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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2020-09-04 compared with 2019-08-30 · 70 added, 87 removed, 82 unchanged (66% of the section changed)

1 unchanged sentence

Quantitative Aspects of Market Risk.

The Corporation does not maintain a trading account for any class of financial instrument nor does it purchase high-risk derivative

financial instruments.

The Corporation does not maintain a trading account for any class of financial instrument nor does it purchase

high-risk derivative financial instruments.

Furthermore, the Corporation is not subject to foreign currency exchange rate risk or commodity price risk.

The primary market risk that the Corporation faces is interest rate risk.

For information regarding the sensitivity

to interest rate risk of the Corporation's interest-earning assets and interest-bearing liabilities, see “Interest Rate Risk” below and Item 1, “Business - Lending Activities - Maturity of Loans Held for Investment,” “- Investment Securities

Activities,” and “- Deposit Activities and Other Sources of Funds - Time Deposits by Maturities” in this Form 10-K.

Qualitative Aspects of Market Risk.

For information

regarding the sensitivity to interest rate risk of the Corporation's interest-earning assets and interest-bearing liabilities, see “Interest Rate Risk” below and Item 1, “Business - Lending Activities - Maturity of Loans Held for Investment,” “-

Investment Securities Activities,” and “- Deposit Activities and Other Sources of Funds - Time Deposits by Maturities” in this Form 10-K.

Interest Rate Risk.

One of the Corporation's principal financial objectives is to achieve long-term profitability while reducing its exposure to fluctuating

interest rates.

The Corporation has sought to reduce the exposure of its earnings to changes in interest rates by attempting to manage the repricing mismatch between interest-earning assets and interest-bearing liabilities.

The principal element in

achieving this objective is to increase the interest-rate sensitivity of the Corporation's interest-earning assets by retaining for its portfolio new loan originations with interest rates subject to periodic adjustment to market conditions and by

selling fixed-rate, single-family mortgage loans.

The Corporation, through the Corporation's Asset-Liability Committee, has sought to reduce the exposure of its earnings to changes in interest rates by attempting to manage the repricing mismatch between interest-earning assets and

interest-bearing liabilities.

The principal element in achieving this objective is to increase the interest-rate sensitivity of the Corporation's interest-earning assets by retaining for its portfolio new loan originations with interest rates

subject to periodic adjustment to market conditions.

In addition, the Corporation maintains an investment portfolio, which is largely comprised of U.S.

government agency MBS and U.S.

government sponsored enterprise MBS with contractual maturities of up

to 30 years that reprice frequently or have a relatively short-average life.

government sponsored enterprise MBS with contractual maturities of

up to 30 years that reprice frequently or have a relatively short-average life.

The Corporation relies on retail deposits as its primary source of funds while utilizing FHLB - San Francisco advances as a secondary source of funding.

Management believes

retail deposits, unlike brokered deposits, reduce the effects of interest rate fluctuations because they generally represent a more stable source of funds.

As part of its interest rate risk management strategy, the Corporation promotes transaction

accounts and time deposits with terms up to seven years.

believes retail deposits, unlike brokered deposits, reduce the effects of interest rate fluctuations because they generally represent a more stable source of funds.

As part of its interest rate risk management strategy, the Corporation promotes

transaction accounts and time deposits with terms up to seven years.

For additional information, see Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K.

Interest Rate Risk.

The principal financial objective of the Corporation's interest rate risk management function is to achieve long-term profitability while limiting its

exposure to the fluctuation of interest rates.

The Corporation, through the Corporation's Asset-Liability Committee, has sought to reduce the exposure of its earnings to changes in interest rates by managing the repricing mismatch between

interest-earning assets and interest-bearing liabilities.

The principal element in achieving this objective is to manage the interest-rate sensitivity of the Corporation's assets by retaining loans with interest rates subject to periodic market

In addition, the Corporation maintains a liquid investment portfolio primarily comprised of U.S.

government agency MBS and government sponsored enterprise MBS.

The Corporation relies on retail deposits as its primary source of funding

while utilizing FHLB - San Francisco advances as a secondary source of funding which can be structured with favorable interest rate risk characteristics.

As part of its interest rate risk management strategy, the Corporation promotes transaction

accounts and time deposits with maturity terms up to seven years.

Through the use of an internal interest rate risk model, the Corporation is able to analyze its interest rate risk exposure by measuring the change in net portfolio value (“NPV”) over a variety of interest rate

NPV is defined as the net present

value of expected future cash flows from assets, liabilities and off-balance sheet contracts.

The calculation is intended to illustrate the change in NPV that would occur in the event of an immediate change in

interest rates of -200, -100, +100, +200 and +300 basis points (“bp”) with no effect given to steps that management might take to counter the effect of the interest rate movement.

The current federal funds rate is 2.50 percent making an immediate

change of -300 basis points improbable.

interest rate scenarios.

NPV is defined as the net present value of expected future cash flows from assets, liabilities and off-balance sheet contracts.

