bp - $38.1 million - 4.2%
-200 bp - $76.8 million - 8.5%
-300 bp - $105.9 million - 11.7%
-400 bp - $124.8 million -13.8%
(1) These results include the effect of implicit and explicit interest rate floors that limit further reduction in interest rates.
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Economic value of equity estimates the discounted present value of asset and liability cash flows. Discount rates are based upon market prices for like assets and liabilities. Abrupt changes or "shocks" in interest rates, both upward and downward, are used to determine the comparative effect of such interest rate movements relative to the unchanged environment. This measurement tool is used primarily to evaluate the longer-term repricing risks and options in the Corporation's balance sheet. The Corporation's policy limits the economic value of equity that may be at risk, in a non-parallel instantaneous shock, to 10% of the base case economic value of equity for a 100 bps shock in interest rates, 20% for a 200 bps shock, 30% for a 300 bps shock and 40% for a 400 bps shock. As of December 31, 2023, the Corporation was within economic value of equity policy limits for every 100 bps shock.
Interest Rate Derivatives
The Corporation enters into interest rate derivatives with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Corporation simultaneously enters into interest rate derivatives with dealer counterparties, with identical notional amounts and terms. The net result of these interest rate derivatives is that the customer pays a fixed rate of interest and the Corporation receives a floating rate. These interest rate derivatives are derivative financial instruments, and the gross fair values are recorded in other assets and liabilities on the consolidated balance sheets, with changes in fair value during the period recorded in other non-interest income on the consolidated statements of income.
Cash Flow Hedges
The Corporation's objectives in using interest rate derivatives are to reduce volatility in net interest income and net interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Corporation primarily uses interest rate derivatives as part of its interest rate risk management strategy. The Corporation enters into interest rate derivatives designated as cash flow hedges to hedge the variable cash flows associated with existing floating rate loans and borrowings.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the unrealized gain or loss on the derivative is recorded in AOCI and subsequently reclassified into interest income or interest expense in the same period during which the hedged transaction affects earnings. Amounts reported in AOCI related to derivatives will be reclassified to interest income as interest payments are made on the Corporation's variable-rate liabilities.
In January 2023, the Corporation terminated interest rate derivatives designated as cash flow hedges with a combined notional amount of $1.0 billion. As the hedged transaction continues to be probable, the unrealized losses that have been recorded in AOCI will be recognized as reduction to interest income when the previously forecasted hedged item affects earnings in future periods. During 2023, $22.1 million of these unrealized losses have been reclassified as a reduction of interest income on loans, including fees, on the consolidated statements of income.
Liquidity
The Corporation must maintain a sufficient level of liquid assets to meet the cash needs of its customers, who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity is provided on a continuous basis through scheduled and unscheduled principal and interest payments on investments and outstanding loans and through the availability of deposits and borrowings. The Corporation also maintains secondary sources that provide liquidity on a secured and unsecured basis to meet short- and long-term needs.
The Corporation maintains liquidity sources in the form of interest-bearing deposits and customer funding (short-term promissory notes). The Corporation can access additional liquidity from these sources, if necessary, by increasing the rates of interest paid on those instruments. The positive impact to liquidity resulting from paying higher interest rates could have a detrimental impact on NIM and net interest income if rates on interest-earning assets do not experience a proportionate increase. Borrowing availability with the FHLB and the FRB, along with federal funds lines at various correspondent banks, provides the Corporation with additional liquidity.
Fulton Bank is a member of the FHLB and has access to FHLB overnight and term credit facilities. As of December 31, 2023, the Bank had total borrowing capacity of approximately $8.2 billion with $3.3 billion of advances and letters of credit outstanding, for a remaining available borrowing capacity of approximately $4.9 billion. Advances from the FHLB, when utilized, are secured by qualifying commercial real estate and residential mortgage loans, investments and other assets.
As of December 31, 2023, the Corporation had aggregate federal funds lines borrowing capacity of $2.6 billion, with $0.2 billion of outstanding borrowings against that amount. As of December 31, 2023, the Corporation had $1.3 billion of
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collateralized borrowing capacity at the discount window and $1.9 billion of borrowing capacity at the Bank Term Funding Program facility with no amounts outstanding under these programs.
A combination of commercial real estate loans, commercial loans, consumer loans and securities are pledged to the FRB of Philadelphia to provide access to FRB discount window borrowings. Securities carried at $0.4 billion at December 31, 2023 and $1.1 billion at December 31, 2022 were pledged as collateral to secure public and trust deposits.
The Corporation has commitments to extend credit and letters of credit. As of December 31, 2023, the balance of commitments to extend credit was $8.8 billion and total letters of credit were $0.3 billion.
Liquidity must also be managed at the Parent Company level. For safety and soundness reasons, banking regulations limit the amount of cash that can be transferred from subsidiary banks to the parent company in the form of loans and dividends. Generally, these limitations are based on the subsidiary banks’ regulatory capital levels and their net income. Management continues to monitor the liquidity and capital needs of the Parent Company including monitoring the granularity of the deposit portfolio and level of uninsured deposits. Management will implement appropriate strategies, as necessary, to remain adequately capitalized and to meet its cash needs.
The consolidated statements of cash flows provide additional information. The Corporation's operating activities during 2023 generated $363.0 million of cash, mainly due to net income of $284.3 million. Cash used in investing activities was $809.2 million, primarily due to $1.1 billion net increase in loans. Net cash provided by financing activities was $314.0 million, due largely to the increases in time and brokered deposits, partially offset by decreases in demand and savings deposits and other borrowings.
