BASIC ALM / INTEREST RATE RISK POLICY

RESPONSIBILITY:Management& the Board of Directors

ORIGINATION DATE: 2015LATEST REVISION:October 2015

I.STATEMENT OF NEED & DEFINITION

The Board of Directors (BOD) of Maine Solutions FCU hereafter referred to as the “Credit Union,”recognizes the difficulty in monitoring the Credit Union’s vulnerability to interest rate changes in the volatile financial services industry. The Board of Directors also understands that it cannot effectively manage new products, interest rate changes, and profitability without a sound ALM/IRRPolicy, procedures, and process in place. To the extent that the Credit Union is out of compliance with any of this Policy at the time it is approved, Management will proceed to bring about such compliance as expeditiously as possible.

II.PURPOSE

The ALM/IRRPolicy of the Credit Union sets forth the policy statements and guidelines to be followed by Management in the overall management of theinterest rate risk position.

III.ALM OBJECTIVES

The objectives of the ALM process are to ensure the following conditions over all phases of the interest rate cycle:

1.Safe and sound financial performance such that the integrity and reputation of the Credit Union are maintained;

2.Ensure that adequate liquidity and funding is available to meet unexpected cash needs;

3.Fair and equitable treatment of both savers and borrowers; and

4.Measure, monitor and control interest rate risk.

IV.ALCO RESPONSIBILITIES & FUNCTIONS

The BOD is responsible for the formulation of this ALM/IRR Policy, procedures, and guidelines. The Board is responsible for the interest rate risk of the Credit Union according to the 2010 Interest Rate Risk Advisory written by the Federal Financial Institutions Examination Council (FFIEC). The BOD delegates authority to management to conduct day-to-day ALM operations that are consistent with this policy. The BOD will provide the necessary governance and oversight. An Asset-Liability Management Committee (ALCO) will assist management and the BOD in the process of managing interest rate risk and assist the BOD in its oversight responsibility.

Members of this ALCO are as follows:

  1. CEO
  2. Treasurer

The specific functions of the ALCO are as follows:

A.Examine Impact of Current and Changing Interest Rates

Interest rate risk will be evaluated by focusing on the impact of changing interest rates on the Shocked Net Economic Value (NEV) ratio, % change from the current NEV, shocked % change in net interest income (NII), projected book value of net worth, and other financial performance ratios. The Board-approved interest rate risk tolerance guidelines for NEV and Income Simulation are in the next section.

B.Monitor Liquidity Position

The interaction of loans, investments, deposits, and changing interest rates affect the liquidity position. The behavior of embedded options throughout the balance sheet also affect the current and shocked liquidity profile so ALM analyses need to reflect the impact of such embedded options as prepayments, callable structures, and depositors’ ability to early withdrawal. As such, on-going ALM analyses will be a tool that is used by Management and the ALCO to monitor liquidity. Periodically, the Contingency Funding Stress Tests Report produced in CU/ALM-ware will be provided to the ALCO and BOD showing the Liquidity Coverage Ratio under various stressed conditions. Corrective action will be recommended by ALCO to the Board as needed. A separate Liquidity Management Policy, Investment Policy and Contingency Funding Plan have been approved. Investment management is an important part of interest rate risk and liquidity management.

C.Monitor Key Ratios & Statistics

In addition to the ratios and statistics related to interest rate risk and liquidity, the Historical Key Ratios Report produced in CU/ALM-warewill be reviewed to monitor trends inadditional financial aspects of operations. BOD has a responsibility to have financial literacy regarding the Credit Union. As such, Management will promote financial literacy with respect to the BOD. Management will assist new Board members with the learning process in the area of ALM and understanding ratios and risks.

D.Review & Monitor Competitive Position

Management and ALCO will review and monitor the rates charged and paid by competing institutions for loans,MMAs, member certificates, and other products. The objectivesof this review areto:

1.Compare the rates paid on MMAs and CDs to local competition;

2.Compare rates charged on loans to those charged in the local market, keeping risk-based pricing issues in mind, when applicable;

3.Ensure that interest rates paid and charged are fair and equitable to both savers and borrowers; and

4.Assist in the liquidity management process.

E. Review of Underlying Assumptions, Sensitivity Analyses & What-Ifs

At least annually ALCO will review the most important ALM-related assumptions for reasonableness. The primary assumptions are rate sensitivity factors, rate setting lags, and estimated prepayments on mortgage loans and passthrough securities. Since non-maturity deposits (NMDs) will be valued at par according to this BASIC ALM/IRR Policy, no average maturity assumptions on NMDs are applied. Because of changing market conditions and other factors that may affect modeling inputs and assumptions and in accordance with the Internal Controls within this Policy, Management has the authority to adjustinputs and assumptions commensurate with market conditions. Assumptions will be disclosed in the ALM reports provided to the ALCO and the BOD. Sensitivity analyses (what-ifs) may be produced to reflect the impact of different assumptions.

