Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK
The primary source of income for the Bank is net interest income, which is the difference between the interest income generated by interest-earning assets and the interest expense incurred for interest-bearing liabilities. The level of net interest income is a function of the average balance of interest-earning assets and interest-bearing liabilities and the difference between the yield on earning assets and the cost of interest-bearing liabilities. Both the pricing and mix of the Company's interest-earning assets and interest-bearing liabilities influence these factors. All else being equal, if the interest rates on the Company's interest-bearing liabilities increase at a faster pace than the interest rates on its interest-earning assets, the result would be a reduction in net interest income and with it, a reduction in net earnings. Conversely, if the interest rates on the Company's interest-bearing liabilities decrease at a slower pace than the interest rates on its interest-earning assets, the result would be a reduction in net interest income and with it, a reduction in net earnings.
Interest rates, both in terms of their overall levels and volatility, can greatly influence our profitability. Our goal in managing interest rate risk is to assess and control how changes in interest rates affect our net interest income, helping us achieve our financial objectives. We mitigate exposure to interest rate fluctuations through actions determined by the Asset/Liability Management Committee ("ALCO"). This committee meets at least quarterly to establish asset/liability management policies, develop and implement strategies to enhance balance sheet positioning and earnings, and assess interest rate sensitivity. The Company's Board oversees the asset/liability management process, reviews interest rate risk analyses prepared by ALCO, and annually approves the Financial Management policy.
Interest rate risk arises in part due to the Bank's significant holdings of fixed-rate single-family home loans, which are longer-term than customer accounts that constitute its primary liabilities. Accordingly, assets do not usually respond as quickly to changes in interest rates as liabilities. In the absence of management action, net interest income can be expected to decline when interest rates rise and to expand when interest rates fall. Shortening the maturity or repricing of the investment portfolio is one action that management can take. The composition of the investment portfolio was 53.8% variable rate and 46.2% fixed rate as of September 30, 2024 to provide some protection against changing rates. In addition, the Bank is producing more commercial loans that have shorter terms and/or variable rates. There has also been focus on increasing less rate sensitive transaction deposit accounts. These accounts make up 55.3% of the deposit portfolio as of September 30, 2024.
The Company's balance sheet strategy, in conjunction with low operating costs, has allowed the Company to manage interest rate risk, within guidelines established by the Board, through all interest rate cycles. It is Management's objective to grow the dollar amount of net interest income, through the rate cycles, acknowledging that there will be some periods of time when that will not be feasible. Cash and cash equivalents of $2,381,102,000 and shareholders' equity of $3,000,300,000 provide management with flexibility in managing interest rate risk. Based on management's assessment of the current interest rate environment, the Company has taken steps, including growing commercial loans having shorter average lives and transaction deposit accounts, to position itself for changing interest rates.
Net Interest Income Sensitivity. We estimate the sensitivity of our net interest income to changes in market interest rates using an interest rate simulation model that includes assumptions related to the level of balance sheet growth, deposit repricing characteristics and the rate of prepayments for multiple interest rate change scenarios. Interest rate sensitivity depends on certain repricing characteristics in our interest-earning assets and interest-bearing liabilities, including the maturity term structure, contractual rate changes and prepayment/attrition characteristics of assets and liabilities, all of which vary with changes in market interest rates. The analysis presented below assumes a constant balance sheet. Actual results would differ from the assumptions used in this model, as management monitors and adjusts loan and deposit pricing and the composition and overall size of the balance sheet to respond to changing interest rates.
In the event of an immediate and parallel decrease of 200 basis points across all interest rates, the model estimates that net interest income would decrease 1.0% in the next year. This compares to an estimated increase of 7.8% for the same measure as of September 30, 2023. It is noted that a steepening yield curve where the spread between short-term rates and long-term rates increases would likely result in higher net interest income.
In the event of an immediate and parallel increase of 200 basis points across all interest rates, the model estimates that net interest income would increase by 2.8% in the next year. This compares to an estimated decrease of 2.0% for the same measure as of September 30, 2023.
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Net Portfolio Value ("NPV") Sensitivity. The NPV is an estimate of the market value of shareholders' equity at a point in time. It is derived by calculating the difference between the present value of expected cash flows from assets and the present value of expected cash flows from liabilities and off-balance-sheet contracts. The sensitivity of the NPV to changes in interest rates provides a longer-term view of interest rate risk of the current balance sheet as it incorporates all future expected cash flows.
