Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management
Market risk is defined as the sensitivity of income, fair value measurements and capital to changes in interest rates, foreign currency exchange rates, commodity prices and other relevant market rates or prices. The primary market risks to which we are exposed are price and interest rate risks. Price risk is defined as the risk to current or anticipated earnings or capital arising from changes in the value of either assets or liabilities that are entered into as part of distributing or managing risk. Interest rate risk is defined as risk to current or anticipated earnings or capital arising from movements in interest rates.
For the Company, price and interest rate risks arise from the financial instruments and positions we hold. This includes loans, mortgage servicing rights, investment securities, deposits, borrowings, long-term debt and derivative financial instruments. Due to the nature of our current operations, we are not subject to foreign currency exchange or commodity price risk. Our real estate loan portfolio is subject to risks associated with the local economies of our various markets and, in particular, the regional economy of the western United States, including Hawaii.
The spread between the yield on interest-earning assets and the cost of interest-bearing liabilities and the relative dollar amounts of these assets and liabilities are the principal items affecting net interest income. Changes in net interest rates (interest rate risk) are influenced to a significant degree by the repricing characteristics of assets and liabilities (timing risk), the relationship between various rates (basis risk), customer options (option risk) and changes in the shape of the yield curve (time-sensitive risk). We manage the available-for-sale investment securities portfolio while maintaining a balance between risk and return. The Company's funding strategy is to grow core deposits while we efficiently supplement using wholesale borrowings.
We estimate the sensitivity of our net interest income to changes in market interest rates using an interest rate simulation model that includes assumptions related to the level of balance sheet growth, deposit repricing characteristics and the rate of prepayments for multiple interest rate change scenarios. Interest rate sensitivity depends on certain repricing characteristics in our interest-earnings assets and interest-bearing liabilities, including the maturity structure of assets and liabilities and their repricing characteristics during the periods of changes in market interest rates. Effective interest rate risk management seeks to ensure both assets and liabilities respond to changes in interest rates within an acceptable timeframe, minimizing the impact of interest rate changes on net interest income and capital. Interest rate sensitivity is measured as the difference between the volume of assets and liabilities, at a point in time, that are subject to repricing at various time horizons, known as interest rate sensitivity gaps.
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The following table presents sensitivity gaps for these different intervals.
December 31, 2021
(dollars in thousands) 3 Mos.
or Less More Than
3 Mos.
to 6 Mos. More Than
6 Mos.
to 12 Mos. More Than
12 Mos.
to 3 Yrs. More Than
3 Yrs.
to 5 Yrs. More Than
5 to 15 Yrs. More Than 15 Yrs. Non-Rate-
Sensitive Total
Interest-earning assets
Cash & cash equivalents
$ 65,214 $ — $ — $ — $ — $ — $ — $ — $ 65,214
FHLB Stock
1,733 — — — — — 8,628 — 10,361
Investment securities (1)
126,141 16,768 41,320 118,437 125,501 450,335 128,189 — 1,006,691
LHFS 176,131 — — — — — — — 176,131
LHFI 1)
1,254,743 623,888 496,227 1,145,132 1,178,980 824,525 19,354 — 5,542,849
Total 1,623,962 640,656 537,547 1,263,569 1,304,481 1,274,860 156,171 — 6,801,246
Noninterest-earning assets — — — — — — — 402,845 402,845
Total assets $ 1,623,962 $ 640,656 $ 537,547 $ 1,263,569 $ 1,304,481 $ 1,274,860 $ 156,171 $ 402,845 $ 7,204,091
Interest-bearing liabilities
Demand deposit accounts (2)
$ 513,810 $ — $ — $ — $ — $ — $ — $ — $ 513,810
Savings accounts (2)
302,389 — — — — — — — 302,389
Money market
accounts (2)
2,806,313 — — — — — — — 2,806,313
Certificates of deposit 235,675 181,599 301,564 181,507 6,583 — — — 906,928
FHLB advances 41,000 — — — — — — — 41,000
Borrowings — — — — — — — — —
Long-term debt (3)
61,026 — — — 65,000 — — — 126,026
Total 3,960,213 181,599 301,564 181,507 71,583 — — — 4,696,466
Noninterest-bearing liabilities — — — — — — — 1,792,286 1,792,286
Shareholders' Equity — — — — — — — 715,339 715,339
Total liabilities and shareholders’ equity $ 3,960,213 $ 181,599 $ 301,564 $ 181,507 $ 71,583 $ — $ — $ 2,507,625 $ 7,204,091
Interest sensitivity gap $ (2,336,251) $ 459,057 $ 235,983 $ 1,082,062 $ 1,232,898 $ 1,274,860 $ 156,171
Cumulative interest rate sensitivity gap
Total $ (2,336,251) $ (1,877,194) $ (1,641,211) $ (559,149) $ 673,749 $ 1,948,609 $ 2,104,780
As a % of total assets (32) % (26) % (23) % (8) % 9 % 27 % 29 %
As a % of cumulative interest-bearing liabilities 41 % 55 % 63 % 88 % 114 % 141 % 145 %
(1) Based on contractual maturities, repricing dates and forecasted principal payments assuming normal amortization and, where applicable, prepayments.
