CMS Case Study

sheet management strategies to address interest rate risk and earnings. For example, the duration of a funding extension strategy to reduce rising rate risk can be better developed with the results of a five year NII simulation versus a 1 year simulation. The Bank recognizes that a sustained environment of higher/lower rate levels will affect the underlying value of the Bank’s assets, liabilities, and off-balance sheet instruments since the present value of future cash flows (and the cash flows themselves) changes when interest rates change. In monitoring the long term structural and economic position of the balance sheet, ALCO will review the core funding utilization and Economic Value of Equity (EVE) measures on a quarterly basis. To varying degrees, these measures will help determine the extent to which long term funding sources support long term assets. By examining the relationship between long term assets and liabilities under alternative rate environments, ALCO is able to assess whether the interest rate sensitivity beyond five years helps mitigate or exacerbate the shorter term position as measured by income simulations. Additionally, these measures provide indication to how optionality affects that relationship. In this manner, ALCO is able to also determine the potential longer-term effects that optionality may have on the Bank’s earnings. Alternative strategies will be developed based upon a thorough understanding of both the short- and long-term income sensitivity of the Bank. In this regard, the Bank believes it is important to state in this policy that a) it is a portfolio lender/investor and not a trader, and b) it manages under the assumption that it is a going concern. Consequently, an undue focus on preserving and/or increasing the Bank’s "theoretical liquidation value" (i.e. Economic Value of Equity) may conflict with the Bank’s primary objective as a going concern which is the short-term and long-term stability and growth in earnings. Actions to protect "value" may result in 1) unnecessarily locking in unrealized losses; 2) foregoing opportunities to benefit from interest rate cycle reversals, and 3) reduced levels of net interest income. Balance Sheet Management Strategies With the understanding of the current state of the balance sheet attained through the interest rate risk management exercise, the ALCO is then charged with understanding options to improve the bank’s earnings and/or improve the risk profile of the balance sheet. This process includes:  monitoring available opportunities to undertake major corrective actions to redress structural mismatches (amongst the mix of assets and liabilities)  determining the appropriateness of fixed rate vs. adjustable rate lending and the formulation of policies to influence this activity.  developing parameters for the investment portfolio in the context of overall balance sheet management (liquidity, IRR, credit risk and earnings).

 establishing financial goals, including goals for return on assets and equity.

 overseeing the long-term strategic use of capital so as to maximize the return on equity within reasonable levels of risk.

Specific strategies for managing both the short-term (i.e. 1-year) and the longer-term components of interest rate risk are the focal point of the ALCO meeting agenda. At each meeting ALCO reviews the Bank's overall position and related sources of risk and develops a gameplan covering the period up to the next ALCO meeting. Since the nature of the Bank's risk position is not static, the appropriateness of particular plausible strategies will change as the balance sheet and current market conditions change. Notwithstanding, the general types of strategies, which will be considered depending on the structure of the Bank’s then current IRR position, will typically include cash market transactions, such as:

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Approved by Board of Directors 1/20/22