V.INTEREST RATE RISKGUIDELINESINTERNAL CONTROLS

The BODsettriggers and risk tolerance guidelines that provide management with operational latitude and yet specify the degree of interest rate risk that is acceptable to the BOD.

A.Net Economic Value (NEV) & Income Simulation

The primary guidelines for interest rate risk management are in terms of the Shocked Net Economic Value (NEV) and multi-year Income Simulation measurement methodologies. The Shocked NEV is the shocked market value of assets minus the shocked market value of liabilities divided by the shocked market value of assets. The triggers and risk toleranceguidelines in this Policy reflect the fact that the CU/ALM-ware Non-Maturity Deposit (NMD) Valuation Modelhas not beenactivated and the NMDs are valued conservatively at par. The assumptions modeled should also be consistent with the ALM Modeling Guidelinesthat follow.An Income Simulation analysis does not produce a forecast of future income. Rather, it is an estimate of the directional sensitivity of the Net Interest Income (NII), Net Income (NI) and ultimately statutory capital due to the repricing interaction of existing assets and liabilities over time in a hypothetical yield curve shift.

Management has elected to ignore the risk-reducing attributes of NMD accounts in the NEV analysis. These are share drafts, share accounts, and MMAs. The risk-reducing attributes include the fact that collectively share drafts and the share accounts tend to behave like longer-term, stable, low cost deposits whose rates lag the market. (The MMA is typically the least risk reducing of all of the NMD accounts but it still considered an NMD account since it does not have a stated maturity.) When NMDs are valued at par, a very conservative NEV ratio and % change in the NEV ratio will be produced and the interest rate risk according to NEV may actually be overstated. Bearing that in mind, some institutions believe that it is easier to simply value NMDs at par as reflected in this Policy.

In an attempt to be conservative in its IRR modelingthe Credit Union will useas internal controlsthe following minimum RSFs andmaximum lags:

ALM MODELING GUIDELINESfor INTERNAL CONTROLS in+300BPTest

NMD Categories / Minimum
Rate Sensitivity Factors (RSFs) / Maximum
Lag Term
Share Drafts-No Interest / 0.00 / N/A
Interest Bearing Drafts / 0.10 / 6 Months
Regular Shares & Clubs / 0.10 / 6 Months
IRA Shares / 0.40 / 2 Months
MMA Tier(s) / 0.70 / 2 Months

If an above-market offering rate is paid, this could be justification for temporarilymodeling a lowerRSF than the minimum and/or a longer lag than thosespecified above. Such deviations from the ALM Modeling Guidelines must be documented and disclosedto the ALCO and Boardwith an explanation.

An RSF of 0.0 (or a non-rate sensitive classification)on any NMD category reflects a commitment to maintain the current offering rate on the category regardless of changes in external interest rates. Full disclosure of such a commitment and assumption is important since that will favorably impact the income simulation results in a rising rate shock test.

The RSFs in the Table are minimums and may not be sufficiently high to reflect the portion of the +300BP shock test that may filter through to an increase in the NMD offering rate. Judgment must be applied when determining whether higher RSFs should be applied and ALCO discussions regarding these behavioral assumptions would be prudent. Using a higherRSF and/or shorter lag in modeling the +300BP Test than the minimum RSF and maximum lag shown would still be consistent with the Guidelinesbecause a higher RSF and/or a shorter lag are more conservative. The minimum RSFs and the maximum lags are notmandates to change offering rates in a particular manner as external rates rise. The Guidelines are for the purpose of modeling the hypothetical +300BP shock test. If the Credit Union is able to raise the rates less aggressively in an actual rising rate environment, that would be acceptable.

A lag in anticipated offering rate changes is intended to reflect management’s expected rate-setting behavior in relation to the shock test. The longer management expects to wait before changing offering rates in reaction to a shock test, the longer the lag term. The longer the lag in a rising rate shock test, the more favorable the impact on the income simulation results.

1.NEV Triggers, Risk ToleranceGuidelines & Shock Test

In an Immediate, Parallel +300BP Shock Test, the NEV results have the following:

  1. The minimum Shocked NEV Ratio guideline is 4%. Every effort should be made to prevent this ratio from falling below 4% on a sustained basis.

The triggerpoint for the Shocked NEV Ratio is4.5%.

and

b.Themaximum percentage decline guideline in the dollar amount of the Shocked NEV from the dollar amount of the Current NEV is 50%.

The triggerpoint for the percentage decline in the dollar amount of the Shocked NEV from the dollar amount of the Current NEV is 45%.

The triggers are thresholds that when reached management and the ALCO should increase their focus on the IRR since a risk tolerance guideline is being approached.

These interest rate risk tolerance triggers and guidelines are based on the CU/ALM-wareNon-Maturity Deposit Valuation Model notbeing activated andthe modeling assumptions used in the ALM analysis being consistent with the ALM Modeling Guidelines. The Credit Union’s interest rate risk according to the NEV is shown on the ALM Executive Summary(Lines E4c and E4d).