As of September 30, 2024, in the event of an immediate and parallel decrease of 200 basis points in interest rates, the NPV is estimated to increase by $273,000,000, or 9.2%, and the NPV-to-total assets ratio to increase to 11.6% from a base of 11.0%. As of September 30, 2023, in the event of an immediate and parallel decrease of 200 basis points in interest rates, the NPV was estimated to increase by $583,000,000, or 22.1%, and the NPV-to-total assets ratio to increase to 14.3% from a base of 12.4%. The change in the sensitivity of the NPV ratio to this assumed change in interest rates is primarily due to the steepening of the yield curve and changes in balance sheet mix year over year. Prepayment speeds for single family mortgages are increasing though still low at September 30, 2024 with the Bank's conditional payment rate ("CPR") for this portfolio segment at 8.6%, up slightly from 7.0% the year before.
As of September 30, 2024, in the event of an immediate and parallel increase of 200 basis points in interest rates, the NPV is estimated to decrease by $741,000,000, or 24.9%, and the NPV-to-total assets ratio to decline to 8.7% from a base of 11.0%. As of September 30, 2023, in the event of an immediate and parallel increase of 200 basis points in interest rates, the NPV was estimated to decrease by $723,000,000, or 27.4%, and the NPV-to-total assets ratio to decline to 9.5% from a base of 12.4%. Opposite to the down scenario above, this change in the sensitivity of the NPV ratio to the assumed change in interest rates is due to the flattening of the yield curve and changes in balance sheet mix year over year in this scenario.
Interest Rates. The Company measures the difference between the rate on interest-earning assets and the rate on interest-bearing liabilities at the end of each period. The period end interest rate spread was 1.91% at September 30, 2024 and 2.61% at September 30, 2023. As of September 30, 2024, the weighted-average rate on interest-earning assets increased by 4 basis points to 5.11% compared to September 30, 2023. The higher rate on interest-earning assets is due primarily to the Federal Reserve Bank's rate increases from March 2022 until September 2024, which have led to higher rates on adjustable rate loans, investment securities and cash as well as asset mix shifting to loans receivable. As of September 30, 2024, the weighted-average rate on interest-bearing liabilities increased by 74 basis points to 3.20% compared to September 30, 2023. The higher rate on interest-bearing liabilities primarily resulted from the addition of higher yielding deposits in the Merger which also had a higher concentration of the rate sensitive time deposits, customer deposits repricing and higher rates on new borrowings. The period end interest rate spread for the last eight fiscal quarters is shown below:
SEP 2024 JUN 2024 MAR 2024 DEC 2023 SEP 2023 JUN 2023 MAR 2023 DEC 2022
Interest rate on loans and mortgage-backed securities 5.16 % 5.18 % 4.94 % 5.11 % 5.08 % 4.97 % 4.81 % 4.59 %
Interest rate on other interest-earning assets 4.85 5.13 5.02 4.94 4.98 4.74 4.45 3.19
Combined, all interest-earning assets 5.11 5.17 4.94 5.09 5.07 4.94 4.77 4.46
Interest rate on customer accounts 3.09 2.91 2.92 2.35 2.12 1.82 1.48 0.94
Interest rate on borrowings (1) 3.93 4.10 4.48 3.99 3.98 3.93 3.69 3.14
Combined cost of funds 3.20 3.10 3.24 2.67 2.46 2.22 1.91 1.29
Interest rate spread 1.91 % 2.07 % 1.70 % 2.42 % 2.61 % 2.72 % 2.86 % 3.17 %
(1) Represents the effective rate taking into consideration cash flow hedges on FHLB borrowings.
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The chart below shows the volatility of our period end net interest spread (dashed line measured against the right axis) compared to the relatively consistent growth in net interest income (solid line measured against the left axis). The relative consistency of net interest income is accomplished by actively managing the size and composition of the balance sheet through different rate cycles.
Net Interest Margin. The net interest margin is measured using net interest income divided by average interest-earning assets for the period. The net interest margin decreased to 2.69% for the year ended September 30, 2024, from 3.40% for the year ended September 30, 2023. The yield on interest-earning assets increased 46 basis points to 5.59% and the cost of interest-bearing liabilities increased by 128 basis points to 3.46%. The higher yield on interest-earning assets was primarily due to the impact of rising rates on adjustable rate assets and cash. The higher rate in interest-bearing liabilities was primarily due to higher rates on interest-bearing customer accounts combined with the higher interest rates on borrowings and customer accounts obtained in the Merger.
For the year ended September 30, 2024, average interest-earning assets increased by 20.8% to $24,559,665,000, up from $20,327,301,000 for the year ended September 30, 2023. Balance sheet growth in 2024 was primarily due to the Merger. During 2024, average loans receivable increased $3,405,267,000, or 19.9%, while the combined average balances of mortgage-backed securities, other investment securities and cash increased by $822,850,000 or 26.5%.
During 2024, average interest-bearing customer deposit accounts increased $3,420,825,000 or 26.5% and the average balance of borrowings increased by $980,514,000, or 30.1%, from 2023, primarily due to the Merger.
