INTEREST RATE RISK Randy C. Thompson, Ph.D. Federation Webinar - - PowerPoint PPT Presentation

INTEREST RATE RISK

Randy C. Thompson, Ph.D. Federation Webinar September 17, 2014

Definition

• Interest Rate Risk is the risk to earnings or capital arising

from movement of interest rates. It arises from differences between the timing of rate changes and the timing of cash flows .

• For example,

Base 2% Shock Income Yield 4.50% 4.50% Cost of Funds 0.50% 2.50% Margin 4.00% 2.00%

United States Interest Rate History

• 12 CFR Part 741
• IV. IRR Measurement and Monitoring
• A. Risk Measurement Systems
• Generally, credit unions should have IRR measurement

systems that capture and measure all material and identified sources of IRR. An IRR measurement system quantifies the risk contained in the credit union’s balance sheet and integrates the important sources of IRR faced by a credit union in order to facilitate management of its risk exposures. The selection and assessment of appropriate IRR measurement systems is the responsibility of credit union boards and management.

• 12 CFR Part 741
• Management should:
• Rely on assumptions that are reasonable and supportable;
• Document any changes to assumptions based on observed

information;

• Monitor positions with uncertain maturities, rates and cash flows,

such as non-maturity shares, fixed rate mortgages where prepayments may vary, adjustable rate mortgages, and instruments with embedded options, such as calls; and

• Require any interest rate risk calculation techniques, measures and

tests to be sufficiently rigorous to capture risk.

• 12 CFR Part 741
• B. Risk Measurement Methods
• The following discussion is intended only as a general

guide and should not be used by credit unions as an endorsement of a particular method.

• An IRR measurement system may rely on a variety of different
• methods. Common examples of methods available to credit

unions are GAP analysis, income simulation, asset valuation, and net economic value. Any measurement method(s) used by a credit union to analyze IRR exposure should correspond with the complexity of the credit union’s balance sheet so as to identify any material sources of IRR.

Guidance Letter 12-CU-05 May 2012

• Beginning on September 30, 2012, certain federally insured credit

unions (FICUs) will be required to adopt a written policy on interest- rate risk (IRR) management and a program to implement it effectively.1

• This rule affects only 45% of credit unions, yet covers 96% of credit union
• assets. Boards and management of affected credit unions must be

vigilant and well-prepared before interest rates rise. Exposed credit unions without appropriate interest rate risk policies pose unacceptable and preventable risks to the National Credit Union Share Insurance Fund.

• However, our standard for interest rate risk policies is not one-size-fits-
• all. We realize that exposed credit unions have different risk profiles. So

while the rule provides guidelines for policies, we are also providing flexibility for credit union managers and board members to develop their own policy – and we are giving affected credit unions several months to comply.

Guidance Letter 12-CU-11 August 2012 Frequently Asked Questions

• What should the policy include?
• A written policy should:
• Identify parties responsible for review of the credit unions IRR exposure.
• Direct appropriate actions to ensure management identifies, measures,

monitors, and controls IRR exposure.

• State the frequency with which monitoring and measurement will be

reported to the board.

• Set risk limits for IRR exposure based on selected measurement. (for

example GAP, NII or NEV)

• Choose tests such as interest rate shocks, that the credit union will

perform using the selected measures.

• Provide for periodic review of material changes in IRR exposure and

compliance with board approved policy and risk limits.

• Provide for assessment of the IRR impact of any new business activities

prior to implementation.

• Provide for an annual review of policy to ensure it is commensurate with

size, complexity and risk profile of the credit union.

• When appropriate, establish monitoring limits for individual portfolios,

activities, and lines of business.

