Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company’s market risk is composed primarily of interest rate risk arising from its core banking activities of lending and deposit taking. Interest rate risk refers to the exposure arising from changes in interest rates. Fluctuations in interest rates have a significant impact not only upon net income, but also upon the cash flows and market values of assets and liabilities. Our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our interest-earning assets and interest-bearing liabilities. Management continually develops and applies strategies to mitigate this risk.
The Company’s objectives are to manage interest rate risk to foster consistent growth of earnings and capital. It is our policy to maintain an acceptable level of interest rate risk over a range of possible changes in interest rates while remaining responsive to market demand for loan and deposit products. To measure that risk, the Company uses an earnings simulation approach.
The Company has an Asset Liability Committee which meets quarterly to review the interest rate sensitivity position and to review and develop various strategies for managing interest rate risk. Measuring and maintaining interest rate risk is a dynamic process that management performs with the objective of maximizing net interest margin while maintaining interest rate risk within acceptable tolerances. This process relies primarily on the simulation of net interest income over multiple interest rate scenarios. The Company engages a third party that utilizes a modeling program to measure the Company’s exposure to potential interest rate changes. For various assumed hypothetical changes in market interest rates, this analysis measures the estimated change in net interest income. The simulations allow for ongoing assessment of interest rate sensitivity and can include the impact of potential new business strategies. The modeled scenarios begin with a base case in which rates are unchanged and include parallel and nonparallel rate shocks. The results of these shocks are measured in two forms: first, the impact on the net interest margin and earnings over one and two year time frames; and second, the impact on the market value of equity. The results of the simulation are compared against approved policy limits.
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(dollars in thousands, except per share amounts)
The following table presents the estimated change in net interest income for one year under several scenarios of assumed interest rate changes for the rate shock levels shown. The change in each interest rate scenario represents the difference between estimated net interest income in the unchanged interest rate scenario, or the base case, and the estimated net interest income in each of the alternative interest rate scenarios. The net interest income in each scenario is based on parallel yield curve changes in the interest rates applied to a static balance sheet. These do not reflect the earnings expectations of management.
Net Interest Income at
December 31, 2022
Change in Interest Rates Amount % Change
300 basis points rising $ 86,907 (7.24) %
200 basis points rising 89,003 (5.00)
100 basis points rising 90,990 (2.88)
Base case 93,690 —
100 basis points falling 96,460 2.96
200 basis points falling 103,052 9.99
Computations of the prospective effects of hypothetical interest rate changes are based on numerous assumptions. The assumptions used in our interest rate sensitivity simulation discussed above are inherently uncertain and, as a result, the simulations cannot precisely measure net interest income or precisely predict the impact of changes in interest rates on net interest income. Actual results may differ from those projections set forth above due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and customer behavior. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates.
For modeling purposes, as of December 31, 2021, the model simulations projected that 100 and 200 basis point ratable increases in interest rates would result in positive variances in net interest income of 0.99 percent and 2.85 percent, respectively, relative to the flat-rate case over the next 12 months. The model simulations as of December 31, 2021 indicated that our projected balance sheet was slightly asset sensitive in comparison to a liability sensitive balance sheet as of December 31, 2022. The increase in liability sensitivity was partly due to changes in the sensitivity assumptions of our deposits and changes in the mix of balance sheet liabilities. Sensitivity assumptions of deposits were adjusted to be more reflective of actual depositor behavior during the unprecedented interest rate increases in 2022. The change in mix of deposits, brokered funds and short term borrowings and the increase of short term funding on the balance sheet at December 31, 2022 compared to December 31, 2021 has also increased the liability sensitivity of the balance sheet.
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West Bancorporation, Inc. and Subsidiary