Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market Risk
Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. We have identified three primary sources of market risk: interest rate risk, price risk and basis risk.
Interest Rate Risk . Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (repricing risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries and SOFR (basis risk).
Price Risk. Price risk represents the risk of loss arising from adverse movements in the prices of financial instruments that are carried at fair value and subject to fair value accounting. We have price risk from the available for sale SFR mortgage loans and fixed-rate available for sale securities.
Basis Risk. Basis risk represents the risk of loss arising from asset and liability pricing movements not changing in the same direction. We have basis risk in the SFR mortgage loan portfolio, the multifamily loan portfolio and our securities portfolio.
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Our ALCO establishes broad policy limits with respect to interest rate risk. The ALCO establishes specific operating guidelines within the parameters of the board of directors’ policies. In general, we seek to minimize the impact of changing interest rates on net interest income and the economic values of assets and liabilities. The ALCO meets at least quarterly to monitor the level of interest rate risk sensitivity to ensure compliance with the board of directors’ approved risk limits and to oversee management's balance sheet risk management strategies.
Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.
An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on interest-earning assets would reprice upward more quickly than rates paid on interest-bearing liabilities, thus expanding the net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on interest-bearing liabilities would reprice upward more quickly than rates earned on interest-earning assets, thus compressing the net interest margin.
Income Simulation and Economic Value Analysis. Interest rate risk measurement is calculated and reported to the board and the ALCO at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.
We use two approaches to model interest rate risk: Net Interest Income at Risk (NII at Risk), and Economic Value of Equity (“EVE”). Under NII at Risk, net interest income is modeled utilizing various assumptions for assets, liabilities, and derivatives over a 12 month horizon assuming a flat balance sheet and an instantaneous and parallel shift in market interest rates in 100 basis point increments. We report NII at Risk to isolate the change in income related solely to interest-earning assets and interest-bearing liabilities. The model results do not take into consideration any steps management might take to respond to the changes in interest rates. EVE measures the period end market value of assets minus the market value of liabilities and the change in this value as rates change. EVE is a period end measurement.
Net Interest Income Sensitivity
Immediate Change in Rates
-300
-200
-100
+100
+200
+300
December 31, 2024
(dollars in thousands)
Dollar change
$
12,278
$
6,776
$
2,810
$
(960
)
$
(2,321
)
$
(3,612
)
Percent change
10.73
%
5.92
%
2.46
%
(0.84
%)
(2.03
%)
(3.16
%)
December 31, 2023
Dollar change
$
11,086
$
6,553
$
2,545
$
470
$
50
$
(455
)
Percent change
10.48
%
6.20
%
2.41
%
0.44
%
0.05
%
(0.43
)%
At December 31, 2024, our NII at Risk profile is liability sensitive in the down and up rate scenarios. This is directionally consistent with our profile at December 31, 2023 for the down rate and a change from neutral in the up rate scenario. For the up rate scenarios, we are more liability sensitive due to fixed rate debt approaching its maturity date in the first quarter of 2025. Actual results could vary materially from those calculated by our model, due to a variety of factors or assumptions such as the uncertainty of the magnitude, timing and direction of future interest rate movement or the shape of the yield curve. The NII at Risk results are within board policy limits.
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Economic Value of Equity Sensitivity (Shock)
Immediate Change in Rates
-300
-200
-100
+100
+200
+300
December 31, 2024
(dollars in thousands)
Dollar change
(25,835
)
3,288
11,486
(19,175
)
(46,186
)
(80,285
)
Percent change
(3.84
)%
0.49
%
1.71
%
(2.85
)%
(6.86
)%
(11.93
)%
December 31, 2023
Dollar change
(26,488
)
(7,430
)
4,856
(28,251
)
(69,646
)
(111,281
)
Percent change
(4.79
)%
(1.34
)%
0.88
%
(5.11
)%
(12.60
)%
(20.14
)%
At December 31, 2024, the EVE position is projected to decrease in the up rate scenarios. When interest rates rise, fixed rate assets generally lose economic value as these instruments are discounted at a higher rate demonstrating the relative longer asset duration as compared to the overall liability duration. In the down rate scenario, the EVE position is projected to initially increase as assets gain in value at a faster rate than the decrease in the value of noninterest-bearing deposits. However, as the down rate shocks become more severe, the pace of the increase in the value of loans slows a loan prepayments increase and discount rates reach their floors, resulting in a lower EVE position in the down 300 scenario. Actual results could vary materially from those calculated by our model, due to a variety of factors or assumptions such as the uncertainty of the magnitude, timing and direction of future interest rate movement or the shape of the yield curve. The EVE results are within board policy limits.
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