Guidance Letter 12-CU-11 August 2012 Frequently Asked Questions

• How should management implement the Board policy?
• Management should:
• Develop and maintain adequate IRR measurement systems;
• Evaluate and understand IRR exposures;
• Establish an appropriate system of internal controls (risk taker

should be separate from those measuring. i.e. does the modeler also pick the investments?);

• Allocate sufficient resources for an effective IRR program (should

include competent staff with technical knowledge of the IRR program);

• Identify procedures and assumptions involved in the IRR

measurement system (i.e. the credit union’s IRR model inputs);

• Establish clear lines of authority for managing IRR; and
• Provide a sufficient set of reports to comply with Board approved

policies

Definitions – Assets & Liabilities

• Earning Assets are loans and investments
• Deposits are typically all balances in member accounts
• Yield is the rate of return on loans and investments
• Cost of funds is the dividend rate paid on deposits
• Net Interest Income (Margin) is the balance left after

subtracting interest expense from interest income

Definitions - Repricing Schedule

• Loans may be repriced based on the amortization of

principal balances

• Total of principal payments each month available to fund new loans
• Investments repriced based on maturity or cash flow
• Non-maturity shares (savings, checking, money markets,

IRAs) reprice based on management discretion

• Maturity shares (CDs) reprice at maturity.
• Amount of increase is the discretion of the credit union.

Definitions - Shocks

• Shock is an assumed shift of environmental interest rates

affecting both earning assets and deposits

• Shocks may range from negative to positive at differing

levels

• Credit Union policy should require at least minimum

number of shocks such as +3% and down 1%. However, you can include other shocks to broaden your analysis.

Types of Shocks

• Historically we can see two distinct types of shocks:
• Immediate – short term
• Pressures in the economy cause rates to jump quickly
• Sustained/Stepped
• Economic conditions result in multiple, continuous rate increases

Immediate Adjustment

Economics of Immediate Shocks

• 1933 Regulation Q
• Assigned deposit types to institutions
• Set Maximum rates on deposits
• Prohibited interest on checking
• Promoted house lending due to minimal IRR
• Reg Q created a stable cost of funds environment for long-term

lenders, such as Savings and Loans.

Economics of Immediate Shocks

• 1978-1983
• Inflation and high interest rates
• Merrill Lynch Introduces Overnight Investments
• Money Market Accounts
• Interest Gap between Savings and Money Market rates
• Disintermediation
• Deregulation began in 1980
• Phased in over time
• Interest rate caps eliminated in 1981

Immediate Adjustment

Results

• Elimination of the interest cap
• Savings rates increased to match Money Market rates
• Cost of Funds increased
• Margins at Savings and Loans evaporated
• Example
• Loans funded at 4.5%
• Cost of funds now averaged 6.2%
• Negative margin was unsustainable
• Key was the long-term nature of earning assets
• Minimal amortization of principal balances

Shock Effect – Immediate Shock

• 3% Shock with no amortization and immediate deposit

shock

Loans 5.97% $ 30,512,568 $ 1,821,600 Investments 1.25% $ 22,564,812 $ 282,060 $ 2,103,660 Deposits 0.31% $ 58,326,791 $ 180,813 Margin $ 1,922,847

Shock Effect – Immediate Shock

Loans 5.97% $ 30,512,568 $ 1,821,600 Investments 1.25% $ 22,564,812 $ 282,060 $ 2,103,660 $ - Deposits 3.31% $ 58,326,791 $ 1,930,617 Margin $ 173,044

• 3% Shock with no amortization and immediate

deposit shock

Shock Effect – Immediate Shock

• 3% Shock with long-term amortization and immediate

deposit shock

Loans 5.97% $ 28,012,568 $ 1,672,350 Loans New 8.97% $ 2,500,000 $ 224,250 Investments 1.25% $ 21,064,812 $ 263,310 Investments New 4.25% $ 1,500,000 $ 63,750 $ 2,159,910 $ - Deposits 0.31% $ 58,326,791 $ 1,930,617 Margin $ 229,294 New Yield Loans 6.22% New Yield Invest. 1.45%

Shock Effect – Immediate Shock

• 3% Shock with mid-term amortization and immediate

deposit shock

Loans 5.97% $ 23,012,568 $ 1,373,850 Loans New 8.97% $ 7,500,000 $ 672,750 Investments 1.25% $ 19,064,812 $ 238,310 Investments New 4.25% $ 3,500,000 $ 148,750 $ 2,284,910 $ - Deposits 3.31% $ 58,326,791 $ 1,930,617 Margin $ 354,294 New Yield Loans 6.71% New Yield Invest. 1.72%

Shock Effect – Immediate Shock

• Summary of Impact

Amortization Margin At Risk $ At Risk % Base $ 1,922,847 $ - None $ 173,044 $ 1,749,803 91.0% Long-term $ 229,294 $ 1,693,553 88.1% Mid-Term $ 354,294 $ 1,568,553 81.6%

Question

What factors, that led to 1981 immediate shock, are present in our current economic condition?

