45
Earnings simulation
. Management believes that interest rate risk is best estimated by our
earnings simulation
earnings simulation modeling.
Forecasted levels of earning assets, interest-bearing liabilities,
and off
and off-balance-balance sheet financial instruments are combined
with ALCO forecasts of market interest rates for the next
12 months and other
factors in order to produce
various earnings
simulations and estimates. To
help limit interest rate risk, we have guidelines for earnings at
risk which seek to limit the
variance of net interest income from gradual changes in interest rates.
For changes up or down in rates from management’s
flat interest rate forecast over the next 12 months, policy limits
for net interest income variances
are as follows:
●
+/- 20% for a gradual change of 400 basis points
●
+/- 15% for a gradual change of 300 basis points
●
+/- 10% for a gradual change of 200 basis points
●
+/- 5% for a gradual change of 100 basis points
At June 30,
2021,2022, our earnings simulation model indicated that
we were in compliance
with the policy guidelines noted
. EVE measures the extent that the estimated economic values of our
assets, liabilities, and off-
balance sheet items will change as a result of interest rate changes.
Economic values are
estimated by discounting expected
cash flows from assets, liabilities, and off-balance sheet items,
which establishes a base case EVE. In contrast with our
earnings simulation model, which evaluates interest rate risk over a
12 month timeframe,
EVE uses a terminal horizon
which allows for the re-pricing of all assets, liabilities, and
offoff-balance sheet items.
-balance sheet items. Further, EVE
is measured using values
as of a point in time and does not reflect any actions that ALCO
might take in responding to
or anticipating changes in
interest rates, or market and competitive conditions.
To help limit interest rate
risk,
risk, we have stated policy guidelines for an
instantaneous basis point change in interest rates, such that our EVE
should not decrease from our
base case by more than
the following:
●
45% for an instantaneous change of +/-
400 basis points
●
35% for an instantaneous change of +/-
300 basis points
●
25% for an instantaneous change of +/-
200 basis points
●
15% for an instantaneous change of +/-
100 basis points
At June 30,
2021,2022, our EVE model indicated that we were in compliance
with
with theour policy
guidelines noted above.guidelines.
Each of the above analyses may not, on its own, be an accurate
indicator of how our net interest income
will be affected
by
changes in interest rates. Income associated with interest-earning assets
and costs associated
with interest-bearing liabilities
may not be affected uniformly by changes in interest rates.
In addition,
In addition, the magnitude and duration of changes in interest
rates may have a significant impact on net interest income. For
example, although certain
assets and liabilities may have
similar maturities or periods of repricing, they may react in different
degrees to changes in market interest rates, and other
economic and market factors, including market perceptions.
Interest
Interest rates on certain types of assets and liabilities fluctuate
in advance of changes in general market rates, while interest
rates on other types of assets
and liabilities may lag behind
changes in general market rates. In addition, certain assets, such as
adjustable rate
adjustable rate mortgage loans, have features (generally
referred to as “interest rate caps and floors”) which limit changes
in interest rates.
Prepayment Prepaymentsand early withdrawal levels
also could deviate significantly from those assumed in calculating the maturity
of certain instruments.
The ability of many
borrowers to service their debts also may decrease during periods
of rising interest rates or economic
stress, which may
differ across industries and economic sectors. ALCO reviews
each of the
above interest rate sensitivity analyses along with
several different interest rate scenarios in seeking satisfactory,
consistent levels of profitability within the framework of the
Company’s established liquidity,
loan, investment, borrowing, and capital policies.
The Company may also use derivative financial instruments
to improve the balance
between interest-sensitive assets and
interest-sensitive liabilities, and as a tool to manage interest rate
sensitivity
sensitivity while continuing to meet the credit and deposit
needs of our customers. From time to time, the Company
also may
enter into
back-to-backinterest rate swaps to facilitate
customercustomer transactions and meet their financing needs. These interest rate
swaps qualify
swaps qualify as derivatives, but are not
designated as
hedging instruments. At June 30,
20212022 and December 31,
2020,2021, the Company had no derivative contracts
designated as part
of a hedging relationship to assist in managing its interest rate
sensitivity.