Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item
7A. Quantitative and Qualitative Disclosures about Market Risk.
Asset liability management involves developing,
executing and monitoring strategies to maintain appropriate liquidity, maximize net interest income and minimize the impact that significant
fluctuations in market interest rates would have on current and future earnings. The business of the Company and the composition of its
balance sheet consist of investments in interest-earning assets (primarily loans, mortgage-backed securities, and securities available-for-sale)
which are primarily funded by interest-bearing liabilities (deposits and borrowings). With the exception of specific loans which are originated
and held for sale, all of the financial instruments of the Company are for other than trading purposes. All of the Company’s transactions
are denominated in U.S. dollars with no specific foreign exchange exposure. In addition, the Company has limited exposure to commodity
prices related to agricultural loans. The impact of changes in foreign exchange rates and commodity prices on interest rates are assumed
to be insignificant. The Company’s financial instruments have varying levels of sensitivity to changes in market interest rates
resulting in market risk. Interest rate risk is the Company’s primary market risk exposure; to a lesser extent, liquidity risk also
impacts market risk exposure.
Interest rate risk is the exposure of a banking
institution’s financial condition and results to adverse movements in interest rates. Accepting this risk can be an important source
of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to the Company’s
earnings and capital base. Accordingly, effective risk management that maintains interest rate risks at prudent levels is essential to
the Company’s safety and soundness.
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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 risks
at prudent levels of 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 asset quality (when appropriate).
The FRB together with the OCC and the FDIC adopted
a Joint Agency Policy Statement on interest rate risk effective June 26, 1996. The policy statement provides guidance to examiners and
bankers on sound practices for managing interest rate risk, which will form the basis for ongoing evaluation of the adequacy of interest
rate risk management at supervised institutions. The policy statement also outlines fundamental elements of sound management that have
been identified in prior Federal Reserve guidance and discusses the importance of these elements in the context of managing interest rate
risk. Specifically, the guidance emphasizes the need for active board of director and senior management oversight and a comprehensive
risk management process that effectively identifies, measures and controls interest rate risk.
Financial institutions derive their income primarily
from the excess of interest collected over interest paid. The rates of interest an institution earns on its assets and owes on its liabilities
generally are established contractually for a period of time. Since market interest rates change over time, an institution is exposed
to lower profit margins (or losses) if it cannot adapt to interest rate changes. For example, assume that an institution’s assets
carry intermediate or long-term fixed rates and that those assets are funded with short-term liabilities. If market interest rates rise
by the time the short-term liabilities must be refinanced, the increase in the institution’s interest expense on its liabilities
may not be sufficiently offset if assets continue to earn at the long-term fixed rates. Accordingly, an institution’s profits could
decrease on existing assets because the institution will either have lower net interest income or possibly, net interest expense. Similar
risks exist when assets are subject to contractual interest rate ceilings, or rate-sensitive assets are funded by longer-term, fixed-rate
liabilities in a declining rate environment.
There are several ways an institution can manage
interest rate risk including: 1) matching repricing periods for new assets and liabilities, for example, by shortening or lengthening
terms of new loans, investments, or liabilities; 2) selling existing assets or repaying certain liabilities; and 3) hedging existing assets,
liabilities, or anticipated transactions. An institution might also invest in more complex financial instruments intended to hedge or
otherwise change interest rate risk. Interest rate swaps, futures contracts, options on futures contracts, and other such derivative financial
instruments can be used for this purpose. Because these instruments are sensitive to interest rate changes, they require management’s
expertise to be effective. The Company has not purchased derivative financial instruments in the past, but during 2023 and 2022 the Company
entered into interest rate swap agreements as an accommodation to certain loan customers (see Note 8 to the Consolidated Financial Statements).
The Company may purchase such instruments in the future if market conditions are favorable.
The Company manages its interest rate risk by
the employment of strategies to assure that desired levels of both interest-earning assets and interest-bearing liabilities mature or
reprice with similar time frames. Such strategies include: 1) loans receivable which are renewed (and repriced) annually, 2) variable
rate loans, 3) certificates of deposit with terms from one month to six years, 4) securities available-for-sale which mature at various
times primarily from one through ten years, 5) federal funds borrowings with terms of one day to 90 days, and 6) FHLB borrowings with
terms of one day to ten years.
Management believes the most significant impact
on financial results is the Company’s ability to react to changes in interest rates. Management seeks to maintain an essentially
balanced position between interest sensitive assets and liabilities and actively manages loan, security, and liability maturities in order
to protect against the effects of wide interest rate fluctuations on net income and shareholders’ equity.
For additional quantitative and qualitative information
regarding the Company’s interest rate risk, refer to the section captioned “Liquidity” under Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K, which is incorporated herein by reference.
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