(2) Assumes 100% of interest-bearing non-maturity deposits are subject to repricing in three months or less.
(3) Based on contractual maturity.
As of December 31, 2021, the Company is considered liability-sensitive as exhibited by the gap table but our net interest income sensitivity analysis shows positive results in the increasing interest rate scenarios. This is because of the impact of our historical deposit repricing betas which result in an assumed delay in repricing of deposits in an increasing interest rate scenario and a lower magnitude of repricing compared to the repricing of loans and other interest-earning assets. Net interest income would be expected to rise in the long term if interest rates were to rise due to the Bank’s cumulative asset-sensitive position.
Changes in the mix of interest-earning assets or interest-bearing liabilities can either increase or decrease the net interest margin, without affecting interest rate sensitivity. In addition, the interest rate spread between an earning asset and its funding
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liability can vary significantly, while the timing of repricing for both the asset and the liability remains the same, thereby impacting net interest income. This characteristic is referred to as basis risk. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities that are not reflected in the interest rate sensitivity analysis. These prepayments may have a significant impact on our net interest margin. Because of these factors, an interest sensitivity gap analysis may not provide an accurate assessment of our actual exposure to changes in interest rates.
The estimated impact on our net interest income over a time horizon of one year and the change in net portfolio value as of December 31, 2021 and 2020 are provided in the table below. For the scenarios shown, the interest rate simulation assumes an instantaneous and sustained shift in market interest rates and no change in the composition or size of the balance sheet.
December 31, 2021 December 31, 2020
Change in Interest Rates
(basis points) (1)
Percentage Change
Net Interest Income (2)
Net Portfolio Value (3)
Net Interest Income (2)
Net Portfolio Value (3)
+200 7.8 % (5.0) % 3.5 % (9.3) %
+100 3.5 % (2.8) % 1.2 (4.3) %
-100 (1.3) % 1.9 % (3.8) (3.7) %
-200 (2.5) % (4.9) % (4.7) % (5.7) %
(1) For purposes of our model, we assume interest rates will not go below zero. This "floor" limits the effect of a potential negative interest rate shock in a low rate environment like the one we are currently experiencing.
(2) This percentage change represents the impact to net interest income for a one-year period, assuming there is no change in the structure of the balance sheet.
(3) This percentage change represents the impact to the net present value of equity, assuming there is no change in the structure of the balance sheet.
At December 31, 2021 and 2020 we believe our net interest income sensitivity did not exhibit a strong bias to either an increase in interest rates or a decline in interest rates. The changes in interest rate sensitivity between December 31, 2021 and 2020 reflected the impact of higher market interest rates, a steeper yield curve and changes to overall balance sheet composition. Some of the assumptions made in the simulation model may not materialize and unanticipated events and circumstances will occur. We do not allow for negative rate assumptions in our model, but actual results in extreme interest rate decline scenarios may result in negative rates that may cause the modeling results to be inherently unreliable. In addition, the simulation model does not take into account any future actions that we could undertake to mitigate an adverse impact due to changes in interest rates from those expected, in the actual level of market interest rates or competitive influences on our deposits.
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