Interest Rate Risk R&C Bankers Conference Federal Reserve Bank of Boston October 16, 2013 Presenter: Ron Adams

1

Interest Rate Risk

• Where are we now • What happened in the past during

periods when rates rose sharply • What might happen looking ahead • What are some considerations in

planning for future rate changes

2

Interest Rate Risk

• Where are we now?

3

Interest Rate Environment

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

3/01

12/0

19/

026/

033/

0412

/04

9/05

6/06

3/07

12/0

79/

086/

093/

1012

/10

9/11

6/12

3/13

Treasury Yields

10Y

2Y

3M

3.34

6.00 5.22

6.53

1.00

5.25

0

1

2

3

4

5

6

7

8

9

10

Fed

Fund

s R

ate

Fed Funds Rate

Periods of Increasing Rates (>100bp) NBER Recession Indicator

4

Core Deposit Growth Robust

50%

55%

60%

65%

70%

75%

80%

$0

$500

$1,000

$1,500

$2,000

$2,500

Billi

ons

US Community Bank Core Deposits

US Core deposits US Core deposit ratio

50%

55%

60%

65%

70%

75%

$0

$20

$40

$60

$80

$100

$120

$140

Billi

ons

First District Community Bank Core Deposits

Core Deposits Core deposit ratio

5

Earnings Implications • Shrinking margins • Loss of loan sales

3.0%3.2%3.4%3.6%3.8%4.0%4.2%4.4%4.6%

0.00%0.20%0.40%0.60%0.80%1.00%1.20%1.40%1.60%

2007 2008 2009 2010 2011 2012 1H13

Net

inte

rest

mar

gin

US Community Bank Earnings

Core earnings Asset sales Net interest margin

3.0%3.2%3.4%3.6%3.8%4.0%4.2%4.4%4.6%

0.00%0.20%0.40%0.60%0.80%1.00%1.20%1.40%1.60%

2007 2008 2009 2010 2011 2012 1H13

Net

inte

rest

mar

gin

FD Community Bank Earnings

Core earnings Asset sales Net interest margin 6

Negative Trend in Gain on Loan Sales / Average Assets

0.00%0.05%0.10%0.15%0.20%0.25%0.30%0.35%0.40%

Annu

aliz

ed Q

uart

erly

Gai

n on

Loa

n Sa

les /

Ave

rage

As

sets

Gain on Loan Sales / Average Assets First District Community Bank Percentiles

75th Percentile Median 25th Percentile

7

Housing Rebounding?

01020304050607080

New

Pri

vate

ly-O

wne

d H

ousi

ng S

tart

s (T

hous

ands

, Sea

sona

lly A

djus

ted)

Massachusetts Housing Starts

0

1000

2000

3000

4000

5000

Pri

vate

ly-O

wne

d H

ousi

ng U

nits

A

utho

rize

d (M

onth

ly)

Massachusetts Building Permits

Single Family 2 - 4 Unit Family 5+ Unit Family

8

Modest Commercial Loan Growth

9

4.0%5.0%6.0%7.0%8.0%9.0%10.0%11.0%12.0%

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

Mill

ions

US Community Bank C&I Loans

C&I Loans C&I Loan Yields

4%

5%

6%

7%

8%

9%

10%

11%

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

Mill

ions

First District Community Bank

C&I Loans

C&I Loans C&I Yields

Extending portfolios for yield

20%25%30%35%40%45%50%55%60%

First District Community Banks Interest Rate Risk

Net over 3 year position -FD Net over 1 year position - FD

20%25%30%35%40%45%50%55%60%

US Community Banks Interest Rate Risk

Net 3 year position - US Net 1 year position - US

10

High Proportion of Mortgages in New England • First District community banks are more loaned up and have

more first mortgages

11

0%

20%

40%

60%

80%

100%

US First District

Community Bank Asset Composition

Total Loans Total Investments Other Assets

0%

10%

20%

30%

US First District

Community Bank Loan Portfolio as % of Total Assets

First Mortgages

CRE

C&I

Other RE

High proportion of 1st Mortgages mature >15 Years

12

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

50.00

% o

f 1-4

Fam

ily L

oans

(Med

ian

%)

1-4 Family Loans by Maturity/Repricing Date as a Percentage of 1-4 Family Loans First District and US

1-4 Family Loans < 1 Year - First District 1-4 Family Loans 1-5 Years - First District

1-4 Family Loans 5-15 Years - First District 1-4 Family Loans > 15 Years - First District

1-4 Family Loans < 1 Year - US 1-4 Family Loans 1-5 Years - US

1-4 Family Loans 5-15 Years - US 1-4 Family Loans > 15 Years - US

Mind the GAP-NE Community Bank GAPs are Longer than US

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0%

1%

2%

3%

4%

5%

6%

7%

Perc

enta

ge o

f Gro

up P

opul

atio

n

Maturity Gap (Months)

Distribution of Maturity Gaps FD & US - Q2 2013

US FD

Interest Rate Risk • Surveillance tool

• Economic Value of Equity

14

-10%

-9%

-8%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%2005 2006 2007 2008 2009 2010 2011 2012

US Community Banks <$10B ∆EVE/Tier1 for +200bps Shock

Capital Remains Solid

15

0%

5%

10%

15%

20%

25%

Perc

enta

ge o

f Gro

up P

opul

atio

n

Tier 1 RBC Ratio

Tier 1 RBC Ratio Distributions First District and US: 2Q 2013

FD US

Where are we now summary

• Influx of deposits with unknown duration and repricing expectations

• Opportunities to sell loans and investments may have peaked

• Loan growth tempered • Longer duration assets have resulted in higher

maturity gap that could negatively impact both earnings and capital

• Capital cushions are solid.

