Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap”. An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or re-price within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or re-pricing within a specific time period and the amount of interest-bearing liabilities maturing or re-pricing within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to positively affect net interest income. Similarly, during a period of falling interest rates, a negative gap would tend to positively affect net interest income while a positive gap would tend to adversely affect net interest income.
Our practice is to reduce our exposure to interest rate risk generally by matching the maturities of our interest rate sensitive assets and liabilities and by increasing the interest rate sensitivity of our interest-earning assets. We purchase adjustable-rate investment securities and mortgage-backed securities, which at December 31, 2023, totaled $39.7 million, and originate adjustable-rate loans, which at December 31, 2023, totaled $ 4.032 billion or 35.5 % of our gross loan portfolio. Of our $13.283 billion of interest-earning assets at December 31, 2023, $4.072 billion, or 30.7 %, consisted of assets with adjustable rates of interest. When open market conditions are favorable, we also attempt to reduce interest rate risk by lengthening the maturities of our interest-bearing liabilities by using FHLB advances as a source of long-term fixed-rate funds, if necessary, and by promoting longer-term certificates of deposit. At times, the Company may also use derivatives to adjust our interest rate risk profile. As of December 31, 2023 we had $175 million of cash flow hedges.
At December 31, 2023, total interest-earning liabilities maturing or re-pricing within one year exceeded total interest-bearing assets maturing or re-pricing in the same period by $565.9 million, representing a negative one-year gap ratio of 3.92%.
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The following table sets forth, on a carrying value basis, the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2023, which are expected to re-price or mature, based upon certain assumptions, in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown that re-price or mature during a particular period were determined in accordance with the earlier of the term of re-pricing or the contractual term of the asset or liability. We believe that these assumptions approximate the standards used in the financial services industry and consider them appropriate and reasonable.
Amounts maturing or re-pricing
Within
1 year Over
1-3 years Over
3-5 years Over
5-10 years Over 10 years Total
(Dollars in thousands)
Rate-sensitive assets:
Interest-earning deposits $ 78,689 — — — — 78,689
Mortgage-backed securities:
Fixed-rate 208,684 340,821 282,156 443,672 246,467 1,521,800
Variable-rate 29,872 — — — — 29,872
Investment securities 8,655 50,563 113,268 107,436 26,604 306,526
Mortgage loans:
Adjustable-rate 36,973 15,327 33,026 14,735 138 100,199
Fixed-rate 398,133 689,205 572,425 1,034,657 625,453 3,319,873
Home equity loans:
Adjustable-rate 403,123 — — — — 403,123
Fixed-rate 125,323 215,899 178,363 262,420 38,034 820,039
Consumer loans 675,156 982,060 370,114 23,165 15,069 2,065,564
Commercial real estate loans 1,904,597 698,336 314,031 26,459 33,517 2,976,940
Commercial loans 1,062,508 389,577 175,187 14,761 18,698 1,660,731
Total rate-sensitive assets 4,931,713 3,381,788 2,038,570 1,927,305 1,003,980 13,283,356
Rate-sensitive liabilities:
Time deposits 2,465,478 97,076 37,142 2,922 263 2,602,881
Money market demand accounts 1,631,852 — — — 336,366 1,968,218
Savings deposits 429,344 515,956 515,956 643,978 — 2,105,234
Interest-bearing demand deposits 617,807 394,121 394,121 985,303 243,194 2,634,546
FHLB Advances 163,500 25,000 150,000 — — 338,500
Collateral 24,900 — — — — 24,900
Other borrowings 35,495 — — — — 35,495
Trust Preferred Securities 129,574 — — — — 129,574
Subordinated debt (349) 114,538 — — — 114,189
Total rate-sensitive liabilities $ 5,497,601 1,146,691 1,097,219 1,632,203 579,823 9,953,537
Cumulative interest sensitivity gap $ (565,888) 1,669,209 2,610,560 2,905,662 3,329,819 3,329,819
Cumulative interest sensitivity gap as a
percentage of total assets (3.92) % 11.58 % 18.10 % 20.15 % 23.09 % 23.09 %
Cumulative interest-earning assets as a percent of cumulative interest-bearing liabilities 89.71 % 125.12 % 133.72 % 131.00 % 133.45 % 133.45 %
At December 31, 2022, we had a cumulative interest sensitivity gap as a percentage of total assets of 25.41%. We have an Asset/Liability Committee, consisting of members of management, which meets monthly to review market interest rates, economic conditions, the pricing of interest earning assets and interest bearing liabilities and our balance sheet structure. On a quarterly basis, this committee also reviews our interest rate risk position and our cash flow projections.
Our Board of Directors has a Risk Management Committee, which meets quarterly, and reviews interest rate risks and trends, our interest sensitivity position, our liquidity position and the market risk inherent in our investment portfolio.
In an effort to assess interest rate risk, we use a simulation model to determine the effect of immediate incremental increases and decreases in interest rates on net interest income, net income and the market value of our equity. Certain assumptions are made regarding loan prepayments and decay rates of savings and interest-bearing demand deposit accounts. Because it is difficult to
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accurately project the market reaction of depositors and borrowers, the effect of actual changes in interest rates on these assumptions may differ from simulated results. We have established the following guidelines for assessing interest rate risk:
Net Interest Income Simulation . Given a parallel shift of 100 basis points (“bps”), 200 bps, and 300 bps in interest rates, the estimated net interest income may not decrease by more than 5%, 10%, and 15%, respectively, within a one-year period.