The following table presents the expected maturities of government, state and municipal and corporate AFS investment securities, at estimated fair value, as of December 31, 2023 and the weighted average yields on such securities (calculated based on historical cost):
Maturing
Within One Year After One But
Within Five Years After Five But
Within Ten Years After Ten Years
Amount Yield Amount Yield Amount Yield Amount Yield
Available for sale (dollars in thousands)
U.S. Government securities $ 42,161 2.40 % $ — — % $ — — % $ — — %
U.S. Government-sponsored agency securities — — 1,010 3.10 — — — —
State and municipal (1)
— — 5,089 4.57 178,818 3.92 888,106 3.90
Corporate debt securities 6,861 10.00 141,422 5.14 292,268 4.02 — —
Total $ 49,022 3.45 % $ 147,521 5.10 % $ 471,086 3.99 % $ 888,106 3.90 %
(1) Weighted average yields on tax-exempt securities have been computed on a FTE basis assuming a federal tax rate of 21% and statutory interest expense
disallowances.
The Corporation's investment portfolio consists mainly of state and municipal securities, commercial mortgage-backed securities, residential mortgage-backed securities, corporate debt securities and collateralized mortgage obligations. Commercial mortgage-backed securities, residential mortgage-backed securities and collateralized mortgage obligations have stated maturities that may differ from actual maturities due to borrowers' ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans decrease. As rates decrease, cash flows generally increase as prepayments increase.
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The following table presents AFS residential mortgage-backed securities, commercial mortgage-backed securities and collateralized mortgage obligations, at estimated fair value, and HTM residential mortgage-backed securities and commercial mortgage-backed securities, at amortized cost, as of December 31, 2023, without stated maturities, including the weighted average yields and estimated weighted average lives based on prepayment speeds on such securities:
Weighted
Amount Yield Average Life
(dollars in thousands) (in years)
Available for sale
Residential mortgage-backed securities $ 196,795 2.79 % 6.6
Commercial mortgage-backed securities 534,388 2.71 6.6
Collateralized mortgage obligations 111,434 2.71 5.2
Held to maturity
Residential mortgage-backed securities $ 407,075 2.01 % 6.6
Commercial mortgage-backed securities 860,847 1.53 6.6
The following table presents the contractual maturities of fixed rate loans and loan types subject to changes in interest rates as of December 31, 2023:
One Year
or Less One
Through
Five Years More Than
Five Years Total
(dollars in thousands)
Commercial and industrial:
Adjustable and floating rate $ 981,531 $ 2,171,857 $ 474,121 $ 3,627,509
Fixed rate 340,178 491,241 86,666 918,085
Total commercial and industrial 1,321,709 2,663,098 560,787 4,545,594
Real estate - mortgage (1) :
Adjustable and floating rate 1,760,892 4,843,777 3,308,714 9,913,383
Fixed rate 870,638 1,890,160 1,826,655 4,587,453
Total real estate - mortgage (1)
2,631,530 6,733,937 5,135,369 14,500,836
Real estate - construction:
Adjustable and floating rate 325,599 463,450 147,111 936,160
Fixed rate 258,068 41,105 3,742 302,915
Total real estate - construction 583,667 504,555 150,853 1,239,075
Consumer, leases and other:
Adjustable and floating rate 11,322 37,660 8 48,990
Fixed rate 296,185 618,707 139,716 1,054,608
Total consumer, leases and other 307,507 656,367 139,724 1,103,598
Unearned income — (38,009) — (38,009)
Total $ 4,844,413 $ 10,519,948 $ 5,986,733 $ 21,351,094
(1) Includes commercial and residential mortgages and home equity loans.
Contractual maturities of time deposits as of December 31, 2023 were as follows (dollars in thousands):
Year
2024 $ 2,180,323
2025 421,029
2026 64,748
2027 16,343
2028 8,429
Thereafter 48,369
Total $ 2,739,241
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Contractual maturities of the portion of time deposits estimated to be in excess of the FDIC insurance limit as of December 31, 2023 included in the table above, were as follows (dollars in thousands):
Three months or less $ 46,709
Over three through six months 63,171
Over six through twelve months 65,705
Over twelve months 25,366
Total $ 200,951
Total uninsured deposits (excluding intra-Company deposits) were estimated to be $7.2 billion at December 31, 2023 compared with $7.8 billion at December 31, 2022.
Debt Security Market Price Risk
Debt security market price risk is the risk that changes in the values of debt securities, unrelated to interest rate changes, could have a material impact on the financial position or results of operations of the Corporation. The Corporation's debt security investments consist primarily of U.S. government-sponsored agency issued residential mortgage-backed securities, commercial mortgage-backed securities and collateralized mortgage obligations; as well as, state and municipal securities and corporate debt securities. All of the Corporation's investments in residential mortgage-backed securities, commercial mortgage-backed securities and collateralized mortgage obligations have principal payments that are guaranteed by U.S. government-sponsored agencies.
State and Municipal Securities
As of December 31, 2023, the Corporation owned securities issued by various states and municipalities with a total fair value of $1.1 billion. Uncertainty with respect to the financial strength of state and municipal bond insurers places emphasis on the underlying strength of issuers. Pressure on local tax revenues of issuers due to adverse economic conditions could have an adverse impact on the underlying credit quality of issuers. The Corporation evaluates existing and potential holdings primarily based on the underlying creditworthiness of the issuing state or municipality and then, to a lesser extent, on any credit enhancement. State and municipal securities can be supported by the general obligation of the issuing state or municipality, allowing the securities to be repaid by any means available to the issuing state or municipality. As of December 31, 2023, approximately 100% of state and municipal securities were supported by the general obligation of corresponding states or municipalities. Approximately 74% of these securities were school district issuances, which are also supported by the states of the issuing municipalities.
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