• Regulated interest rates?
• High inflation?
• Limited access to deposit types?

Shocks – Sustained/Stepped

Economics of Stepped Shocks

• 2004 to 2006
• Government intervention in housing market
• Easy credit
• High Appreciation of Housing
• Accelerated Demand for consumer credit and consumer deposits
• Resulted in inflation and increased cost of funds
• Fed Response
• Began increasing rates for borrowing
• Multiple adjustments to ratchet down demand
• Taking care not to kill economy

Shocks – Sustained/Stepped

Deposit Re-pricing Factors Stepped Shock

• Key Considerations
• Most credit unions do not price at the top of competition
• Members are not as likely to focus on core deposit rates
• Elasticity of Demand (Econometric Analysis)
• You have discretion on rates and term of increase
• Percent of Shock to Apply
• Low elasticity = lower percent of shock
• 65% of 3% up-shock is 1.95%
• 65% of 5% up-shock is 3.25%
• Length of Time to Achieve Shock
• Low elasticity = longer time to achieve maximum rate increase
• 12 months for lower sensitivity
• 6 months for higher sensitivity

Shock Effect - Sustained/Stepped

• Base Line with 6/30/2013 rates and balances

Loans 5.97% $ 30,512,568 $ 1,821,600 Investments 1.25% $ 22,564,812 $ 282,060 $ 2,103,660 $ - Deposits 0.31% $ 58,326,791 $ 180,813 Margin $ 1,922,847

Shock Effect - Sustained/Stepped

• 3% Up-shock with no asset repricing and Stepped deposit

repricing

Loans 5.97% $ 30,512,568 $ 1,821,600 Investments 1.25% $ 22,564,812 $ 282,060 $ 2,103,660 $ - Deposits 1.96% $ 58,326,791 $ 1,143,205 Margin $ 960,455

Shock Effect - Sustained/Stepped

• 3% Up-shock with long-term asset re-pricing and Stepped

deposit re-pricing

Loans 5.97% $ 28,012,568 $ 1,672,350 Loans New 8.97% $ 2,500,000 $ 224,250 Investments 1.25% $ 21,064,812 $ 263,310 Investments New 4.25% $ 1,500,000 $ 63,750 $ 2,159,910 $ - Deposits 1.96% $ 58,326,791 $ 1,143,205 Margin $ 1,016,705 New Yield Loans 6.22% New Yield Invest. 1.45%

Shock Effect - Sustained/Stepped

• 3% Up-shock with mid-term asset re-pricing and Stepped

deposit re-pricing

Loans 5.97% $ 23,012,568 $ 1,373,850 Loans New 8.97% $ 7,500,000 $ 672,750 Investments 1.25% $ 19,064,812 $ 238,310 Investments New 4.25% $ 3,500,000 $ 148,750 $ 2,284,910 $ - Deposits 1.96% $ 58,326,791 $ 1,143,205 Margin $ 1,141,705 New Yield Loans 6.71% New Yield Invest. 1.72%

Shock Effects – Margin at Risk

• Comparison of Margins in each scenario

Amortization Margin At Risk $ At Risk % Margin At Risk $ At Risk % Base $1,922,847 $1,922,847 None $173,044 $1,749,803 91.00% $ 960,455 $ 962,392 50.05% Long-term $229,294 $1,693,553 88.08% $ 1,016,705 $ 906,142 47.12% Mid-Term $354,294 $1,568,553 81.57% $ 1,141,705 $ 781,142 40.62%

Margin At Risk Effect on Earnings

• Simulation of Immediate Shock

Amortization Margin Other Inc. Operating Exp. Income None $173,044 $424,500 $1,356,000 ($758,456) Long-term $229,294 $424,500 $1,356,000 ($702,206) Mid-Term $354,294 $424,500 $1,356,000 ($577,206)

