TBHS » Topics » Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

This excerpt taken from the TBHS 10-Q filed May 20, 2009.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

 

These excerpts taken from the TBHS 10-K filed Mar 31, 2009.
ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk Management

 

Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices.  The Bank’s market risk exposure is primarily that of interest rate risk, and it has established policies and procedures to monitor and limit earnings and balance sheet exposure to changes in interest rates.  The Bank does not engage in trading of financial instruments, nor does the Bank have any exposure to exchange rates.

 

The principal objective of interest rate risk management (often referred to as “asset/liability management”) is to manage the financial components of the Company in a manner that will optimize the risk/reward equation for earnings and capital in relation to changing interest rates.  To identify areas of potential exposure to rate changes, the Bank uses modeling software to perform an earnings simulation analysis and a market value of portfolio equity calculation on a quarterly basis.  This identifies more dynamic interest rate risk exposures than those apparent in standard re-pricing gap analyses.

 

BancWare modeling software is used for asset/liability management in order to simulate the effects of potential interest rate changes on the Company’s primary subsidiary, Nevada Security Bank and its net interest margin.  These simulations can also provide both static and dynamic information on the projected fair market values of the Bank’s financial instruments under different interest rate scenarios.  The simulation program utilizes Bank specific loan, deposit and investment data, and incorporates assumptions on the re-pricing characteristics of embedded options to determine the effects of a given interest rate change on the subsidiary Bank’s interest income and interest expense.  Rate scenarios consisting of key rate and yield curve projections are run against the Bank’s investment, loan, deposit and borrowed funds portfolios.  These rate projections can be shocked (an immediate and sustained change in rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels).  The Bank typically uses seven standard interest rate scenarios in conducting its simulations, four of which are provided in Appendix 13.

 

85



Table of Contents

 

The Bank’s policy is to target the change in the Bank’s net interest income for the next 12 months to plus or minus 7% based on a 100 basis point (b.p.) shock, plus or minus 14% based on a 200 b.p. shock, and plus or minus 21% based on a 300 b.p. shock in interest rates.

 

Appendix 13 sets forth information on the Bank’s estimated net interest income sensitivity profile as of December 31, 2008.  The table illustrates that if there were an immediate downward adjustment of 100 basis points in interest rates and the Bank did nothing further with regard to the active management of its assets or liabilities, net interest income would likely increase by around $203,000, or approximately 0.01%, over the next twelve months.  By the same token, if there were an immediate increase of 100 basis points in interest rates, the Bank’s net interest income would decrease by $281,000 or 0.04% over the next year.  Management does not expect current rates to fall further over the next twelve months.  While the simulations as of December 31, 2008 show potential declines in net interest income in three out of the four scenarios presented, the impact on earnings is negligible.  The Company’s balance sheet is fairly well insulated to interest rate risk and management is proactive in addressing the maintenance of the Company’s net interest margin.  However, the preceding interest rate simulation model discussion does not represent a financial forecast and should not be relied upon as being indicative of future results.

 

One lesser utilized method of reviewing an institution’s likely changes in net interest income is to analyze its “gap” position.  That is, to look at the dollar volume of assets and liabilities with interest rates earned and paid, that will be repricing in various base periods.  This repricing information is also used in liquidity management.  These repricing characteristics are the time frames within which the interest bearing assets and liabilities are currently subject to change in interest rates, either at replacement, repricing or maturity during the life of the instruments.  Interest rate sensitivity management focuses on the repricing characteristics and the maturity structure of assets and liabilities during periods of changes in market interest rates.  Effective interest rate sensitivity management seeks to examine how and when assets and liabilities respond to changes in interest rates, and quantify the impact of interest rate changes on net interest income.  Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in our current portfolios that are subject to repricing at various time horizons: immediate; within three months; over three to twelve months; one to five years; over five years; and on a cumulative basis.  The differences are known as interest rate sensitivity gaps.

 

As shown in Appendix 14, Interest Rate Sensitivity Gap, during the first three months of 2009, approximately 37% of interest bearing liabilities could reprice, compared with 35% of all interest earning assets.  This would be characterized as a positive gap, that is, more assets reprice in this period than liabilities.  A negative gap implies that more liabilities than assets reprice in a given time frame, and the intuitive reaction would be that in a falling rate environment, it would be more beneficial to be negatively gapped; that is, interest bearing liabilities drop in price faster than interest earning assets, and in a rising interest rate environment it would be better to have interest earning assets reprice quicker than interest bearing liabilities, thereby creating additional short-term income.