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The following table sets forth the information explaining the changes in the net interest income and net interest margin.
Net Interest Income and Margin Summary
Year Ended September 30,
2024 2023 2022
Average
Balance Interest Average
Rate Average
Balance Interest Average
Rate Average
Balance Interest Average
Rate
($ in thousands)
Assets
Loans receivable (1) $ 20,500,281 $ 1,165,849 5.69 % $ 17,095,014 $ 900,068 5.27 % $ 15,083,111 $ 601,593 3.99 %
Mortgage-backed securities 1,597,566 59,782 3.74 1,362,415 43,184 3.17 1,141,501 26,332 2.31
Cash & Investments (2) 2,330,505 133,608 5.73 1,742,806 91,058 5.22 2,500,008 33,555 1.34
FHLB & FRB stock 131,313 12,471 9.50 127,066 8,645 6.80 87,861 4,879 5.55
Total interest-earning assets 24,559,665 1,371,710 5.59 % 20,327,301 1,042,955 5.13 % 18,812,481 666,359 3.54 %
Other assets 1,682,721 1,484,271 1,343,848
Total assets $ 26,242,386 $ 21,811,572 $ 20,156,329
Liabilities and Shareholders’ Equity
Interest-bearing customer accounts $ 16,327,208 532,434 3.26 % $ 12,906,383 237,233 1.84 % $ 12,738,719 43,041 0.34 %
Borrowings 4,242,431 178,444 4.21 3,261,917 115,488 3.54 1,731,120 28,729 1.66
Total interest-bearing liabilities 20,569,639 710,878 3.46 % 16,168,300 352,721 2.18 % 14,469,839 71,770 0.50 %
Noninterest-bearing customer accounts 2,593,567 2,969,970 3,249,120
Other liabilities 322,071 296,840 242,213
Total liabilities 23,485,277 19,435,110 17,961,172
Shareholders’ equity 2,757,109 2,376,462 2,195,157
Total liabilities and shareholders’ equity $ 26,242,386 $ 21,811,572 $ 20,156,329
Net interest income/interest rate spread $ 660,832 2.13 % $ 690,234 2.95 % $ 594,589 3.04 %
Net interest margin (3) 2.69 % 3.40 % 3.16 %
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(1) Interest income includes net amortization-accretion of deferred loan fees, costs, discounts and premiums of $37,489,000, $20,130,000 and $29,156,000 for year ended 2024, 2023 and 2022, respectively.
(2) Includes cash equivalents and non-mortgage backed security investments, such as U.S. agency obligations, mutual funds, corporate bonds, and municipal bonds.
(3) Net interest income divided by average interest-earning assets.
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The following table shows the potential impact of changing interest rates on net income for one year. The Company's focus is primarily on the impact of abrupt upward or downward changes in short term rates. It is important to note that this is not a forecast or prediction of future events, but is used as a tool for measuring potential risk. This analysis assumes zero balance sheet growth and a constant percentage composition of assets and liabilities.
Potential Increase (Decrease) in Net Interest Income
Basis Point Increase (Decrease) in Interest Rates September 30, 2024
(In thousands, except percentages)
(300) $ (35,155) (4.27) %
(200) (8,414) (1.02)
(100) 1,702 0.21
100 (274) (0.03)
200 22,686 2.76
Actual results will differ from the assumptions used in this model, as management monitors and adjusts both the size and the composition of the balance sheet in order to respond to changing interest rates. In a rising interest rate environment, it is likely that the Company will grow its balance sheet to offset margin compression that may occur. Improvement in the net interest income sensitivity during the year is primarily the result of interest rate swap activity, as well as increased time deposits and an increased federal funds balances which help reduce sensitivity in rising shock scenarios.
Another method used to quantify interest rate risk is the NPV analysis. This analysis calculates the difference between the present value of interest-bearing liabilities and the present value of expected cash flows from interest-earning assets and off-balance-sheet contracts. The following tables set forth an analysis of the Company’s interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve (measured in 100-basis-point increments).
The tables below express the NPV under varying interest scenarios.
September 30, 2024
Change in
Interest Rates Estimated
NPV Amount Estimated Increase/(Decrease) in NPV Amount NPV as
% of Assets
(Basis Points) (In thousands) (In thousands)
200 $ 2,236,691 $ (740,588) 8.69 %
100 2,472,251 (505,028) 9.41
No change 2,977,279 — 10.99
(100) 3,045,962 68,683 11.08
(200) 3,249,949 272,670 11.56
(300) 3,232,362 255,083 11.32
As of September 30, 2024, the Company was in compliance with all of its interest rate risk policy limits.
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