CMS Case Study

Current Position Assessment - 12/31/2021

Balance Sheet: The balance sheet grew by $68 million, to $964 million, as non-maturity deposit inflows and FHLB borrowings funded investment and loan demand. Investment purchases were primarily MBS and to a lesser extent treasuries, DUS bonds and municipal bonds. Loans increased by $30MM driven by growth in CRE and C&I. Additionally, shifts in asset and funding mix occurred as cash and PPP loan cash flow supported investment and lending activity while non-maturity deposits and FHLB advances replaced slight CD runoff. The aggregate asset yield was unchanged at 2.65% as the increase in higher yielding core loan balances and extension of cash was offset by a larger percentage increase in lower yielding investments and loan originations at yields below existing portfolio averages. The cost of funds declined by 1bps to 0.24% due to the addition of lower costing FHLB borrowings and the rollover of time deposits into lower current rates. Accordingly, the balance sheet spread was unchanged at 2.41%. Liquidity: Despite higher levels of investments, the Tier 1 Basic Surplus measure declined by $33 million to $171 million or 17.8% of assets, as an increase in public deposits requiring collateral reduced the total amount of unencumbered collateral. An increase in outstanding FHLB advances combined with no change in levels of loan collateral pledged resulted in security collateral encumbering a portion of borrowings further reducing available bond collateral. Due to outstanding FHLB advances and letters of credit measuring greater than loan collateral pledged there is currently no additional loan-based borrowing capacity. The result is a net decrease of $45 million to the Tier 2 Basic Surplus position, to $171 million or 17.8% of assets. An additional $145 million in funding is available through the brokered deposit market bringing the Tier 3 Basic Surplus position to $316 million or 32.8% of assets. Interest Rate Risk: Balance sheet growth while maintaining spread resulted in a higher starting level of projected net interest income (NII) when compared to the September analysis. As the simulation progresses the benefit to comparative NII improves driven by higher cash flow replacement rates for investment and residential loans (due in part to the continued bond market sell-off over the quarter). The interest-rate-risk profile depicts modest near-term exposure to rising rates due to asset extension over the quarter (cash to fund MBS/treasury purchases and loan growth) coupled with inflows rate sensitive funding MMDA/public deposits and callable borrowings (assumed to be called and rolled into short term FHLB in rising rate scenarios). Note the relative exposure to falling rates increased due to a back-up the intermediate part of the yield curve (2-5 years) which results in asset cash flow tied to that part of the yield curve having more room to price downward versus last quarter. While NII exposure remains within policy for ramped rate movements, policy exceptions occur for the NII Down 100bps shock scenarios in year 1 and 2 (sensitivity metric is change vs. Year 1 Base NII) and EVE Shock Up 200, 300 and 400bps scenarios. The observed pressure for the Shock Up 200, 300bp and 400bp EVE calculation is driven by asset extension over the quarter (reduction in cash and increase in longer duration securities and loans, exacerbated by higher long-term rates which further lower assumed prepay activity in rising rates). If functional cost assumption were removed from deposits the observed policy violations would be alleviated (see Remove Functional Costs on Deposits EVE simulation).

Current Rates: NII is projected to trend sideways over the life of the simulation as asset cash flow that is replaced/repriced at lower than portfolio rates is offset by slight term funding cost relief.

Rising Rates: NII is projected to trend modestly below the Current Rates scenario during a rising rate environment as funding cost increases outpace floating rate assets adjusting higher and asset cash flow replacing at elevated rates. Once market rates stabilize at higher levels, asset yields continue to improve as cashflows are replaced while funding cost increases continue to lag, driving an upward trend to NII as margins recover. If the yield curve were to flatten as rates rise, often occurring during periods of tighter Fed policy, the projected earnings benefit is mitigated vs. a parallel market rate shift as asset cash flow replacement yields, which are tied to longer-term market rates, reprice upward to a lesser degree (see Flat Up 200BP scenario).

Falling Rates: NII is projected to fall below the Current Rates environment for the 5-year life of the simulation as funding cost relief becomes exhausted and investment and loans reprice/replace into lower yields in turn compressing margin.

Capital: As of 12/31/2021, the Leverage, Common Equity Tier 1, and Total Risk Based Capital ratios of 9.39%, 16.43% and 17.68% respectively, remain well above both internal policy guidelines and regulatory minimums for “well capitalized” institutions . Note: $7MM of capital was downstream from the holding company over the quarter and contributes to higher ratios throughout.

Cloyd Bank & Trust - Page 4