Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is defined as the sensitivity of income, expense, fair value measurements, and capital to changes in interest rates, foreign currency rates, commodity prices, and other relevant market rates or prices. The primary market risks that we are exposed to are interest rate and price risks, in addition to risk in the Alaska economy due to our community banking focus. Price risk is the risk to current or future 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 the risk to current or future earnings or capital arising from changes in interest rates. Generally, there are four sources of interest rate risk as described below:
• Re-pricing Risk : Generally, re-pricing risk is the risk of adverse consequences from a change in interest rates that arises because of differences in the timing of when those interest rate changes affect an institution’s assets and liabilities.
• Basis Risk : Basis risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different instruments with the same maturity.
• Yield Curve Risk : Also called yield curve twist risk, yield curve risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different maturities for the same instrument.
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• Option Risk : In banking, option risks are known as borrower options to prepay loans and depositor options to make deposits, withdrawals, and early redemptions. Option risk arises whenever bank products give customers the right, but not the obligation, to alter the quantity of the timing of cash flows.
The Company is exposed to price and interest rate risks in the financial instruments and positions we hold. This includes investment securities, loans, loans held for sale, mortgage servicing rights, deposits, borrowings, and derivative financial instruments. Market risks such as foreign currency exchange risk and commodity price risk do not arise in the normal course of the Company's business.
The Company's price and interest rate risks are managed by the Asset and Liability Committee, a management committee that identifies and manages the sensitivity of earnings and capital to changing interest rates to achieve our overall financial objectives. Based on economic conditions, asset quality and various other considerations, the Asset and Liability Committee establishes overall balance sheet management policies as well as tolerance ranges for interest rate sensitivity and manages within these ranges.
A number of measures are used to monitor and manage interest rate risk, including interest sensitivity (gap) analysis and income simulations. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include loan and deposit volumes and pricing, prepayment speeds on fixed rate assets, and cash flows and maturities of investment securities. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in market conditions and management strategies, among other factors.
Although analysis of interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is one standard tool for the measurement of exposure to interest rate risk, we believe that because interest rate gap analysis does not address all factors that can affect earnings performance it should not be used as the primary indicator of exposure to interest rate risk and the related volatility of net interest income in a changing interest rate environment. Interest rate gap analysis is primarily a measure of liquidity based upon the amount of change in principal amounts of assets and liabilities outstanding, as opposed to a measure of changes in the overall net interest margin.
The Company uses derivatives in the Home Mortgage Lending segment, including commitments to originate residential mortgage loans at fixed prices, and it enters into forward delivery contracts to sell mortgage-backed securities to broker/dealers at specific prices and dates in order to hedge the interest rate risk in its residential mortgage loan commitments. The Company does not use derivatives outside of these activities in the Home Mortgage Lending segment to manage our interest rate risk exposures. However, the Company does enter into commercial loan interest rate swap agreements in its Community Banking segment in order to provide commercial loan customers the ability to convert from variable to fixed interest rates. Commercial loan interest rate swap agreements are offset with corresponding swap agreements with a third party swap dealer in order to offset the Company's exposure on the fixed component of the customer’s interest rate swap. Additional information regarding the Company’s customer interest rate swap program is presented in Note 20 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report.
The following table sets forth the estimated maturity or repricing, and the resulting interest rate gap, of our interest-earning assets (which exclude nonaccrual loans) and interest-bearing liabilities at December 31, 2021. The amounts shown below could be significantly affected by external factors such as changes in prepayment assumptions, early withdrawals of deposits, and competition.
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Estimated maturity or repricing at December 31, 2021
(In Thousands) Within 1 year 1-5 years >5 years Total
Interest -Earning Assets:
Interest bearing deposits in other banks $625,022 $— $— $625,022
Investments securities and FHLB Stock 144,270 313,941 — 458,211
Loans 650,478 675,118 88,183 1,413,779
Loans held for sale 73,650 — — 73,650
Total interest-earning assets $1,493,420 $989,059 $88,183 $2,570,662
Percent of total interest-earning assets 58.09 % 38.47 % 3.43 % 99.99 %
Interest-Bearing Liabilities:
Interest-bearing demand accounts $692,683 $— $— $692,683
Money market accounts 314,996 — — 314,996
Savings accounts 348,164 — — 348,164
Certificates of deposit 121,515 55,131 1,318 177,964
Securities sold under repurchase agreements — — — —
Borrowings 812 3,540 10,156 14,508
Junior subordinated debentures — — 10,310 10,310
Total interest-bearing liabilities $1,478,170 $58,671 $21,784 $1,558,625
Percent of total interest-bearing liabilities 94.84 % 3.76 % 1.40 % 100.00 %
Interest sensitivity gap $15,250 $930,388 $66,399 $1,012,037
Cumulative interest sensitivity gap $15,250 $945,638 $1,012,037
Cumulative interest sensitivity gap as a percentage
of total interest-earning assets 0.6 % 36.8 % 39.4 %
As stated previously, certain shortcomings, including those described below, are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. Additionally, certain assets have features that restrict changes in their interest rates, both on a short-term basis and over the lives of the assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables as can the relationship of rates between different loan and deposit categories. Moreover, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates.
While the analysis above sets forth the estimated maturity or repricing and the resulting interest rate gap of our interest-earning assets and interest-bearing liabilities, the following tables show the estimated impact on net interest income and net income at one and two year time horizons with instantaneous parallel rate shocks of up 400 basis points, up 300 basis points, up 200 basis points, up 100 basis points, and up 50 basis points. The Company did not perform analyses for rate shock scenarios where interest rates instantaneously drop as of December 31, 2021 because those scenarios do not produce meaningful results in the current low interest rate environment. Due to the various assumptions used for this modeling and potential balance sheet strategies management may implement to mitigate interest rate risk, no assurance can be given that projections will reflect actual results.
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The following table shows the estimated impact on net interest income under the stated interest rate scenarios:
1st Year Change in net interest income from base scenario Percentage change 2nd Year Change in net interest income from base scenario Percentage change
(In Thousands)
Scenario:
Up 400 basis points $22,226 31.06 % $30,206 43.61 %
Up 300 basis points $16,926 23.65 % $22,966 33.16 %
Up 200 basis points $11,235 15.70 % $15,302 22.09 %
Up 100 basis points $5,590 7.81 % $7,653 11.05 %
Up 50 basis points $4,552 6.36 % $5,730 8.27 %
Up 25 basis points $2,321 3.24 % $2,892 4.18 %
Down 50 basis points NM NM NM NM
Down 100 basis points NM NM NM NM
The following table shows the estimated impact on net income under the stated interest rate scenarios. The trends in the estimated impact on net income under the stated interest rate scenarios differ from the table above primarily due to the inclusion of the estimated impact of changes in other operating income and expense related to mortgage banking activities:
1st Year Change in net income from base scenario Percentage change 2nd Year Change in net income from base scenario Percentage change
(In Thousands)
Scenario:
Up 400 basis points $11,151 59.21 % $17,223 147.02 %
Up 300 basis points $10,187 54.09 % $14,757 125.97 %
Up 200 basis points $6,968 37.00 % $10,044 85.74 %
Up 100 basis points $3,786 20.10 % $5,342 45.61 %
Up 50 basis points $3,222 17.11 % $4,095 34.96 %
Up 25 basis points $1,841 9.77 % $2,260 19.29 %
Down 50 basis points NM NM NM NM
Down 100 basis points NM NM NM NM
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