CMS Case Study

In both the NII and EVE simulations, the bank might suspend or modify the performance of certain rate scenarios if economic conditions make such scenarios mathematically improbable. In such cases, the rational for the change will be discussed and ratified by the ALCO, and reported to the Board for approval. Refer to Appendix E for a current statement of interest rate risk limits. “Other” Rate Scenarios / Stress Testing of Assumptions Prevailing market conditions may warrant running additional scenarios so the ALCO and the board can better visualize and articulate its interest rate risk position. For instance, sustained low rate environments are often accompanied by steep yield curves which subsequently flatten in the ensuing rising rate environment. When this type of environment exists, the bank might elect to perform a rising rate scenario with a flattening of the yield curve to better assess potential interest rate risk (in this case, capturing yield curve risk). Similarly, when the yield curve is inordinately flat, a steepening yield curve scenario(s) may be modeled. If interest rates fall far below a statistical norm, the bank may elect to examine more extreme (e.g. + 400bp or more) rate movements. Heightened inflation fears may justify periodically examining more rapid rate movements than a 12 month ramp. These are just a sampling of examples that can lead to “situational” rate scenarios whose probabilities of occurrence can vary greatly over time and, therefore, are better suited to ALCO discretion vs. promulgated by policy. Additionally, we periodically may perform stress tests of critical model assumptions so the impact of the assumptions is firmly understood by the ALCO. While the exercises outlined above are critical in understanding the risk profile of the balance sheet, the utility of these more specialized simulations will diminish over time as market conditions change (e.g. makes little sense to perform a flattening yield curve analysis when the yield curve is flat). Accordingly, specific policy limits will not be placed on these scenarios. Measuring and Managing Short-Term Earnings-at-Risk NII simulation will be the bank’s primary tool for benchmarking near term earnings exposure. Given the ALCO’s objective to understand the potential risk/volatility embedded within the current mix of assets and liabilities, standard rate scenario simulations will assume total assets remain static (i.e. no growth). The Bank may also use a standard gap report in its interest rate risk management process. The primary use for the gap report will be to provide supporting detailed information to ALCO's discussion. The Bank has particular concerns with the utility of the gap report as a risk management tool because of difficulties in relating gap directly to changes in net interest income. Hence, the income simulation will be the key indicator for earnings-at-risk since it expressly measures what the gap report attempts to estimate. Short term interest rate risk management tactics will be decided by the Committee where risk exposures exist out to the 1 year horizon. Tactics will be formulated and presented to the Committee for discussion, modification and/or approval. Such tactics may include asset and liability acquisitions of appropriate maturities in the cash market, loan and deposit product / pricing strategy modification, and derivatives hedging activities to the extent such activity is authorized by the Board of Directors. Since the impact of rate changes due to mismatched balance sheet positions in the one year horizon can quickly and materially effect the current year's income statement, they require constant monitoring and management. Measuring and Managing the Long-Term Interest Rate Risk and Economic Positions Additionally, the need exists for a more general management of the longer-term maturity/repricing sectors of the balance sheet. Hence it is the Committee's responsibility to identify potential long term exposures to sustained higher/lower rate environments. One tool for accomplishing this task will be to perform longer range NII simulations of 5 years. This exercise will help the bank better visualize the impact of interest rate risk on NII in various rate cycles and will capture points when the balance sheet responds (favorably or otherwise) to a given rate environment. This will also help the bank develop better balance

8

Approved by Board of Directors 1/20/22