CMS Case Study

Option Risk Stress Methodology: Investment and Loan Portfolio - 03/31/2021

Option Risk Stress Methodology: Investment and Loan Portfolio

Basis/Rationale: Challenges to maintain the loan portfolio’s current volume and/or generate growth are placing additional pressure on loan pricing in many regions and elevating option risk. In the investment portfolio, accelerated cashflows compound earnings pressure given the lack of opportunities to replace attractive yields. There is potential for additional acceleration in prepayment or refinancing activity, incremental to that currently projected by prepayment models, if rates remain at current levels or undergo further declines. Conversely, in a higher rate environment there is potential for prepayment speeds to slow more than traditionally projected by prepayment models. DCG currently utilizes Yield Book to project investment cashflows and Black Knight Financial Services (BKFS) prepayment model prepayment speeds for Residential, Home Equity, and Auto loan portfolios. To the extent the institution provides specific prepayment assumptions for Commercial loans (C&I, CRE, Ag, Ag RE) these speeds are incorporated into the model, otherwise DCG utilizes 10 CPR in the flat rate environment, 12.5 CPR in the Down 100BP scenario, and 5 CPR in all rising rate scenarios. All model prepayment speeds are detailed in the Summary of Simulation Assumptions document on the page titled Asset/Liability prepayment speeds.

The following stress tests were designed to capture the dynamic of more extreme optionality in the investment and loan portfolios:

Detail:

Expected Results

Stress Test Scenario - Assumptions

 Increased cash flow in the current and falling rate scenarios.  Shorten the investment and loan portfolio average life  Potential for accelerated margin compression.  Accelerated investment premium amortization

1) In the current and falling rate scenarios, investment/loan prepayment speeds are assumed to increase relative to the model assumptions. a. Yield Book prepayment model projections are increased by 100% (MBS and CMO) b. BKFS prepayment model projections are increased by 100% (Res, HE, Auto). c. Non-BKFS prepayment model projections are increased

by 100% in the current rate scenario (20 CPR) and an additional 100% in the falling rate scenarios (40 CPR) (e.g. Commercial).

 Reduced loan cash flow in the rising rate scenarios  Lengthen the investment and loan portfolio average life  Potential for additional liability sensitivity or less asset sensitivity  Slowdown of investment premium amortization

2) In the rising rate scenarios, investment/loan prepayment speeds are assumed to slow relative to the model assumptions. a. Yield Book prepayment model projections are reduced by 50% (MBS and CMO) b. BKFS prepayment model projections are reduced by 50% (Res, HE, Auto). c. Non-BKFS prepayment speeds are slowed to 0 CPR.

Cloyd Bank & Trust - Page 43