Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. Our profitability is dependent to a large extent on our net interest income, which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing liabilities. Our activities, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on the institution’s earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of an institution’s assets, liabilities and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk affecting our financial performance.
Our Asset/Liability Management Committee (“ALCO”) is responsible for monitoring and reviewing asset/liability processes and interest rate risk exposure to determine the level of risk appropriate given our operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability allocation alternatives; and to manage our interest rate risk consistent with regulatory guidelines and policies approved by the Board of Directors. Through such management, we seek to reduce the vulnerability of our earnings and capital position to changes in the level of interest rates. Our actions in this regard are taken under the guidance of the ALCO, which is comprised of members of our senior management. The ALCO closely monitors our interest sensitivity exposure, asset and liability allocation decisions, liquidity and capital positions, and local and national economic conditions and attempts to structure the loan and investment portfolios and funding sources to maximize earnings within acceptable risk tolerances.
The Company does not maintain a trading account for any class of financial instrument nor does it engage in hedging activities or purchase high-risk derivative instruments. Furthermore, the Company is not subject to foreign currency exchange rate risk or commodity price risk. For information regarding the sensitivity to interest rate risk of the Company’s interest-earning assets and interest-bearing liabilities, see the tables under Item 1. “Business – Lending Activities,” “– Investment Activities” and “– Deposit Activities and Other Sources of Funds”.
The Company’s principal financial objective is to achieve long-term profitability while limiting its exposure to fluctuating market interest rates. The Company intends to reduce risk where appropriate but accepts a degree of risk when warranted by economic circumstances. The Company has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates. The principal element in achieving this objective is to increase the interest rate sensitivity of the Company’s interest-earning assets by retaining in its loan portfolio, short–term loans and loans with interest rates subject to periodic adjustments.
Consumer and commercial loans are originated and held in the loan portfolio as the short-term nature of these portfolio loans match durations more closely with the short-term nature of retail deposits such as interest checking, money market accounts and savings accounts. The Company relies on retail deposits as its primary source of funds. Management believes retail 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 Company promotes transaction accounts and certificates of deposit with longer terms to maturity. Except for immediate short-term cash needs, and depending on the current interest rate environment, FHLB advances will have short or long-term maturities. FRB borrowings have short-term maturities. For additional information, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained herein.
A number of measures are utilized to monitor and manage interest rate risk, including simulation modeling and traditional interest rate gap analysis. While both methods provide an indication of risk for a given change in interest rates, the simulation model is primarily used to assess the impact on earnings that changes in interest rates may produce. Key assumptions in the model include cash flows and maturities of financial instruments, changes in market conditions, loan volumes and pricing, deposit sensitivity, consumer preferences and management’s capital leverage plans. These assumptions are inherently uncertain; therefore, 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 may significantly differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and specific strategies among other factors.
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The following table shows the approximate percentage change in net interest income as of March 31, 2025 over a 12 and 24-month period under several instantaneous changes in interest rate scenarios:
Percent change in net
Percent change in net
interest income (12
interest income (24
Change in interest rates
months)
months)
Up 400 basis points
(25.6)
%
(4.4)
%
Up 300 basis points
(19.4)
%
(1.3)
%
Up 200 basis points
(13.2)
%
1.9
%
Up 100 basis points
(6.1)
%
7.2
%
Base case
—
—
%
Down 100 basis points
4.7
%
11.4
%
Down 200 basis points
8.0
%
9.7
%
Down 300 basis points
10.9
%
7.2
%
Down 400 basis points
10.5
%
2.4
%
As of March 31, 2025, the Company’s interest rate risk simulation model indicates that net interest income is more negatively affected by rising interest rates than it is positively impacted by falling rates, particularly over the short term. This is primarily due to the presence of a significant number of fixed-rate loans in the loan portfolio, which limits the repricing of interest-earning assets relative to interest-bearing liabilities. In a rising interest rate environment, net interest income is projected to decline over the first 12 months, as interest-bearing liabilities are expected to reprice more quickly than interest-earning assets. Conversely, in a falling interest rate environment, net interest income is expected to increase, as interest-bearing liabilities tend to reprice more rapidly than interest-earning assets.
The Company seeks to manage interest rate risk through active monitoring and adjustment of the repricing characteristics of its assets and liabilities. However, as with any method of measuring interest rate risk, the simulation model is subject to certain inherent limitations. For instance, assets and liabilities with similar maturities or repricing characteristics may respond differently to changes in market interest rates. Some rates may change in anticipation of or lag behind market rate movements, while others, such as ARM loans, include caps and lags that limit near-term rate adjustments. Additionally, changes in interest rates may materially alter client behaviors, such as prepayment speeds on loans or early withdrawals from time deposits, which may deviate significantly from the assumptions used in the model. As such, actual results could differ materially from those projected by the model.
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