Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A– Quantitative and Qualitative Disclosures about Market Risk
Asset/Liability Management and Market Risk
Asset/Liability Management.
Our asset/liability management process consists of quantifying, analyzing and controlling interest rate risk to maintain reasonably stable net interest income levels under various interest rate environments. The principal objective of asset/liability management is to maximize net interest income while operating within acceptable limits established for interest rate risk and to maintain adequate levels of liquidity.
The majority of our assets and liabilities are monetary in nature. Consequently, one of our most significant forms of market risk is interest rate risk, which is inherent in our lending and deposit-taking activities. Our assets, consisting primarily of loans secured by real estate and fixed rate securities in our investment portfolio, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. The board of directors of First Guaranty Bank has established two committees, the management asset liability committee and the board investment committee, to oversee the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. The management asset liability committee is comprised of senior officers of the Bank and meets as needed to review our asset liability policies and interest rate risk position. The board ALCO investment committee is comprised of certain members of the board of directors of the Bank and meets monthly. The management asset liability committee provides a monthly report to the board ALCO investment committee.
The need for interest sensitivity gap management is most critical in times of rapid changes in overall interest rates. We generally seek to limit our exposure to interest rate fluctuations by maintaining a relatively balanced mix of rate sensitive assets and liabilities on a one-year time horizon and greater than one-year time horizon. Because of the significant impact on net interest margin from mismatches in repricing opportunities, we monitor the asset-liability mix periodically depending upon the management asset liability committee's assessment of current business conditions and the interest rate outlook. We maintain exposure to interest rate fluctuations within prudent levels using varying investment strategies. These strategies include, but are not limited to, frequent internal modeling of asset and liability values and behavior due to changes in interest rates. We monitor cash flow forecasts closely and evaluate the impact of both prepayments and extension risk.
-74-
The following interest sensitivity analysis is one measurement of interest rate risk. This analysis, which we prepare quarterly, reflects the contractual maturity characteristics of assets and liabilities over various time periods. This analysis does not factor in prepayments or interest rate floors on loans which may significantly change the report. This table includes nonaccrual loans in their respective maturity periods. The gap indicates whether more assets or liabilities are subject to repricing over a given time period. The interest sensitivity analysis at December 31, 2021 illustrated below reflects a liability-sensitive position with a negative cumulative gap on a one-year basis.
December 31, 2021
Interest Sensitivity Within
(dollars in thousands) 3 Months Or Less Over 3 Months
thru 12 Months Total One Year Over One Year Total
Earning Assets:
Loans (including loans held for sale) $ 608,701 $ 175,726 $ 784,427 $ 1,374,932 $ 2,159,359
Securities (including FHLB stock) 1,669 333 2,002 363,513 365,515
Federal Funds Sold 183 — 183 — 183
Other earning assets 249,294 — 249,294 — 249,294
Total earning assets $ 859,847 $ 176,059 $ 1,035,906 $ 1,738,445 $ 2,774,351
Source of Funds:
Interest-bearing accounts:
Demand deposits $ 1,275,544 $ — $ 1,275,544 $ — $ 1,275,544
Savings deposits 201,699 — 201,699 — 201,699
Time deposits 80,741 186,996 267,737 318,934 586,671
Short-term borrowings — — — 5,988 5,988
Senior long-term debt 25,170 — 25,170 3,208 28,378
Junior subordinated debt — — — 14,818 14,818
Noninterest-bearing, net — — — 661,253 661,253
Total source of funds $ 1,583,154 $ 186,996 $ 1,770,150 $ 1,004,201 $ 2,774,351
Period gap $ (723,307) $ (10,937) $ (734,244) $ 734,244
Cumulative gap $ (723,307) $ (734,244) $ (734,244) $ —
Cumulative gap as a percent of earning assets (26.1) % (26.5) % (26.5) %
-75-
Net Interest Income at Risk.
Net interest income at risk measures the risk of a decline in earnings due to changes in interest rates. The first table below presents an analysis of our interest rate risk as measured by the estimated changes in net interest income resulting from an instantaneous and sustained parallel shift in the yield curve over a 12-month horizon at December 31, 2021. The second table below presents an analysis of our interest rate risk as measured by the estimated changes in net interest income resulting from a gradual shift in the yield curve over a 12-month period. Shifts are measured in 100 basis point increments (+400 through -25 basis points) from base case. We do not present shifts less than 25 basis points because of the current low interest rate environment. The base case scenario encompasses key assumptions for asset/liability mix, loan and deposit growth, pricing, prepayment speeds, deposit decay rates, securities portfolio cash flows and reinvestment strategy and the market value of certain assets under the various interest rate scenarios. The base case scenario assumes that the current interest rate environment is held constant throughout the forecast period for a static balance sheet and the instantaneous and gradual shocks are performed against that yield curve.
December 31, 2021
Instantaneous Changes in Interest Rates (basis points) Percent Change in Net Interest Income
+400 5.68%
+300 4.83%
+200 3.96%
+100 2.57%
Base 0%
-25 (1.17)%
Gradual Changes in Interest Rates (basis points) Percent Change in Net Interest Income
+400 0.94%
+300 1.03%
+200 0.9%
+100 0.63%
Base 0%
-25 (0.10)%
These scenarios above are both instantaneous and gradual shocks that assume balance sheet management will mirror the base case. Even if interest rates change in the designated amounts, there can be no assurance that our assets and liabilities would perform as anticipated. Additionally, a change in the U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the U.S. Treasury yield curve would cause significantly different changes to net interest income than indicated above. Strategic management of our balance sheet would be adjusted to accommodate these movements. As with any method of measuring interest rate risk, certain shortcomings are inherent in the methods of analysis presented above. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Also, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. We consider all of these factors in monitoring exposure to interest rate risk.
First Guaranty continues to pursue its strategy to increase loans as a percentage of average assets compared to securities. First Guaranty has also been collateralizing more of its public funds deposits with either FHLB letters of credit or with reciprocal deposit insurance programs. This facilitates the investment of our deposits in higher yielding loans rather than lower yielding securities that generally have higher interest rate risk. This strategy is designed to reduce interest rate risk and improve net interest income. New loans that are originated generally are either floating rate or were fixed rate with maturities that did not exceed five years. Loans as a percentage of average interest- earning assets increased to 77.3% in 2021 compared to 74.7% in 2020. Securities as a percentage of average interest-earning assets decreased from 17.1% in 2020 to 12.8% in 2021.
-76-