Margin At Risk Effect on Earnings

• Simulation of Sustained/Stepped Shock

Amortization Margin Other Inc. Operating Exp. Income None $960,455 $424,500 $1,356,000 $28,955 Long-term $1,016,705 $424,500 $1,356,000 $85,205 Mid-Term $1,141,705 $424,500 $1,356,000 $210,205

Measurement Models

• GAP
• Income Simulation
• Net Economic Valuation
• Earnings at Risk

Measurement Models

• Net Economic Valuation
• Applies a Present Value Calculation against future cash flows to:
• Discount the value of assets
• Discount the value of liabilities, Then
• Subtracts values to arrive at NEV
• Designed to identify liquidation value of credit union
• Requires:
• Maturities
• Market prices
• Discount rate

Measurement Models

• Questions?
• What are the maturities of your non-maturity deposits?
• What is the market price for a checking or savings account?
• Where is the market where we can “purchase” a core account?
• How do we establish a discount rate with no market?

Measurement Models

• Questions?
• What are the maturities of your non-maturity deposits?
• There are none
• What is the market price for a checking or savings account?
• Where is the market where we can “purchase” a core account?
• How do we establish a discount rate with no market?

Measurement Models

• Questions?
• What are the maturities of your non-maturity deposits?
• There are none
• What is the market price for a checking or savings account?
• There isn’t one
• Where is the market where we can “purchase” a core account?
• How do we establish a discount rate with no market?

Measurement Models

• Questions?
• What are the maturities of your non-maturity deposits?
• There are none
• What is the market price for a checking or savings account?
• There isn’t one
• Where is the market where we can “purchase” a core account?
• There isn’t one
• How do we establish a discount rate with no market?

Measurement Models

• Questions?
• What are the maturities of your non-maturity deposits?
• There are none
• What is the market price for a checking or savings account?
• There is not one
• Where is the market where we can “purchase” a core account?
• There is not one
• How do we establish a discount rate with no market?
• We just make a guess

Measurement Models

• Earnings At Risk
• Holds the balance sheet static
• Establishes amortization rate for earning assets
• Establishes price elasticity of deposits
• Creates a repricing schedule for earnings assets and deposits
• Simulates earnings and resulting equity
• Designed to simulate actual performance and resulting

income and equity

• Requires:
• Amortization schedule
• Current rates and yields
• Projections of other income and operating expenses

Amortization and Repricing

Loans

Balance

• Amort. %

Amort/Mo Amort/Qtr Year 1 Year 2 Year 3 Year 4 Year 5 No Change NEW AUTO $448,624 3.57% $16,022 $48,067 $192,268 $192,268 $64,089 $0 $0 $0 USED AUTO $675,115 3.85% $25,966 $77,898 $311,592 $311,592 $51,932 $0 $0 $0 RV'S $209,437 1.92% $4,028 $12,083 $48,332 $48,332 $48,332 $48,332 $16,111 $0 WATERCRAFT $42,080 2.13% $895 $2,686 $10,744 $10,744 $10,744 $9,849 $0 $0 MOTORCYCLES $100,935 3.70% $3,738 $11,215 $44,860 $44,860 $11,215 $0 $0 $0 IHOME EQUITY $1,282,805 7.69% $98,677 $296,032 $1,184,127 $98,677 $0 $0 $0 $0 FIRST MORTGAGES $2,469,356 1.12% $27,746 $83,237 $332,947 $332,947 $332,947 $332,947 $332,947 $804,621 PERSONAL UNSECURED $291,338 4.35% $12,667 $38,001 $152,003 $139,336 $0 $0 $0 $0 SHARE SECURE $140,803 7.69% $10,831 $32,493 $129,972 $10,831 $0 $0 $0 $0 Total $5,660,493 $2,406,843 $1,189,585 $519,258 $391,127 $349,057 $804,621