 

A short term positive net interest income effect would occur in either instance, based on the positive gap in a falling rate environment, or a negative gap in a rising interest rate environment, at least until all interest bearing liabilities or assets are repriced in respect to their maturities, and the enhanced net interest margin is reduced.  However, loan and deposit portfolio repricing periods do not bring automatic short-term increases or decreases in the net interest margin, because rates may not be adjusted concurrently with market condition changes, and may be “sticky” in either direction.

 

86



Table of Contents

 

Further changes in the mix of earning assets or interest bearing liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity.  In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing for both the asset and the liability remains the same, thereby impacting net interest income.  This characteristic is referred to as basis risk and in general relates to the possibility that the repricing characteristics of short-term assets tied to various indices are different from those of funding sources.  Varying interest rate environments can create unexpected changes in prepayment volumes of assets, and pre-maturity demands for liabilities that are not reflected in the interest rate sensitivity analysis.  These customer originated prepayments or pre-maturities may have a significant impact on our net interest margin.  Because of these factors, an interest rate sensitivity gap analysis may not provide an accurate assessment of our exposure to changes in interest rates and we use modeling software to more accurately reflect interest rate risk.

 

The economic (or “fair”) value of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed.  Economic values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while the fair value of non-financial accounts is assumed to equal book value and does not vary with interest rate fluctuations.  An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of the Company’s balance sheet evolve and as interest rate and yield curve assumptions are updated.  At the current time, the Company determines the economic value of equity (“EVE”) on a quarterly basis, and has established guidelines for such variances based on historical economic and Company trends.

 

Federal Taxation

 

The Company files a consolidated federal tax return for all entities, using the accrual method of accounting.  All required tax returns have been filed when due. Financial institutions are subject to the provisions of the Internal Revenue Code of 1986, as amended in the same general manner as other corporations.  See NOTE 12 to the Consolidated Financial Statements for additional information.

 

State Taxation

 

Under Nevada law, financial institutions are subject to employment and branch location taxes but not income taxes.  The employment tax is calculated 2.0% of total salaries and wages, while the branch location fee is $7,000 per branch location, per year.  Montana and California impose state income taxes.  In these states the Company files a tax return based on allocated income that is calculated pursuant to income allocation criteria.  These criteria are:

 

·                  Property Factor.  Real and personal property, rent or lease expense and loan and credit card receivables sourced on the location;

·                  Revenue Factor.  Interest, fees and penalties secured by real property sourced to the state where the property is located; and

·                  Payroll Factor.  Payroll consists of salaries, wages and other compensation by state tied to Federal 940 reports or state unemployment reports.

 

87



ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK



 



Interest Rate Risk Management



 



Market risk arises from changes in interest rates, exchange rates,
commodity prices and equity prices.  The
Bank’s market risk exposure is primarily that of interest rate risk, and it has
established policies and procedures to monitor and limit earnings and balance
sheet exposure to changes in interest rates. 
The Bank does not engage in trading of financial instruments, nor does
the Bank have any exposure to exchange rates.



 



The principal objective of interest rate risk management (often
referred to as “asset/liability management”) is to manage the financial
components of the Company in a manner that will optimize the risk/reward
equation for earnings and capital in relation to changing interest rates.  To identify areas of potential exposure to
rate changes, the Bank uses modeling software to perform an earnings simulation
analysis and a market value of portfolio equity calculation on a quarterly
basis.  This identifies more dynamic
interest rate risk exposures than those apparent in standard re-pricing gap
analyses.



 



BancWare modeling software is used for asset/liability management in
order to simulate the effects of potential interest rate changes on the Company’s
primary subsidiary, Nevada Security Bank and its net interest margin.  These simulations can also provide both
static and dynamic information on the projected fair market values of the Bank’s
financial instruments under different interest rate scenarios.  The simulation program utilizes Bank specific
loan, deposit and investment data, and incorporates assumptions on the
re-pricing characteristics of embedded options to determine the effects of a
given interest rate change on the subsidiary Bank’s interest income and
interest expense.  Rate scenarios
consisting of key rate and yield curve projections are run against the Bank’s
investment, loan, deposit and borrowed funds portfolios.  These rate projections can be shocked (an
immediate and sustained change in rates, up or down), ramped (an incremental
increase or decrease in rates over a specified time period), economic (based on
current trends and econometric models) or stable (unchanged from current actual
levels).  The Bank typically uses seven
standard interest rate scenarios in conducting its simulations, four of which
are provided in Appendix 13.



