ServisFirst Bancshares, Inc. 10-K

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.   Like all financial institutions, we are subject to market risk from changes in interest rates. Interest rate risk is inherent in the balance sheet due to the mismatch between the maturities of rate-sensitive assets and rate-sensitive liabilities. If rates are rising, and the level of rate-sensitive assets exceed the level of rate-sensitive liabilities, the impact on the net interest margin will be favorable. Conversely, if rates are falling, and the level of rate-sensitive assets is less than the level of rate-sensitive liabilities, the impact on the net interest margin will be unfavorable. Managing interest rate risk is further complicated by the fact that all rates do not change at the same pace; in other words, short term rates may be rising while longer term rates remain stable. In addition, different types of rate-sensitive assets and rate-sensitive liabilities react differently to changes in rates.   59     To manage interest rate risk, we must take a position on the expected future trend of interest rates. Rates may rise, fall, or remain the same. Our asset liability committee develops its view of future rate trends and strives to manage rate risk within a targeted range by monitoring economic indicators, examining the views of economists and other experts, and understanding the current status of our balance sheet. Our annual budget reflects the anticipated rate environment for the next twelve months. The asset liability committee conducts a quarterly analysis of the rate sensitivity position and reports its results to our board of directors.   The asset liability committee employs multiple modeling scenarios to analyze the maturities of rate-sensitive assets and liabilities. The interest rate risk model measures the “gap” which is defined as the difference between the dollar amount of rate-sensitive assets repricing during a period and the volume of rate-sensitive liabilities repricing during the same period. The gap is also expressed as the ratio of rate-sensitive assets divided by rate-sensitive liabilities. If the ratio is greater than “one,” the dollar value of assets exceeds the dollar value of liabilities; the balance sheet is “asset sensitive.” Conversely, if the value of liabilities exceeds the value of assets, the ratio is less than one and the balance sheet is “liability sensitive.” Our internal policy requires management to maintain the gap such that net interest margins will not change more than 10% if interest rates change 100 basis points or more than 15% if interest rates change 200 basis points. As of December 31, 2022, our gap was within such ranges.   The interest rate risk model measures scheduled maturities in periods of three months, four to twelve months, one to five years and over five years. The chart below illustrates our rate-sensitive position at December 31, 2022. Management uses the one-year gap as the appropriate time period for setting strategy.   Rate Sensitive Gap Analysis       1-3 Months     4-12 Months     1-5 Years     Over 5 Years     Total       (Dollars in Thousands)   Interest-earning assets:                                         Loans, including mortgages held for sale   $ 5,013,349     $ 1,696,696     $ 4,436,221     $ 397,011     $ 11,543,278   Securities     63,079       119,636       1,043,469       460,485       1,686,670   Federal funds sold     1,515       -       -       -       1,515   Interest bearing balances with banks     708,221       -       -       -       708,221   Total interest-earning assets   $ 5,786,165     $ 1,816,333     $ 5,479,690     $ 857,496     $ 13,939,684                                             Interest-bearing liabilities:                                         Deposits:                                         Interest-bearing checking   $ 1,845,939     $ -     $ -     $ -     $ 1,845,939   Money market and savings     5,515,052       -       -       -       5,515,052   Time deposits     311,315       336,066       215,426       -       862,807   Federal funds purchased     -       -       -       64,726       64,726   Other borrowings     1,618,798       -       -       -       1,618,798   Total interest-bearing liabilities     9,291,104       336,066       215,426       64,726       9,907,322   Interest sensitivity gap   $ (3,504,939 )   $ 1,480,267     $ 5,264,264     $ 792,770     $ 4,032,362   Cumulative sensitivity gap   $ (3,504,939 )   $ (2,024,672 )   $ 3,239,591     $ 4,032,362     $ -   Percent of cumulative sensitivity Gap to total interest-earning assets     (25.14 )%     (14.52 )%     23.24 %     28.93 %           The interest rate risk model that defines the gap position also performs a “rate shock” test of the balance sheet.  The rate shock procedure measures the impact on the economic value of equity (EVE) which is a measure of long term interest rate risk. EVE is the difference between the market value of our assets and the liabilities and is our liquidation value. In EVE analysis, the model calculates the discounted cash flow or market value of each category on the balance sheet. The percentage change in EVE is a measure of the volatility of risk. Regulatory guidelines specify a maximum change of 30% for a 200 basis points rate change. After starting the year at a rate of 0.15%, the Federal Reserve increased its targeted federal funds rate by 425 basis points and ended the 2022 year at a 4.40%. At December 31, 2022, the model shows an increase in our EVE for an upward shift of 100 basis points and decrease in upward shifts of 200, 300 and 400 basis points.   The chart below identifies the EVE impact of a downward shift in rates of 100 basis points and an upward shift in rates of 100, 200, 300 and 400 basis points.   60     Economic Value of Equity Under Rate Shock   At December 31, 2022                                                         0 bps     -100 bps     +100 bps     +200 bps     +300 bps     +400 bps       (Dollars in Thousands)   Economic value of equity   $ 1,297,896     $ 1,216,129     $ 1,299,194     $ 1,283,619     $ 1,275,832     $ 1,264,151   Actual dollar change           $ (81,767 )   $ 1,298     $ (14,277 )   $ (22,064 )   $ (33,745 ) Percent change             (6.30 )%     0.10 %     (1.10 )%     (1.70 )%     (2.60 )%   The one-year gap ratio of negative -14.52% indicates that we would show a decrease in net interest income in a rising rate environment, and the EVE rate shock shows that the EVE would increase in a rising rate environment. The EVE simulation model is a static model which provides information only at a certain point in time. For example, in a rising rate environment, the model does not take into account actions which management might take to change the impact of rising rates on us. Given that limitation, it is still useful in assessing the long-range impact of unanticipated movements in interest rates.   The above analysis may not on its own be an entirely accurate indicator of how net interest income or EVE will be affected by changes in interest rates. Income associated with interest earning assets and costs associated with interest bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates. Our asset liability committee develops its view of future rate trends by monitoring economic indicators, examining the views of economists and other experts, and understanding the current status of our balance sheet and conducts a quarterly analysis of the rate sensitivity position.  The results of the analysis are reported to our board of directors on a quarterly basis.   61