Investments

Balance Year 1 Year 2 Year 3 Year 4 Year 5 No Change 1-12 Months $3,826,000 $3,826,000 $0 $0 $0 $0 $0 13-24 Months $2,702,000 $0 $2,702,000 $0 $0 $0 $0 25-36 Months $1,269,000 $0 $0 $1,269,000 $0 $0 $0 37-48 Months $1,538,000 $0 $0 $0 $1,538,000 $0 $0 49-60 Months $2,014,000 $0 $0 $0 $0 $2,014,000 $0 Total $12,429,000 $3,826,000 $2,702,000 $1,269,000 $1,538,000 $2,014,000 $1,080,000

Input Schedule

Sources of Funds Balance Maturity Shock % Reg Shares $14,171,540 3 Months 100.00% Share Draft $2,331,397 3 Months 0.00% Money Market $0 3 Months 100.00% Certificates $102,029 At Maturity 100.00% Other $1,498,324 3 Months 100.00% Total $18,103,290

Calculation of Yield Curves

Average Yield on Loans (see page 24) Base Yr. Year 1 Year 2 Year 3 Year 4 Year 5 5% Upshock 5.65% 7.78% 8.83% 9.29% 9.63% 9.94% 4% Upshock 5.65% 7.35% 8.19% 8.56% 8.84% 9.08% 3% Upshock 5.65% 6.93% 7.56% 7.83% 8.04% 8.23% 1% Upshock 5.65% 6.08% 6.29% 6.38% 6.45% 6.51%

• 1% Downshock

5.65% 5.23% 5.02% 4.93% 4.86% 4.79% Average Yield on Investments (see page 24) Base Yr. Year 1 Year 2 Year 3 Year 4 Year 5 5% Upshock 1.28% 2.82% 3.91% 4.42% 5.03% 5.84% 4% Upshock 1.28% 2.51% 3.38% 3.79% 4.28% 4.93% 3% Upshock 1.28% 2.20% 2.86% 3.16% 3.53% 4.02% 1% Upshock 1.28% 1.59% 1.80% 1.91% 2.03% 2.19%

• 1% Downshock

1.28% 0.97% 0.75% 0.65% 0.53% 0.37% Cost of Funds (see page 24) Base Yr. Year 1 Year 2 Year 3 Year 4 Year 5 5% Upshock 0.10% 4.44% 4.44% 4.44% 4.44% 4.44% 4% Upshock 0.10% 3.57% 3.57% 3.57% 3.57% 3.57% 3% Upshock 0.10% 2.71% 2.71% 2.71% 2.71% 2.71% 1% Upshock 0.10% 0.97% 0.97% 0.97% 0.97% 0.97%

• 1% Downshock

0.10% 0.03% 0.03% 0.03% 0.03% 0.03%

Simulation of Income Statement

Dollars Change Interest Income Loans $365,080 14.10% Interest Income Investments $230,762 45.11% Dividend Expense $450,680 2286.75% Net Margin $145,163

• 68.45%

Other Income $250,219 10.00% Operating Expense $631,842 2.00% Net Income

• $236,460
• 447.16%

Equity Valuation

5.00%

Calculation of Equity Valuation

5% Upshock 4% Upshock 3% Upshock 1% Upshock

• 1% Downshock

Base Year Equity $ 1,201,679 $ 1,201,679 $ 1,201,679 $ 1,201,679 $ 1,201,679 Year 1 Profit/Loss $ (446,414) $ (341,437) $ (236,460) $ (26,506) $ 53,642 Year 1 Equity $ 755,265 $ 860,242 $ 965,219 $ 1,175,173 $ 1,255,321 Year 2 Profit/Loss $ (258,684) $ (188,776) $ (118,868) $ 20,948 $ 17,900 Year 2 Equity $ 496,581 $ 671,466 $ 846,351 $ 1,196,121 $ 1,273,220 Year 3 Profit/Loss $ (115,305) $ (71,146) $ (26,987) $ 61,332 $ 6,785 Year 3 Equity $ 381,276 $ 600,320 $ 819,365 $ 1,257,453 $ 1,280,005 Year 4 Profit/Loss $ (6,529) $ 19,301 $ 45,130 $ 96,790 $ 5,585 Year 4 Equity $ 374,747 $ 619,621 $ 864,495 $ 1,354,243 $ 1,285,590 Year 5 Profit/Loss $ 123,616 $ 127,396 $ 131,175 $ 138,734 $ 3,428 Year 5 Equity $ 498,363 $ 747,017 $ 995,670 $ 1,492,977 $ 1,289,019 Cummulative Equity Change $ (703,316) $ (454,662) $ (206,009) $ 291,298 $ 87,340 Equity Ratio 5% Upshock 4% Upshock 3% Upshock 1% Upshock