 



85
















Table
of Contents



 



The Bank’s policy is to target the change in the Bank’s net interest
income for the next 12 months to plus or minus 7% based on a 100 basis point
(b.p.) shock, plus or minus 14% based on a 200 b.p. shock, and plus or minus
21% based on a 300 b.p. shock in interest rates.



 



Appendix 13 sets forth information on the Bank’s estimated net interest
income sensitivity profile as of December 31, 2008.  The table illustrates that if there were an
immediate downward adjustment of 100 basis points in interest rates and the
Bank did nothing further with regard to the active management of its assets or
liabilities, net interest income would likely increase by around $203,000, or
approximately 0.01%, over the next twelve months.  By the same token, if there were an immediate
increase of 100 basis points in interest rates, the Bank’s net interest income
would decrease by $281,000 or 0.04% over the next year.  Management does not expect current rates to
fall further over the next twelve months. 
While the simulations as of December 31, 2008 show potential
declines in net interest income in three out of the four scenarios presented,
the impact on earnings is negligible. 
The Company’s balance sheet is fairly well insulated to interest rate
risk and management is proactive in addressing the maintenance of the Company’s
net interest margin.  However, the
preceding interest rate simulation model discussion does not represent a
financial forecast and should not be relied upon as being indicative of future
results.



 



One
lesser utilized method of reviewing an institution’s likely changes in net
interest income is to analyze its “gap” position.  That is, to look at the dollar volume of
assets and liabilities with interest rates earned and paid, that will be
repricing in various base periods.  This
repricing information is also used in liquidity management.  These repricing characteristics are the time
frames within which the interest bearing assets and liabilities are currently
subject to change in interest rates, either at replacement, repricing or
maturity during the life of the instruments. 
Interest rate sensitivity management focuses on the repricing
characteristics and the maturity structure of assets and liabilities during
periods of changes in market interest rates. 
Effective interest rate sensitivity management seeks to examine how and
when assets and liabilities respond to changes in interest rates, and quantify
the impact of interest rate changes on net interest income.  Interest rate sensitivity is measured as the
difference between the volumes of assets and liabilities in our current
portfolios that are subject to repricing at various time horizons: immediate;
within three months; over three to twelve months; one to five years; over five
years; and on a cumulative basis.  The
differences are known as interest rate sensitivity gaps.



 



As
shown in Appendix 14, Interest Rate Sensitivity Gap, during the first three
months of 2009, approximately 37% of interest bearing liabilities could
reprice, compared with 35% of all interest earning assets.  This would be characterized as a positive
gap, that is, more assets reprice in this period than liabilities.  A negative gap implies that more liabilities than
assets reprice in a given time frame, and the intuitive reaction would be that
in a falling rate environment, it would be more beneficial to be negatively
gapped; that is, interest bearing liabilities drop in price faster than
interest earning assets, and in a rising interest rate environment it would be
better to have interest earning assets reprice quicker than interest bearing
liabilities, thereby creating additional short-term income.



 



A
short term positive net interest income effect would occur in either instance,
based on the positive gap in a falling rate environment, or a negative gap in a
rising interest rate environment, at least until all interest bearing
liabilities or assets are repriced in respect to their maturities, and the
enhanced net interest margin is reduced. 
However, loan and deposit portfolio repricing periods do not bring
automatic short-term increases or decreases in the net interest margin, because
rates may not be adjusted concurrently with market condition changes, and may
be “sticky” in either direction.



 



86















Table
of Contents



 



Further
changes in the mix of earning assets or interest bearing liabilities can either
increase or decrease the net interest margin without affecting interest rate
sensitivity.  In addition, the interest
rate spread between an asset and its supporting liability can vary
significantly while the timing of repricing for both the asset and the
liability remains the same, thereby impacting net interest income.  This characteristic is referred to as basis
risk and in general relates to the possibility that the repricing
characteristics of short-term assets tied to various indices are different from
those of funding sources.  Varying
interest rate environments can create unexpected changes in prepayment volumes
of assets, and pre-maturity demands for liabilities that are not reflected in
the interest rate sensitivity analysis. 
These customer originated prepayments or pre-maturities may have a
significant impact on our net interest margin. 
Because of these factors, an interest rate sensitivity gap analysis may
not provide an accurate assessment of our exposure to changes in interest rates
and we use modeling software to more accurately reflect interest rate risk.



