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ratios reviewed periodically by management and the Board include net loans to total deposits and wholesale 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, 2015. Despite the increase in loan balances in 2015, 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 repur-
chases, and its primary source of funds is dividends from the Bank since the holding company does not conduct regular
banking operations. Management anticipates that the Bank will have sufficient earnings 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 utilize commercially available modeling software
to perform earnings simulations and calculate the Company’s market value of portfolio equity under varying interest
rate scenarios every month. 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 interest income, interest expense, and the value of the Company’s financial
instruments. 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 rolling 12-month net interest income 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 decline in net interest income relative to the
stable rate scenario to no more than 5% for a 100 basis point (bp) interest rate shock, 10% for a 200 bp shock, 15% for
a 300 bp shock, and 20% for a 400 bp shock. As of December 31, 2015 the Company had the following estimated net
interest income sensitivity profile, without factoring in any potential negative impact on spreads resulting from com-
petitive 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)
-$18,357 -$12,827
-$6,784
+$1,409
+$3,234
+$5,068
+$6,432
% Change
-27.60%
-19.29%
-10.20%
+2.12%
+4.86%
+7.62%
+9.67%
Our current simulations indicate that the Company has an asset-sensitive profile, meaning that net interest income
increases with a parallel shift up in the yield curve but a drop in interest rates could have a negative impact. This profile
is consistent with the Company’s relatively large balance of less rate-sensitive non-maturity deposits and large volume
of variable-rate loans, which contribute to higher net interest income in rising rate scenarios and compression in net
interest income in declining rate scenarios.
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 $6.784 million lower than in a stable interest
rate scenario, for a negative variance of 10.20%. 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 non-floored variable-rate loan yields continue to drop. This