• 1% Downshock

Base Year 6.23% 6.23% 6.23% 6.23% 6.23% Year 1 3.91% 4.46% 5.00% 6.09% 6.51% Year 2 2.57% 3.48% 4.39% 6.20% 6.60% Year 3 1.98% 3.11% 4.25% 6.52% 6.63% Year 4 1.94% 3.21% 4.48% 7.02% 6.66% Year 5 2.58% 3.87% 5.16% 7.74% 6.68%

Amortization and Repricing

Loans

Balance

• Amort. %

Amort/Mo Amort/Qtr Year 1 Year 2 Year 3 Year 4 Year 5 No Change NEW AUTO $448,624 3.57% $16,022 $48,067 $192,268 $192,268 $64,089 $0 $0 $0 USED AUTO $675,115 3.85% $25,966 $77,898 $311,592 $311,592 $51,932 $0 $0 $0 RV'S $209,437 1.92% $4,028 $12,083 $48,332 $48,332 $48,332 $48,332 $16,111 $0 WATERCRAFT $42,080 2.13% $895 $2,686 $10,744 $10,744 $10,744 $9,849 $0 $0 MOTORCYCLES $100,935 3.70% $3,738 $11,215 $44,860 $44,860 $11,215 $0 $0 $0 IHOME EQUITY $1,282,805 7.69% $98,677 $296,032 $1,184,127 $98,677 $0 $0 $0 $0 FIRST MORTGAGES $2,469,356 1.12% $27,746 $83,237 $332,947 $332,947 $332,947 $332,947 $332,947 $804,621 PERSONAL UNSECURED $291,338 4.35% $12,667 $38,001 $152,003 $139,336 $0 $0 $0 $0 SHARE SECURE $140,803 7.69% $10,831 $32,493 $129,972 $10,831 $0 $0 $0 $0 Total $5,660,493 $2,406,843 $1,189,585 $519,258 $391,127 $349,057 $804,621

Investments

Balance Year 1 Year 2 Year 3 Year 4 Year 5 No Change 1-12 Months $3,826,000 $3,826,000 $0 $0 $0 $0 $0 13-24 Months $2,702,000 $0 $2,702,000 $0 $0 $0 $0 25-36 Months $1,269,000 $0 $0 $1,269,000 $0 $0 $0 37-48 Months $1,538,000 $0 $0 $0 $1,538,000 $0 $0 49-60 Months $2,014,000 $0 $0 $0 $0 $2,014,000 $0 Total $12,429,000 $3,826,000 $2,702,000 $1,269,000 $1,538,000 $2,014,000 $1,080,000

Input Schedule

Sources of Funds Balance Maturity Shock % Reg Shares $14,171,540 3 Months 65.00% Share Draft $2,331,397 3 Months 0.00% Money Market $0 3 Months 80.00% Certificates $102,029 At Maturity 90.00% Other $1,498,324 3 Months 90.00% Total $18,103,290

Calculation of Yield Curves

Average Yield on Loans (see page 24) Base Yr. Year 1 Year 2 Year 3 Year 4 Year 5 5% Upshock 5.65% 7.78% 8.83% 9.29% 9.63% 9.94% 4% Upshock 5.65% 7.35% 8.19% 8.56% 8.84% 9.08% 3% Upshock 5.65% 6.93% 7.56% 7.83% 8.04% 8.23% 1% Upshock 5.65% 6.08% 6.29% 6.38% 6.45% 6.51%

