OCEANFIRST FINANCIAL CORP 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk Management of Interest Rate Risk (“IRR”) Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises primarily from the IRR inherent in its lending, investment, deposit-taking, and funding activities. The Company’s profitability is affected by fluctuations in interest rates. Changes in interest rates may negatively or positively impact the Company’s earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. Changes in interest rates may also negatively or positively impact the market value of the Company’s investment securities, in particular fixed-rate instruments. Net gains or losses in available-for-sale securities can increase or decrease accumulated other comprehensive income or loss and total stockholders’ equity. To that end, management actively monitors and manages IRR. The extent of the movement of interest rates, higher or lower, is an uncertainty that could have a substantial impact on the earnings and stockholders’ equity of the Company. The principal objectives of the IRR management function are to evaluate the IRR inherent in the Company’s business; determine the level of risk appropriate given the Company’s business focus, operating environment, capital, and liquidity requirements and performance objectives; and manage the risk consistent with Board approved guidelines. The Company’s Board has established an Asset Liability Committee (“ALCO”) consisting of members of management, responsible for reviewing asset liability policies and the IRR position. ALCO meets regularly and reports the Company’s IRR position and trends to the Board on a regular basis. The Company utilizes a number of strategies to manage IRR including, but not limited to: (1) managing the origination, purchase, sale, and retention of various types of loans with differing IRR profiles; (2) attempting to reduce the overall interest rate sensitivity of liabilities by emphasizing core and longer-term deposits; (3) selectively purchasing interest rate swaps and caps converting the rates for customer loans to manage individual loans and the Bank’s overall IRR profile; (4) managing the investment portfolio IRR profile; (5) managing the maturities and rate structures of borrowings; and (6) purchasing interest rate swaps to manage overall balance sheet interest rate risk. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive.” Interest rate sensitivity is monitored through the use of an IRR model, which measures the change in the institution’s economic value of equity (“EVE”) and net interest income under various interest rate scenarios. EVE is the difference between the net present value of assets, liabilities and off-balance-sheet contracts. The EVE ratio, in any interest rate scenario, is defined as the EVE in that scenario divided by the fair value of assets in the same scenario. Interest rate sensitivity is monitored by management through the use of a model which measures IRR by modeling the change in EVE and net interest income over a range of interest rate scenarios. Modeled assets and liabilities are assumed to reprice at respective repricing or maturity dates. Pricing caps and floors are included in the results, where applicable. The Company uses prepayment expectations set forth by market sources as well as Company generated data where applicable. Generally, cash flows from loans and securities are assumed to be reinvested to maintain a static balance sheet. Other assumptions about balance sheet mix are generally held constant. The Company’s interest rate sensitivity should be reviewed in conjunction with the financial statements and notes thereto contained in the 2022 Form 10-K. The Company performs a variety of EVE and twelve-month net interest income sensitivity scenarios. The following table sets forth sensitivity scenarios for a specific range of interest rate scenarios as of March 31, 2023 and December 31, 2022 (dollars in thousands). March 31, 2023 December 31, 2022 Change in Interest Rates in Basis Points (Rate Shock) Economic Value of Equity Net Interest Income Economic Value of Equity Net Interest Income Amount % Change EVE Ratio Amount % Change Amount % Change EVE Ratio Amount % Change (dollars in thousands) 200 $ 1,357,372 (13.0) % 11.4 % $ 405,929 3.0 % $ 1,574,239 (8.5) % 13.7 % $ 440,916 1.2 % 100 1,445,725 (7.3) 11.8 400,033 1.5 1,646,301 (4.3) 13.9 438,280 0.6 Static 1,559,654 — 12.3 394,125 — 1,719,619 — 14.1 435,492 — (100) 1,700,426 9.0 13.0 384,961 (2.3) 1,762,678 2.5 14.0 428,519 (1.6) (200) 1,810,221 16.1 13.4 371,839 (5.7) 1,740,837 1.2 13.5 412,038 (5.4) The change in interest rate sensitivity was impacted by an increase in cash on hand position, floating rate loan growth and an increase in longer term fixed rate funding, partially offset by the deposit mix shift into short-term certificate of deposits. 17 Table of Contents Certain shortcomings are inherent in the methodology used in the EVE and net interest income IRR measurements. The model requires the making of certain assumptions which may tend to oversimplify the manner in which actual yields and costs respond to changes in market interest rates. First, the model assumes that the composition of the Company’s interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured. Second, the model assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Third, the model does not take into account the Company’s business or strategic plans or any steps it may take to respond to changes in rates. Fourth, prepayment, rate sensitivity, and average life assumptions can have a significant impact on the IRR model results. Lastly, the model utilizes data derived from historical performance. Accordingly, although the above measurements provide an indication of the Company’s IRR exposure at a particular point in time, such measurements are not intended to provide a precise forecast of the effect of changes in market interest rates, given the unique nature of the post-pandemic interest rate environment and the speed with which interest rates have been changing, the projections noted above on the Company’s EVE and net interest income and can be expected to significantly differ from actual results.