16

Interest Rate Risk

• What Happened in the Past? • Assess 2004-2006 period

17

3.34

6.00 5.22

6.53

1.00

5.25

0

1

2

3

4

5

6

7

8

9

10

Fed

Fund

s Rat

e

Fed Funds Rate

NBER Recession Indicator Periods of Increasing Rates (>100bp) Fed Funds Rate

Core Deposits Experience Was Mixed

Change in Core Deposits 1Q04-4Q06

18

1.55 0.78

3.10

7.75

12.79

20.16

13.57 12.40

6.98

5.43 4.26

2.71

1.16 1.94

1.16 1.55 0.39 0.78

0.00 0.39 0.39 0.78

0

5

10

15

20

25

Perc

ent o

f Ban

ks

Percent Change in Core Deposits

First District

3.58

1.41 2.65

5.08

8.27

11.29 12.28

11.57

8.80

7.12

5.37

3.87 2.79 2.71 2.30

1.70 1.30 1.18 0.95 0.58 0.55

4.66

0

5

10

15

20

25

Perc

ent o

f Ba

nks

Percent Change in Core Deposits

US

Transaction Costs & Earning Assets Yield Change Ratio

(2.0)

(1.0)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Q12004

Q22004

Q32004

Q42004

Q12005

Q22005

Q32005

Q42005

Q12006

Q22006

Q32006

Q42006

Ratio

of C

ost C

hang

e to

Ear

ning

Ass

ets Y

ield

Cha

nge

Quarterly Change Ratio – First District Community Banks

75% 50% 25%

19

Savings/MM Costs & Earning Assets Yield Change Ratio

(2.0)

(1.0)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Q12004

Q22004

Q32004

Q42004

Q12005

Q22005

Q32005

Q42005

Q12006

Q22006

Q32006

Q42006Ra

tio o

f Cos

t Cha

nge

to E

arni

ng A

sset

s Yie

ld C

hang

e

Quarterly Change Ratio – First District Community Banks

75% 50% 25%20

Time Deposits Under $100k Costs & Earning Assets Yield Change Ratio

(2.0)

(1.0)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Q12004

Q22004

Q32004

Q42004

Q12005

Q22005

Q32005

Q42005

Q12006

Q22006

Q32006

Q42006

Ratio

of C

ost C

hang

e to

Ear

ning

Ass

ets Y

ield

Cha

nge

Quarterly Change Ratio – First District Community Banks

75% 50% 25%

21

Interest Rate Risk

• Where Are We Going?

22

Interest Rate Yield Curves • We have experienced a parallel downward shift and steepening of the

yield curve • Most recently a steepening of the curve: 70-90bp increase In 5Y-30Y

maturities since YE2012

23

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

1M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 30Y

12/07

12/08

12/09

12/10

12/11

12/12

9/13

Possible Rate Scenarios

• Flattening: 2007 prior to start of crisis-short-term rates increased at a faster rate than long-term rates.

• Shock: 2008/2009 Rates move down aggressively coupled with quantitative easing and slowing economy.

• Steepening 2009/2010: Short-term rates remain low while long-term rates increased. • Parallel: 2011/2012. The long end came down as benefited by quantitative easing. • Current 2013: Rates remain at current levels? Possibly for a long time?

• What should you consider in managing IRR across the various scenarios

• Asset strategies • Liability strategies • Hedging/Matched Funding Strategies

24

Questions to Consider: Asset Strategies • Opportunity to reinvest cash flows:

• What will the impact of varying PPS have on your estimated cash flows? And opportunities to reinvest

• What is the cost benefit of various strategies? • selling long duration residential loan originations • increasing yields in the investment portfolio, while taking a

balanced approach CMOS or callable bonds • retaining versus selling investments

25

Questions to Consider: Deposit Retention • Will retirees look to maintain risk free deposits? • Will there be a movement to nondeposit products-driven

by market dynamics? • How will the deposit base associated with the new

branches you opened in the last 5 years respond to the change in rates versus legacy branches?

• When will mean reversion kick in to restore the traditional deposit mix with a shift out of low cost nonmaturity deposits back to time deposits? Traditional view 67 NMD/33 Time now 87/13 on average.

26

Questions to Consider: Deposit Sensitivity • estimating the stickiness of deposits (surge deposits); • estimating the impact of rate changes on deposits in terms of

shifts into other products (NMD to Time); • determining products that you can adjust the pricing on to

cause a shift into to reduce the full blown market rate affect (tiered money market accounts);

• and your expectations for the mean reversion from non maturity deposits to time deposits (overall shift from NMD to time).

27

Question to Consider: Hedging Strategies • Under what circumstances it benefit your bank to hedge

certain instruments?

• Interest Rate Swaps (inclusive of forward swaps) i.e. converting fixed rate payments to floating or the reverse i.e. convert variable rate to fixed TPS to fixed by entering into a pay float and received fix=expense is fixed over the duration of the hedge.

• Questions for ALCO-assessing earnings impact if cash flow

hedge is imperfect. From a cost benefit perspective you may find that a micro hedge is more appropriate than hedging a pool of loans.

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Decision Tree

• Act now or wait? What do you need to weather the current period and reduce longer term rate risk? Take a hit today to reposition the balance sheet? If no action is taken what capital resources do you have to cover overhead?

• Immunizing against IRR? At what point do you consider

term funding in a match funding scenario to lock in a margin or enter into a derivative contract?

• What steps can you take to reduce IRR in the long run?

Reduce asset duration over time? Increase liability duration over time?

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