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Company’s primary market risk exposure is interest rate
risk and, to a lesser extent, liquidity risk. Interest
rate risk is the exposure of a banking organization’s
financial condition to adverse movements in interest rates.
The Company seeks to achieve consistent growth in net
interest income and net income while managing volatility
that arises from shifts in interest rates. The Company’s
Asset and Liability Management Committee (“ALCO”) oversees
interest rate risk programs instituted by management and
measurements of interest rate risk to determine that they
are within authorized limits set by the Company’s Board
of Directors.
Evaluating a financial institution’s
exposure to changes in interest rates includes assessing
both the adequacy of the management process used to
control interest rate risk and the organization’s quantitative
level of exposure. When assessing the interest rate
risk management process, the Company seeks to ensure
that appropriate policies, procedures, management information
systems and internal controls are in place to maintain
interest rate risk at prudent levels with consistency
and continuity. Evaluating the quantitative level of
interest rate risk exposure requires the Company to
assess the existing and potential future effects of
changes in interest rates on its consolidated financial
condition, including capital adequacy, earnings, liquidity,
and where appropriate, asset quality.
Proper interest rate risk
evaluation must include active board of director and
senior management oversight and comprehensive risk-management
process that effectively identifies, measures, and
controls interest rate risk. Several techniques might
be used by an institution to minimize interest rate
risk. Such activities fall under the broad definition
of asset/liability management.
One approach used by the Company
is to periodically analyze the matching of assets
and liabilities by examining the extent to which such
assets and liabilities are "interest rate sensitive"
and by monitoring an institution's interest rate sensitivity
"gap".
An asset or liability is said
to be interest rate sensitive within a specific time
period if it will mature or reprice within that time
period. The interest rate sensitivity gap defined
as the difference between the amount of interest earning
assets maturing or repricing within a specific time
period and the amount of interest bearing liabilities
maturing or repricing within that same time period.
A gap is considered
positive when the amount of interest rate sensitive
assets exceeds the amount of interest rate sensitive
liabilities. A gap is considered negative when the
amount of interest rate sensitive liabilities exceeds
the amount of interest rate sensitive assets. During
a period of rising interest rates, a negative gap
would tend to adversely affect net interest income
while a positive gap would tend to result in an increase
in net interest income. The Company's gap
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position
is illustrated in Table 10, “Maturity or Repricing of
Assets and Liabilities”.
Rate sensitivity varies with
different types of interest earning assets and interest
bearing liabilities. Rate sensitivity on loans tied to
the prime rate differs considerably from long-term investment
securities and fixed rate loans. Time deposits are usually
more rate sensitive than savings accounts. Management
has portrayed savings accounts and NOW accounts as immediately
repricable in Table 10, because of management's ability
to change the savings and NOW account interest rate even
though market conditions may allow these rates to remain
stable.
Table 11, “Time Deposits,
$100,000 and Over Maturity Schedule”, allows one to calculate
that at December 31, 2005, 26.8% of the time deposits
$100,000 and over mature after one year, differing from
4.7% at December 31, 2004. This shows a lengthening of
maturities in this type of deposit as the Company has
tried to lower its negative gap position in 2005.
The Company historically
has had high levels of time deposits over $100,000. As
of December 31, 2005, time deposits over $100,000 were
29.9% of total interest bearing liabilities compared to
30.1% in 2004. Table 11 shows at year-end 2005 that there
were $52,882,000 or 30.5% of the time deposits over $100,000
from public depositors. Being located in the county seat,
the Company accepts time deposits over $100,000 from various
local governmental units.
At December 31, 2005, approximately
47% of the Company's loan and lease portfolio float with
the prime rate or are repricable within 90 days, a decrease
from 52% at December 31, 2004. This decrease is from pressure
by borrowers requesting fixed rate loans as the prime
rate increased 200 basis points in 2005. If interest rates
continue to increase in 2006, borrowers will continue
to pressure lenders to make them fixed rate loans so that
their loan rate will not rise with perceived future rate
increases. These developments, along with competition,
may cause the percentage of fixed rate loans to increase
in 2006.
Securities issued by U.S.
government-sponsored entities that reprice within 365
days amount to $54,725,000 according to Table 10. It should
be noted that in Table 10, the repricing of these securities
is based on the maturity date of the investments. At December
31, 2005, $187.3 million or 75% of the Company’s U.S.
government-sponsored entity securities have call options
that allow the issuer to call or payoff the security prior
to maturity. It is expected that interest rates will increase
in 2006 and consequently it is expected that few of these
securities will be called. However if interest rates should
decline the possibility that these securities will be
called increases.
As Table 10 shows, at December
31, 2005, the Company had a negative gap in the immediate
to 90 days time horizon of $129,699,000, with the cumulative
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