CMS Case Study

a. b. c. d. e.

Coupon Issuer

Yield

Maturity, average life and duration Geographic characteristics, if available

f. Number and average balance outstanding, if available A periodic check of each mortgage-backed pool will be completed as to the actual performance versus projected performance, at a minimum on an annual basis. Collateralized Mortgage Obligation (CMOs) Analysis Prior to the purchase of more complex securities such as CMOs and structured notes, the Bank must document its understanding of the sensitivity of such securities to changes in interest rates. Accordingly, the Bank will test the effect of instantaneous rate shocks of 300BP up and down on the principal and interest cashflows of the subject security in an effort to assess the potential impact of interest rate caps/floors, call options, prepayment risk, tranche structures, etc. on the price and yield characteristics of the instrument. Other rate shock ranges may be performed as deemed appropriate. These tests will be performed on complex securities in a standard and verifiable manner (e.g. using industry standard calculators) prior to purchase in order to ensure a thorough understanding of the potential risks vis-à vis the desired characteristics. If the shape of the yield curve is a primary determinant of performance, expected security characteristics/performance should be evaluated accordingly (flattening and steepening yield curve). The Bank may rely on analyses provided by broker/dealers if they are prepared using industry standard calculators (e.g. Bloomberg), with sources of assumptions (e.g. prepayment rates) and related methodologies clearly understood by the Bank. It will be the policy to have the appropriate tests performed on complex securities after purchase no less than annually. In addition, the sensitivity characteristics of complex securities will be reflected in the Bank’s quarterly interest rate risk modeling procedures as carried out under the Asset/Liability and Funds Management Policy. A determination of the diversification of the underlying mortgages will be done prior to purchase. The following criteria will be reviewed: a) Coupon b) Issuer c) Yield d) Maturity, average life and duration e) Geographic characteristics f) Number and average balances outstanding To the extent that complex securities are purchased in conjunction with an overall ALCO strategy focused on minimizing the volatility of the Bank’s net interest income (interest rate risk), the above analysis must support the Bank’s ability to hold the security without compromising the net interest income (NII) sensitivity limits of ALCO. If the security is classified as Available for Sale (AFS), then in addition to supporting the ALCO NII limits, the potential price sensitivity of the instrument must be considered relative to the price volatility limits of Section 3 of this policy for the entire AFS portfolio. 11. Financial Derivatives Financial derivatives can be broadly defined as instruments whose performance or value is derived from the performance of underlying assets, interest or currency exchange rates, or other financial variables. They can be further delineated as either cash market or exchange traded contracts. Cash market derivatives include mortgage derivative securities (collateralized mortgage obligations) and other structured debt obligations as discussed in Section 10. Exchange-traded derivatives include over-the-counter transactions such as swaps, caps, floors, collars, options and futures.

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Board Approval 8/19/21