Mechanics Bancorp 10-Q

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk Management The primary objective of the following information is to provide forward-looking quantitative and qualitative information about our potential exposure to market risks. 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 that we are exposed to 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. This forward-looking information provides an indicator of how we view and manage our ongoing market risk exposures. Mechanics is engaged primarily in the business of investing funds obtained from deposits and borrowings in interest earning loans and investments, and our primary component of market risk is sensitivity to changes in interest rates. Consequently, our earnings depend to a significant extent on our net interest income, which is the difference between interest income on loans and investments and our interest expense on deposits and borrowings. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-bearing assets, we are subject to interest rate risk and corresponding fluctuations in net interest income. For the Company, price and interest rate risks arise from the financial instruments and positions we hold. This includes loans, MSRs, 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, 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 (repricing risk), the relationship between various rates (basis risk), customer options (optionality risk) and changes in the shape of the yield curve (yield curve 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-earning 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, which are subject to repricing at various time horizons, known as interest rate sensitivity gaps. 74 The following table presents sensitivity gaps for these different intervals: At June 30, 2026 (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. Total Interest-earning assets: Cash & cash equivalents $ 553,915 $ — $ — $ — $ — $ — $ — $ 553,915 Investment securities (1) 873,104 138,097 244,217 930,487 1,021,792 2,008,533 236,393 5,452,623 Loans held for sale 5,345 — — — — — — 5,345 Loan receivables (1) 2,669,852 796,793 1,398,040 3,943,567 1,950,076 2,339,192 478,676 13,576,196 FHLB stock and other investments — — — — — — 147,919 147,919 Total rate sensitive assets $ 4,102,216 $ 934,890 $ 1,642,257 $ 4,874,054 $ 2,971,868 $ 4,347,725 $ 862,988 $ 19,735,998 Interest-bearing liabilities: Demand deposits (2), (3) $ 404,538 $ — $ — $ — $ — $ 7,687,440 $ — $ 8,091,978 Savings (2) 1,442 — — — — 1,327,061 — 1,328,503 Money market accounts (2) 6,070,548 — — — — 652,928 — 6,723,476 Certificates of deposit 868,204 535,349 495,248 38,534 7,158 946 41 1,945,480 Borrowings (4) 80,000 — — — — — — 80,000 Long-term debt (4) 48,527 — 81,893 — — — — 130,420 Total rate sensitive liabilities $ 7,473,259 $ 535,349 $ 577,141 $ 38,534 $ 7,158 $ 9,668,375 $ 41 $ 18,299,857 Interest sensitivity gap (3,371,043) 399,541 1,065,116 4,835,520 2,964,710 (5,320,650) 862,947 Cumulative interest sensitivity gap $ (3,371,043) $ (2,971,502) $ (1,906,386) $ 2,929,134 $ 5,893,844 $ 573,194 $ 1,436,141 Cumulative ratio of interest-earning assets to interest-bearing liabilities 55 % 63 % 78 % 134 % 168 % 103 % 108 % Ratio of interest sensitivity gap to total assets (16) % 2 % 5 % 23 % 14 % (25) % 4 % Ratio of cumulative gap to total assets (16) % (14) % (9) % 14 % 28 % 3 % 7 % (1) Based on contractual maturities, repricing dates and forecasted principal payments assuming normal amortization and, where applicable, prepayments. (2) Interest-bearing deposits with a rate less than 25 basis points are included in the More than 5 to 15 Years category. (3) Non-interest bearing demand accounts are included in the More than 5 to 15 Years category based on the projected weighted average life of those deposits. (4) Based on repricing dates. The negative interest sensitivity gap for durations less than 12 months in the interest rate analysis indicates that net interest income would decline if short-term rates increase. Because of the inherent limitations in the interest rate gap analysis, Mechanics employs multiple interest rate risk measurement approaches. Mechanics runs interest rate simulations to the existing repricing conditions to rising and falling interest rates in increments and decrements of 100 basis points to determine the effect on net interest income changes for the next twelve months. In addition, Mechanics also measures the effects that changes in interest rates on the economic value of equity by discounting future cash flows. We believe that the simulation analysis presents a more accurate picture than the gap analysis. Our simulation analysis recognizes that deposit products may not react to changes in interest rates as quickly or with the same magnitude as earning assets contractually tied to a market rate index. The sensitivity to changes in market rates varies across deposit products. The estimated impact on our net interest income over a time horizon of one year and the change in net portfolio value as of June 30, 2026 are provided in the table below. For the scenarios shown, the interest rate simulation assumes an instantaneous and parallel shift in market interest rates and no change in the composition or size of the balance sheet. 75 At June 30, 2026 Change in Interest Rates (basis points) Percentage Change Net Interest Income (1) Net Portfolio Value (2) -300 (0.6) % (0.6) % -200 0.3 % 1.9 % -100 0.5 % 2.0 % +100 (1.2) % (6.3) % +200 (2.7) % (14.8) % +300 (4.5) % (23.5) % (1) 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. (2) This percentage change represents the impact to the net present value of equity, assuming contractual runoff of the balance sheet. The projected changes in the table above were in compliance with established internal policy guidelines and are based on numerous assumptions. The timing and magnitude of future interest rate movements, along with changes to the balance sheet composition, may impact projected changes in net interest income, but may not necessarily reflect the manner in which actual cash flows, yields and costs respond to changes in market interest rates. We continue to evaluate the interest rate risk position and may reposition the banking segment’s balance sheet in the future to better align with management’s target rate risk position. The impact of rate movements will change with the shape of the yield curve, including any changes in steepness or flatness and inversions at any points on the yield curve. Since the assumptions used relative to changes in interest rates are uncertain, the simulation analysis may not be indicative of actual results, particularly in times of stress and uncertainty. In addition, this analysis does not consider actions that management might employ in the future in response to changes in interest rates, as well as changes in earning asset and interest bearing liability balances. Current Banking Environment Market conditions and external factors may unpredictably impact the competitive landscape for deposits in the banking industry. Additionally, the higher interest rate environment has increased competition for liquidity and the premium at which liquidity is available to meet funding needs. Reliance on secondary funding sources could increase the Company’s overall cost of funding and reduce net interest income. As of June 30, 2026, the Company had available liquidity of $15.9 billion, which is equal to 88% of its total deposits and the level of uninsured deposits was 43% of total deposits. The Company believes it has sufficient liquidity to meet its current needs. 76