In addition to satisfying the NEV Guidelines, Guideline 2 below must be satisfied.

2.Income Simulation Trigger, Risk Tolerance Guideline & Shock Tests

In +/-300BP 12-Month Ramped Tests, the Net Interest Income (NII) volatility has a:

Maximum decline guideline of 20% in the shocked projected NII each year over the next five years from the base case projected NII which assumes rates are unchanged over the next 12 months.

Trigger pointdecline of 18% in the shocked projected NII each year over the next five years from the base case for the projected NII which assumes rates are unchanged over the next 12 months.

If this trigger point is reached, management and the ALCO should increase their focus on the IRR since the risk tolerance guideline is being approached.

The NCUA’s 2012 Interest Rate Risk Regulation indicates that the BOD and Management should determine the interest rate shock tests that will be performed. The 2010 FFIEC IRR Advisory indicated that shock tests applied when measuring IRR should be “severe but plausible.” Therefore, +/-300BP 12-month Ramp Tests are the tests that the Income Simulation guidelines are based upon. The greater the degree of interest rate risk in the balance sheet, the more important it is to evaluate a long simulation horizon such as 5 years. A 12-Month Ramp Test reflects one-twelfth of the shock test occurring each month over the next twelve months. As pointed out earlier, an Income Simulation analysis does not produce a forecast of future income as in a budgeting sense. Rather, it is an estimate of the directional sensitivity of the NII, NI and ultimately statutory capital due to the repricing interaction of existing assets and liabilities over time in a hypothetical yield curve shift.

The 5-year income simulation results appear on the ALM Executive Summary (Line B1 of Version 10) and the 5-Year Income Simulation Report(Line 11). In the event of a projected decline in the NII in the hypothetical shock test, the projected timeline for recovery in the NIIwill be reviewed and monitored. A significant and prolonged decline in the projected NII may be evidence of a more severe interest rate risk problem whereas a rapid recovery period may indicate the lack of significant risk. The hypothetical shocked projected NetWorth Ratio at Book Value on the ALM Executive Summary(Line B3) should be reviewed for safety and soundness.

There may be conflicts between the NEV results and the income simulation results. For example, the income simulation results may indicate that the NII would increase as external rates rise but the Shocked NEV ratio is below the minimum shocked NEV guideline. Possible causes of this could be a low current book value of net worth and/or the fact that the risk-reducing attributes of the NMD Accounts were ignored in the NEV analysis since the NEV Guidelines and Modeling Guidelines in this Policy assume that NMDs are being valued extremely conservatively at par. Valuing NMDs at par typically results in the Shocked NEV ratio in a rising rate shock test being materially lower and the % change in the NEV being materially larger than if the risk-reducing attributes of the NMD accounts were reflected in the ALM analysis.

The ALM Modeling Guidelines, internal controls, triggers and risk tolerance guidelines are subject to change at the discretion of the Boardas the historic rate environment, economic conditions, and regulatory environment change over time.

The NII is unaffected by operating expenses, fee income, loan losses, or assessments. Therefore, the % change in the NII following a shock test is a better measure of balance sheet interest rate risk than the % change in the NI. However, the effects of changing interest rates and changes in the portfolio yields on the NI will be monitored.

Although the Income Simulation guidelines reflect a +/-300BP 12-month Ramp Test, it is recognized that in a low rate environment a shock test of -300BPs or -200BPswould not produce meaningful results. In such environments, the Income Simulation results produced by a -100BPShock Test or a 0% shock testwill be reviewed until external rates rise to a level where more severe falling rate shock tests once again make sense. ALCO and/or BODwill periodically review the projected Shocked NII effects of other interest rate scenarios, such as +400BPs,for informational purposes.

C.Action Steps

The BOD recognizes that rising interest rates alone may cause a previously acceptable Shocked NEV Ratio to decline to a lower and perhaps unacceptable level in the shock test even if management has not taken on additional balance sheet risk. The 2012 IRR Regulation states “Management should utilize the results of the CU’s IRR measurement systems in making operational decisions such as changing balance sheet structure, funding, pricing strategies, and business planning.” The following are action stepsthat will be followed as circumstances warrant.

1.If an NEV or Income Simulation trigger is reached, management and ALCO will increase their focus on the IRR since a risk tolerance guideline is being approached;

2.If a risk tolerance guideline for NEV or Income Simulation is reached or exceeded the BOD will be notified at the next Board meeting;

3.In the event that action is necessary to prevent or correct an NEV and/or a projected NII problem, management and/or ALCO will formulate and presentstrategies to the BOD as soon as possible; and

4.What-If ALM analyses may be produced to assist in the development of strategies.

The appropriate strategy or combination of strategies will depend on a variety of factors including but not limited to:

1.The specific cause or causes of the interest rate risk problem;

2.The economic and interest rate environments at the time;

3.Financial performance;