The calculation is intended to illustrate the change in NPV that would occur in the event of an

immediate change in interest rates of -100, +100, +200 and +300 basis points (“bp”) with no effect given to steps that management might take to counter the effect of the interest rate movement.

As of June 30, 2020, the targeted federal funds rate

range was 0.00% to 0.25%, making an immediate change of minus 200 basis points or more improbable.

The following table sets forth as of June 30, 2020 the estimated changes in NPV based on the indicated interest rate environment (dollars in thousands):

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Change in NPV Ratio

The pre-shock NPV ratio increased 156 basis points to 11.80 percent at June 30, 2019 from 10.24 percent at June 30, 2018 and the post-shock NPV ratio increased 105 basis points to 10.67 percent at June 30, 2019 from

9.62 percent at June 30, 2018.

The increase of the NPV ratios was primarily attributable to net income in the fiscal 2019 and a higher net valuation of total assets in comparison to total liabilities, partly offset by a $7.5 million cash dividend

distribution from the Bank to the Corporation in September 2018.

The pre-shock NPV ratio increased 13 basis points to 11.93 percent at June 30, 2020 from 11.80 percent at June 30, 2019 while the post-shock NPV ratio decreased 10 basis points to 10.57 percent at

June 30, 2020 from 10.67 percent at June 30, 2019.

The increase of the NPV ratios was primarily attributable to net income in fiscal 2020 and a higher net valuation of total assets in comparison to total liabilities, partly offset by a $7.5 million

cash dividend distribution from the Bank to the Corporation in September 2019.

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing tables.

For example, although certain assets and liabilities may have similar

maturities or periods to 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 of assets and liabilities may lag behind changes in market interest rates.

Additionally, certain assets, such as ARM loans, have features that restrict changes in interest rates on a short-term basis and over the life

of the asset.

Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from time deposits could likely deviate significantly from those assumed when calculating the results described in the

tables above.

For example, although certain assets and

liabilities may have similar maturities or periods to 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 of assets and liabilities may lag behind changes in market interest rates.

Additionally, certain assets, such as ARM loans, have features that restrict changes in interest rates on a

short-term basis and over the life of the asset.

Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from time deposits could likely deviate significantly from those assumed when

calculating the results described in the tables above.

It is also possible that, as a result of an interest rate increase, the higher mortgage payments required from ARM borrowers could result in an increase in delinquencies and defaults.

Changes in market interest rates may also affect

the volume and profitability of the Corporation’s origination of saleable mortgage loans.

Accordingly, the data presented in the tables in this section should not be relied upon as indicative of

actual results in the event of changes in interest rates.

Furthermore, the NPV presented in the foregoing tables is not intended to present the fair market value of the Corporation, nor does it represent amounts that

would be available for distribution to shareholders in the event of the liquidation of the Corporation.

Accordingly, the data presented in the tables in this section should not be relied upon as indicative of actual results in the event of changes in interest rates.

Furthermore, the NPV presented in the foregoing tables is not intended to present the

fair market value of the Corporation, nor does it represent amounts that would be available for distribution to shareholders in the event of the liquidation of the Corporation.

The Corporation measures and evaluates the potential effects of interest rate movements through an interest rate sensitivity "gap" analysis.

Interest rate sensitivity reflects the potential effect on net interest

income when there is movement in interest rates.

For loans, securities and liabilities with contractual maturities, the table presents contractual repricing or scheduled maturity.

For transaction accounts (checking, money market and savings

deposits) that have no contractual maturity, the table presents estimated principal cash flows and, as applicable, the Corporation's historical experience, management's judgment and statistical analysis concerning their most likely withdrawal

Interest rate sensitivity reflects the potential effect

on net interest income when there is movement in interest rates.

For loans, securities and liabilities with contractual maturities, the table presents contractual repricing or scheduled

For transaction accounts (checking, money market and savings deposits) that have no contractual maturity, the table presents estimated principal cash flows and, as applicable, the

Corporation's historical experience, management's judgment and statistical analysis concerning their most likely withdrawal behaviors.

The following table represents the interest rate gap analysis of the Corporation's assets and liabilities as of June 30, 2020:

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(1) Cash and cash equivalents are presented as estimated repricing;

investment securities and loans held for investment are presented as contractual maturities or

contractual repricing (without consideration for prepayments);

investment securities and loans held for investment are presented as

contractual maturities or contractual repricing (without consideration for prepayments);

FHLB - San Francisco stock is presented as contractual repricing;

transaction accounts (checking, savings and money market deposits) are presented as estimated repricing;

deposits (without consideration for early withdrawals) and borrowings are presented as contractual maturities.

transaction accounts (checking, savings and money market deposits) are presented as estimated

while time deposits (without consideration for early withdrawals) and borrowings are presented as contractual maturities.

The static gap analysis shows a positive position in the "Cumulative repricing gap - dollar amount" category, indicating more assets are sensitive to repricing than liabilities.

Management views non-interest bearing

deposits to be the least sensitive to changes in market interest rates and these accounts are therefore characterized as long-term funding.

