50
funding to total assets (including ratios and sub-limits for the various components comprising wholesale funding),
which were well within policy guidelines at December 31, 2014. Strong growth in core deposits and relatively high
levels of potentially liquid investments have had a positive impact on our liquidity position in recent periods,
although no assurance can be provided that our liquidity will continue at current robust levels.
The holding company’s primary uses of funds are ordinary operating expenses, shareholder dividends and stock
repurchases, and its primary source of funds is dividends from the Bank since the holding company does not conduct
regular banking operations. Management anticipates that there will be sufficient earnings at the Bank to provide
dividends to the holding company to meet its funding requirements for the foreseeable future. Both the holding
company and the Bank are subject to legal and regulatory limitations on dividend payments, as outlined in Item 5(c)
Dividends in this Form 10-K.
Interest Rate Risk Management
Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The Company
does not engage in the trading of financial instruments, nor does it have exposure to currency exchange rates. Our
market risk exposure is primarily that of interest rate risk, and we have established policies and procedures to monitor
and limit our earnings and balance sheet exposure to changes in interest rates. The principal objective of interest rate
risk management is to manage the financial components of the Company’s balance sheet in a manner that will
optimize the risk/reward equation for earnings and capital under a variety of interest rate scenarios. To identify areas
of potential exposure to interest rate changes, we perform earnings simulations and calculate the Company’s market
value of portfolio equity under varying interest rate scenarios every month.
We use commercially-available modeling software to simulate the effects of potential interest rate changes on our net
interest income. The model imports relevant information for the Company’s financial instruments and incorporates
management’s assumptions on pricing, duration, and optionality for anticipated new volumes. Various rate
scenarios, consisting of key rate and yield curve projections, are then applied in order to calculate the expected effect
of a given interest rate change on projected interest income and interest expense. The rate projections can be shocked
(an immediate and parallel change in all base rates, up or down), ramped (an incremental increase or decrease in rates
over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from
current actual levels).
We use eight standard interest rate scenarios in conducting our simulations: “stable,” upward shocks of 100, 200,
300 and 400 basis points, and downward shocks of 100, 200, and 300 basis points. Pursuant to policy guidelines, we
typically attempt to limit the projected 12-month decline in net interest income relative to the stable rate scenario to
no more than 5% for a 100 basis point (bp) shock, 10% for a 200 bp shock, 15% for a 300 bp shock, and 20% for a
400 bp shock in interest rates. As of December 31, 2014 the Company had the following estimated net interest
income sensitivity profile, without factoring in any potential negative impact on spreads resulting from competitive
pressures or credit quality deterioration:
Immediate Change in Rate
-300 bp
-200 bp
-100 bp
+100 bp
+200 bp
+300 bp
+400 bp
Change in Net Int. Inc. (in $000’s)
-$14,296
-$10,248
-$5,481
+$918
+$1,827
+$2,561
+$3,142
% Change
-25.01%
-17.93%
-9.59%
+1.61%
+3.20%
+4.48%
+5.50%
Our current simulations indicate that the Company has an asset-sensitive profile, meaning that net interest income
increases in rising interest rate scenarios but a drop in interest rates could have a negative impact. The Company’s
increasing balance of lower-cost non-maturity deposits would typically lead to further improvement in net interest
income in rising rate scenarios, but that impact has been counteracted in recent periods by a growing proportion of
fixed-rate assets.
If there were an immediate and sustained downward adjustment of 100 basis points in interest rates, all else being
equal, net interest income over the next twelve months would likely be around $5.481 million lower than in a stable
interest rate scenario, for a negative variance of 9.59%. The unfavorable variance increases when rates drop 200 or
300 basis points, due to the fact that certain deposit rates are already relatively low (on NOW accounts and savings
accounts, for example), and will hit a natural floor of close to zero while some variable-rate loan yields continue to
drop. This effect is exacerbated by accelerated prepayments on fixed-rate loans and mortgage-backed securities