 



The economic (or “fair”) value of financial instruments on the Company’s
balance sheet will also vary under the interest rate scenarios previously
discussed.  Economic values for financial
instruments are estimated by discounting projected cash flows (principal and
interest) at current replacement rates for each account type, while the fair
value of non-financial accounts is assumed to equal book value and does not
vary with interest rate fluctuations.  An
economic value simulation is a static measure for balance sheet accounts at a
given point in time, but this measurement can change substantially over time as
the characteristics of the Company’s balance sheet evolve and as interest rate
and yield curve assumptions are updated. 
At the current time, the Company determines the economic value of equity
(“EVE”) on a quarterly basis, and has established guidelines for such variances
based on historical economic and Company trends.



 



Federal Taxation



 



The Company files a consolidated federal tax return for all entities, using
the accrual method of accounting.  All
required tax returns have been filed when due. Financial institutions are
subject to the provisions of the Internal Revenue Code of 1986, as amended in
the same general manner as other corporations. 
See NOTE 12 to the Consolidated Financial Statements for additional
information.



 



State Taxation



 



Under Nevada law, financial institutions are subject to employment and
branch location taxes but not income taxes. 
The employment tax is calculated 2.0% of total salaries and wages, while
the branch location fee is $7,000 per branch location, per year.  Montana and California impose state income
taxes.  In these states the Company files
a tax return based on allocated income that is calculated pursuant to income
allocation criteria.  These criteria are:



 



·                  Property Factor.  Real and personal property, rent or lease
expense and loan and credit card receivables sourced on the location;



·                  Revenue Factor.  Interest, fees and penalties secured by real
property sourced to the state where the property is located; and



·                  Payroll Factor.  Payroll consists of salaries, wages and other
compensation by state tied to Federal 940 reports or state unemployment
reports.



 



87














This excerpt taken from the TBHS 10-Q filed Nov 10, 2008.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

 

This excerpt taken from the TBHS 10-Q filed Aug 8, 2008.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

 

This excerpt taken from the TBHS 10-Q filed May 6, 2008.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

 

These excerpts taken from the TBHS 10-K filed Apr 1, 2008.
ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk Management

 

Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices.  The Bank’s market risk exposure is primarily that of interest rate risk, and it has established policies and procedures to monitor and limit earnings and balance sheet exposure to changes in interest rates.  The Bank does not engage in trading of financial instruments, nor does the Bank have any exposure to exchange rates.

 

The principal objective of interest rate risk management (often referred to as “asset/liability management”) is to manage the financial components of the Company in a manner that will optimize the risk/reward equation for earnings and capital in relation to changing interest rates.  To identify areas of potential exposure to rate changes, the Bank uses modeling software to perform an earnings simulation analysis and a market value of portfolio equity calculation on a quarterly basis.  This identifies more dynamic interest rate risk exposures than those apparent in standard re-pricing gap analyses.

 

BancWare modeling software is used for asset/liability management in order to simulate the effects of potential interest rate changes on the Company’s primary subsidiary, Nevada Security Bank and its net interest margin.  These simulations can also provide both static and dynamic information on the projected fair market values of the Bank’s financial instruments under different interest rate scenarios.  The simulation

 

72



 

program utilizes Bank specific loan, deposit and investment data, and incorporates assumptions on the re-pricing characteristics of embedded options to determine the effects of a given interest rate change on the subsidiary bank’s interest income and interest expense.  Rate scenarios consisting of key rate and yield curve projections are run against the Bank’s investment, loan, deposit and borrowed funds portfolios.  These rate projections can be shocked (an immediate and sustained change in rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels).  The Bank typically uses seven standard interest rate scenarios in conducting its simulations, four of which are provided in Appendix 13.

 

The Bank’s policy is to target the change in the Bank’s net interest income for the next 12 months to plus or minus 7% based on a 100 basis point (b.p.) shock, plus or minus 14% based on a 200 b.p. shock, and plus or minus 21% based on a 300 b.p. shock in interest rates.

 

See Appendix 13 for information on the Bank’s estimated net interest income sensitivity profile as of December 31, 2007.  The table illustrates that if there were an immediate downward adjustment of 100 basis points in interest rates and the Bank did nothing further with regard to the active management of its assets or liabilities, net interest income would likely decrease by around $44,000, or approximately 0.01%, over the next twelve months.  By the same token, if there were an immediate increase of 100 basis points in interest rates, the Bank’s net interest income would decrease by $281,000 or 0.05% over the next year.  Management expects current rates to fall further over the next twelve months.  While the simulations as of December 31, 2007 show declines in net interest income in all scenarios, the impact in earnings is negligible.  The Company’s balance sheet is fairly well insulated to interest rate risk and management is proactive in addressing the maintenance of the Company’s net interest margin.  However, the preceding interest rate simulation model discussion does not represent a financial forecast and should not be relied upon as being indicative of future results.

