CHFC 2018 Annual Report

Net interest income (FTE) of $641.8 million in 2018 was $71.1 million, or 12.5%, higher than net interest income (FTE) of $570.7 million in 2017, primarily attributable to increases in average balances and yields earned on loans and investment securities, partially offset by an increase in our average balances of deposits and cost of funds. The net interest margin (FTE) increased to 3.53% in 2018, compared to 3.48% in 2017. The average yield on interest-earning assets increased 39 basis points to 4.32% in 2018 from 3.93% in 2017, with the increase primarily attributable to the benefit received from the increases in volume and yields earned on loans and taxable investment securities. The average yield on loans increased 41 basis points to 4.65% in 2018 from 4.24% in 2017. Interest accretion from purchase accounting discounts on acquired loans contributed 25 basis points to the net interest margin (FTE) in 2018, compared to 20 basis points in 2017. The increase in our investment securities portfolio was primarily due to management's long-term plan to increase investment securities as a percent of total assets. The average cost of interest-bearing liabilities increased 46 basis points to 1.07% in 2018 from 0.61% in 2017, primarily due to an increase in funding costs resulting from a rising interest rate environment combined with an increase in average balances of deposits and short-term borrowings. Net interest income (FTE) of $570.7 million in 2017 was $179.9 million, or 46.1%, higher than net interest income (FTE) of $390.7 million in 2016. The increase in net interest income (FTE) in 2017, compared to 2016, was primarily attributable to originated loan growth, and increases in the investment securities portfolio and interest accretion from purchase accounting discounts on acquired loans. The net interest margin (FTE) was 3.48% in 2017, compared to 3.60% in 2016. The average yield on interest-earning assets increased six basis points to 3.93% in 2017 from 3.87% in 2016, with the increase primarily attributable to increases and improvement in yield earned in our investment securities portfolio. Interest accretion from purchase accounting discounts on acquired loans contributed 20 basis points to the net interest margin (FTE) in 2017, compared to nine basis points in 2016, with the increase primarily due to the addition of the loans from our merger with Talmer in August of 2016. The average yield on loans increased nine basis points to 4.24% in 2017 from 4.15% in 2016, primarily due to the increased benefit from interest accretion from purchase accounting discounts on acquired loans. The average cost of interest-bearing liabilities increased 24 basis points to 0.61% in 2017 from 0.37% in 2016, primarily due to an increase in short-term borrowings and deposit rates, both resulting from a rise in market rates. Changes in our net interest income are influenced by a variety of factors, including changes in the level and mix of interest-earning assets and interest-bearing liabilities, current and prior years' interest rate changes, the level and direction of interest rates, the difference between short-term and long-term interest rates (the steepness of the yield curve) and the general strength of the economies in our markets. Risk management plays an important role in our level of net interest income. The ineffective management of credit risk, and more significantly interest rate risk, can adversely impact our net interest income. Management monitors our Consolidated Statement of Financial Position to seek to reduce the potential adverse impact on net interest income caused by significant changes in interest rates. Our policies in this regard are further discussed under the subheading "Market Risk" in Item 7A of this Annual Report. The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, increased to 5.50% in December 2018, from the previous rates of 5.25% in September 2018, 5.00% in June 2018, 4.75% in January 2018, 4.50% in December 2017, 4.25% in June 2017, 4.00% in March 2017 and 3.50% in December 2016. The prime interest rate has historically been 300 basis points higher than the federal funds rate. The majority of our variable interest rate loans in our commercial loan portfolio are tied to the prime rate. We are primarily funded by core deposits, which are a lower-cost funding base than wholesale funding and historically has had a positive impact on our net interest income and net interest margin. 72