• 1% Downshock

5.65% 5.23% 5.02% 4.93% 4.86% 4.79% Average Yield on Investments (see page 24) Base Yr. Year 1 Year 2 Year 3 Year 4 Year 5 5% Upshock 1.28% 2.82% 3.91% 4.42% 5.03% 5.84% 4% Upshock 1.28% 2.51% 3.38% 3.79% 4.28% 4.93% 3% Upshock 1.28% 2.20% 2.86% 3.16% 3.53% 4.02% 1% Upshock 1.28% 1.59% 1.80% 1.91% 2.03% 2.19%

• 1% Downshock

1.28% 0.97% 0.75% 0.65% 0.53% 0.37% Cost of Funds (see page 24) Base Yr. Year 1 Year 2 Year 3 Year 4 Year 5 5% Upshock 0.10% 3.03% 3.03% 3.03% 3.03% 3.03% 4% Upshock 0.10% 2.44% 2.44% 2.44% 2.44% 2.44% 3% Upshock 0.10% 1.86% 1.86% 1.86% 1.86% 1.86% 1% Upshock 0.10% 0.69% 0.69% 0.69% 0.69% 0.69%

• 1% Downshock

0.10% 0.03% 0.03% 0.03% 0.03% 0.03%

Simulation of Income Statement

Dollars Change Interest Income Loans $365,080 14.10% Interest Income Investments $230,762 45.11% Dividend Expense $201,472 966.97% Net Margin $394,370

• 14.28%

Other Income $250,219 10.00% Operating Expense $631,842 2.00% Net Income $12,748

• 81.28%

Equity Valuation 6.29%

Calculation of Equity Valuation

5% Upshock 4% Upshock 3% Upshock 1% Upshock

• 1% Downshock

Base Year Equity $ 1,201,679 $ 1,201,679 $ 1,201,679 $ 1,201,679 $ 1,201,679 Year 1 Profit/Loss $ (31,068) $ (9,160) $ 12,748 $ 56,563 $ 53,186 Year 1 Equity $ 1,170,611 $ 1,192,519 $ 1,214,427 $ 1,258,242 $ 1,254,866 Year 2 Profit/Loss $ (3,191) $ 15,619 $ 34,428 $ 72,047 $ 17,900 Year 2 Equity $ 1,167,420 $ 1,208,138 $ 1,248,855 $ 1,330,289 $ 1,272,765 Year 3 Profit/Loss $ 140,189 $ 133,249 $ 126,310 $ 112,430 $ 6,785 Year 3 Equity $ 1,307,609 $ 1,341,387 $ 1,375,164 $ 1,442,720 $ 1,279,550 Year 4 Profit/Loss $ 248,964 $ 223,695 $ 198,427 $ 147,889 $ 5,585 Year 4 Equity $ 1,556,574 $ 1,565,082 $ 1,573,591 $ 1,590,609 $ 1,285,135 Year 5 Profit/Loss $ 379,110 $ 331,791 $ 284,471 $ 189,833 $ 3,428 Year 5 Equity $ 1,935,683 $ 1,896,873 $ 1,858,063 $ 1,780,442 $ 1,288,564 Cummulative Equity Change $ 734,004 $ 695,194 $ 656,383 $ 578,762 $ 86,885 Equity Ratio 5% Upshock 4% Upshock 3% Upshock 1% Upshock

• 1% Downshock

Base Year 6.23% 6.23% 6.23% 6.23% 6.23% Year 1 6.07% 6.18% 6.29% 6.52% 6.50% Year 2 6.05% 6.26% 6.47% 6.89% 6.60% Year 3 6.78% 6.95% 7.13% 7.48% 6.63% Year 4 8.07% 8.11% 8.16% 8.24% 6.66% Year 5 10.03% 9.83% 9.63% 9.23% 6.68%

Regulatory Expectation

• Develop assumptions that are:
• Reasonable
• Defensible
• Consistently applied
• Monitor results and adjust balance sheet as indicated
• Model anticipated changes to measure IRR

Questions

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Contact

• Randy Thompson, Ph.D.

TCT, Inc. P.O. Box 2210 Eagle, ID 83616

• E-mail: rthompson@tctconsult.com
• Office: (208) 939-8366
• Website: www.tctconsult.com