Net Income Simulation . Given a parallel shift of 100 bps, 200 bps, and 300 bps in interest rates, the estimated net income may not decrease by more than 10%, 20%, and 30%, respectively, within a one-year period.
Market Value of Equity Simulation . The market value of our equity is the present value of our assets and liabilities. Given a parallel shift of 100 bps, 200 bps, and 300 bps in interest rates, the market value of equity may not decrease by more than 15%, 30%, and 35%, respectively, from the computed economic value at current interest rate levels.
The following table illustrates the simulated impact of a parallel 100 bps, 200 bps or 300 bps upward or 100 bps, 200 bps, or 300 bps downward movement in interest rates on net interest income, net income, return on average equity, earnings per share, and market value of equity. These analyses were prepared assuming that total interest-earning asset and interest-bearing liability levels at December 31, 2023 remain constant. The impact of the rate movements was computed by simulating the effect of an immediate and sustained shift in interest rates over a twelve-month period from December 31, 2023 levels.
Increase Decrease
Parallel shift in interest rates over the next 12 months 100 bps 200 bps 300 bps 100 bps 200 bps 300 bps
Projected percentage increase/(decrease) in net interest income (1.4) % (3.1) % (4.9) % (0.1) % (5.2) % (11.2) %
Projected percentage increase/(decrease) in net income (3.3) % (7.4) % (11.5) % (0.3) % (12.7) % (27.0) %
Projected increase/(decrease) in return on average equity (3.1) % (7.1) % (11.1) % (0.2) % (12.2) % (26.1) %
Projected increase/(decrease) in earnings per share $ (0.04) $ (0.08) $ (0.13) $ — $ (0.14) $ (0.29)
Projected percentage increase/(decrease) in market value of equity (8.6) % (17.2) % (25.3) % 8.6 % 10.8 % 9.4 %
The following table illustrates the simulated impact of a parallel 100 bps, 200 bps or 300 bps upward or 100 bps downward movement in interest rates on net interest income, net income, return on average equity, earnings per share, and market value of equity. These analyses were prepared assuming that total interest-earning asset and interest-bearing liability levels at December 31, 2022 remain constant. The impact of the rate movements was computed by simulating the effect of an immediate and sustained shift in interest rates over a twelve-month period from December 31, 2022 levels.
Increase Decrease
Parallel shift in interest rates over the next 12 months 100 bps 200 bps 300 bps 100 bps 200 bps 300 bps
Projected percentage decrease in net interest income (1.3) % (2.7) % (4.3) % (5.0) % (10.8) % (16.9) %
Projected percentage decrease in net income (2.8) % (5.9) % (9.3) % (11.8) % (25.0) % (39.2) %
Projected decrease in return on average equity (2.6) % (5.6) % (8.9) % (11.2) % (24.0) % (37.9) %
Projected decrease in earnings per share $ (0.03) $ (0.07) $ (0.11) $ (0.14) $ (0.30) $ (0.48)
Projected percentage decrease in market value of equity (8.1) % (16.3) % (26.2) % 2.6 % 6.3 % 7.1 %
The figures included in the tables above represent projections that were computed based upon certain assumptions including loan prepayment rates and deposit decay rates. These assumptions are inherently uncertain and, as a result, we cannot precisely predict the impact of changes in interest rates. Actual results may differ significantly due to timing, magnitude and frequency of interest rate changes and changes in market conditions.
When assessing our interest rate sensitivity, analysis of historical trends indicates that loans will prepay at various speeds (or annual rates) depending on the variance between the weighted average portfolio rates and the current market rates. In preparing the table above, the following assumptions were used: (i) adjustable-rate mortgage loans will prepay at an annual rate of 8% to 23%; (ii) fixed-rate mortgage loans will prepay at an annual rate of 6% to 70%, depending on the type of loan; (iii) commercial loans will prepay at an annual rate of 10% to 30%; and (iv) consumer loans held by Northwest Bank will prepay at an annual rate of 13% to 23%. In regards to our deposits, it has been assumed that (i) fixed maturity deposits will not be withdrawn prior to maturity; (ii) a significant majority of money market accounts will re-price immediately; (iii) savings accounts will gradually re-price over three years; and (iv) checking accounts will re-price either when the rates on such accounts re-price as interest rate levels change, or when deposit holders withdraw funds from such accounts and select other types of deposit accounts, such as certificate accounts, which may have higher interest rates. For purposes of this analysis, management has estimated, based on historical trends, that $617.8 million, or 23.5%, of our interest-bearing demand accounts and $429.3 million, or 20.4%, of our savings deposits are interest sensitive and may re-price in one year or less, and that the remainder may re-price over longer time periods.
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The above assumptions are annual percentages based on remaining balances and should not be regarded as indicative of the actual prepayments and withdrawals that we may experience. Moreover, certain shortcomings are inherent in the analysis presented by the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to re-pricing, they may react in different degrees to changes in market interest rates. Also, interest rates on certain types of assets and liabilities may fluctuate in advance of or lag behind changes in market interest rates. Additionally, certain assets, such as some adjustable-rate loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Moreover, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in preparing the table.
In addition, we regularly measure and monitor the market value of our net assets and the changes therein. While fluctuations are expected because of changes in interest rates, we have established policy limits for various interest rate scenarios. Given interest rate shocks of +100 to +300 bps and -100 to -300 bps the market value of net assets is not expected to decrease by more than 15% to 35%.
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