Interest-bearing checking deposits are considered more sensitive, followed by increased sensitivity for

savings and money market deposits.

For the purpose of calculating gap, a portion of these interest-bearing deposit balances are assumed to be subject to estimated repricing as follows:

interest-bearing checking deposits at 15% per year, savings

deposits at 20% per year and money market deposits at 50% in the first and second years.

Management views

non-interest bearing deposits to be the least sensitive to changes in market interest rates and these accounts are therefore characterized as long-term funding.

Interest-bearing checking deposits are considered more sensitive, followed by increased

sensitivity for savings and money market deposits.

For the purpose of calculating gap, a portion of these interest-bearing deposit balances are assumed to be subject to estimated repricing

interest-bearing checking deposits at 15% per year, savings deposits at 20% per year and money market deposits at 50% in the first and second years.

The gap results presented above could vary substantially if different assumptions are used or if actual experience differs from the assumptions used in the preparation of the gap analysis.

Furthermore, the gap

analysis provides a static view of interest rate risk exposure at a specific point in time without taking into account redirection of cash flows activity and deposit fluctuations.

The extent to which the net interest margin will be impacted by changes in prevailing interest rates will depend on a number of factors, including how quickly interest-earning assets and interest-bearing liabilities

react to interest rate changes.

Furthermore, the gap analysis provides a static view of interest rate risk exposure at a specific point in time without taking into account redirection of cash flows activity and deposit fluctuations.

The extent to which the net interest margin will be impacted by changes in prevailing interest rates will depend on a number of factors, including how quickly interest-earning assets and

interest-bearing liabilities react to interest rate changes.

It is not uncommon for rates on certain assets or liabilities to lag behind changes in the market rates of interest.

Additionally, prepayments of loans and early withdrawals of certificates of deposit could cause

interest sensitivities to vary.

As a result, the relationship between interest-earning assets and interest-bearing liabilities, as shown in the previous table, is only a general indicator of interest rate sensitivity and the effect of changing

interest rates on net interest income is likely to be different from that predicted solely on the basis of the interest rate sensitivity analysis set forth in the previous table.

Additionally, prepayments of loans and early withdrawals of

certificates of deposit could cause interest sensitivities to vary.

As a result, the relationship between interest-earning assets and interest-bearing liabilities, as shown in the previous table, is only a general indicator of interest rate

sensitivity and the effect of changing interest rates on net interest income is likely to be different from that predicted solely on the basis of the interest rate sensitivity analysis set forth in the previous table.

The Corporation also models the sensitivity of net interest income for the 12-month period subsequent to any given month-end assuming a dynamic balance sheet accounting for, among other items:

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Loan prepayment estimates for each type of loan;

Immediate, permanent and parallel movements in interest rates of plus 300, 200 and 100 and minus 100 and 200 basis points.

Immediate, permanent and parallel movements in interest rates of plus 300, 200 and 100 and minus 100 basis points.

The following table describes the results of the analysis at June 30, 2020 and 2019:

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Net Interest Income

At June 30, 2019 and 2018, the Corporation was asset sensitive as its interest-earning assets at those dates are expected to reprice more quickly than its interest-bearing liabilities during the subsequent 12-month

At June 30, 2020 and 2019, the Corporation was asset sensitive as its interest-earning assets at those dates are expected to reprice more quickly than its interest-bearing liabilities during the

subsequent 12-month period.

Therefore, in a rising interest rate environment, the model projects an increase in net interest income over the subsequent 12-month period.

In a falling interest rate environment, the results project a decrease in net interest income over

the subsequent 12-month period.

In a falling interest rate environment, the results project a decrease in net

interest income over the subsequent 12-month period.

Management believes that the assumptions used to complete the analysis described in the table above are reasonable.

However, past experience has shown that immediate, permanent and parallel movements in interest rates

will not necessarily occur.

Additionally, while the analysis provides a tool to evaluate the projected net interest income to changes in interest rates, actual results may be substantially different if actual experience differs from the assumptions

used to complete the analysis, particularly with respect to the 12-month business plan when asset growth is forecast.

Therefore, the model results that the Corporation discloses should be thought of as a risk management tool to compare the trends of

the Corporation’s current disclosure to previous disclosures, over time, within the context of the actual performance of the treasury yield curve.

However, past experience has shown that immediate, permanent and parallel

movements in interest rates will not necessarily occur.

Additionally, while the analysis provides a tool to evaluate the projected net interest income to changes in interest rates, actual results may be substantially different if actual experience

differs from the assumptions used to complete the analysis, particularly with respect to the 12-month business plan when asset growth is forecast.

Therefore, the model results that the Corporation discloses should be thought of as a risk management

tool to compare the trends of the Corporation’s current disclosure to previous disclosures, over time, within the context of the actual performance of the treasury yield curve.

Financial Statements and Supplementary Data

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What changed 10-K

Item 7A. Quantitative and Qualitative Disclosures About Market Risk