 

One lesser utilized method of reviewing an institution’s likely changes in net interest income is to analyze its “gap” position.  That is, to look at the dollar volume of assets and liabilities whose interest rates earned and paid, will be repricing in various base periods.  This repricing information is also used in the liquidity management.  These repricing characteristics are the time frames within which the interest bearing assets and liabilities are currently subject to change in interest rates, either at replacement, repricing or maturity during the life of the instruments.  Interest rate sensitivity management focuses on the repricing characteristics and the maturity structure of assets and liabilities during periods of changes in market interest rates.  Effective interest rate sensitivity management seeks to examine how and when assets and liabilities respond to changes in interest rates, and quantify the impact of interest rate changes on net interest income.  Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in our current portfolios that are subject to repricing at various time horizons: immediate; within three months; over three to twelve months; one to five years; over five years, and on a cumulative basis.  The differences are known as interest rate sensitivity gaps.

 

As shown in Appendix 14, Interest Rate Sensitivity Gap, during the first three months of 2008, approximately 64% of interest bearing liabilities could reprice, compared with 46% of all interest earning assets.  This would be characterized as a negative gap, that is, more liabilities reprice in this period than assets.  A positive gap implies that more assets than liabilities reprice in a given time frame, and the intuitive reaction would be that in a falling rate environment, it would be more beneficial to be negatively gapped; that is, interest bearing liabilities drop in price faster than interest earning assets, and in a rising interest rate environment it would be better to have interest earning assets reprice quicker than interest bearing liabilities, thereby creating additional short-term income.

 

A short term positive net interest income effect would occur in either instance, based on the positive gap in a falling rate environment, or a negative gap in a rising interest rate environment, at least until all interest

 

73



 

bearing liabilities or assets are repriced in respect to their maturities, and the enhanced net interest margin is reduced.  However, loan and deposit portfolio repricing periods do not bring automatic short-term increases or decreases in the net interest margin, because rates may not be adjusted concurrently with market condition changes, and may be “sticky” in either direction.

 

Further changes in the mix of earning assets or interest bearing liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity.  In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing for both the asset and the liability remains the same, thereby impacting net interest income.  This characteristic is referred to as basis risk and in general relates to the possibility that the repricing characteristics of short-term assets tied to various indices are different from those of funding sources.  Varying interest rate environments can create unexpected changes in prepayment volumes of assets, and pre-maturity demands for liabilities that are not reflected in the interest rate sensitivity analysis.  These customer originated prepayments or pre-maturities may have a significant impact on our net interest margin.  Because of these factors, an interest rate sensitivity gap analysis may not provide an accurate assessment of our exposure to changes in interest rates and we use modeling software to more accurately reflect interest rate risk.

 

The economic (or “fair”) value of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed.  Economic values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while the fair value of non-financial accounts is assumed to equal book value and does not vary with interest rate fluctuations.  An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of the Company’s balance sheet evolve and as interest rate and yield curve assumptions are updated.  At the current time, the Company determines the economic value of equity (“EVE”) on a quarterly basis, and has established guidelines for such variances based on historical economic and Company trends.

 

Federal Taxation

 

The Company files a consolidated federal tax return for all entities, using the accrual method of accounting.  All required tax returns have been filed when due. Financial institutions are subject to the provisions of the Internal Revenue Code of 1986, as amended in the same general manner as other corporations.  See NOTE 9 to the Consolidated Financial Statements for additional information.

 

State Taxation

 

Under Nevada law, financial institutions are subject to employment and branch location taxes but not income taxes.  The employment tax is calculated 2.0% of total salaries and wages, while the branch location fee is $7,000 per branch location, per year.  Montana and California impose state income taxes.  In these states the Company files a tax return based on allocated income that is calculated pursuant to income allocation criteria.  These criteria are:

 

·   Property Factor.  Real and personal property, rent or lease expense and loan and credit card receivables sourced on the location;

 

·   Revenue Factor.  Interest, fees and penalties secured by real property sourced to the state where the property is located; and

 

·   Payroll Factor.  Payroll consists of salaries, wages and other compensation by state tied to Federal 940 reports or state unemployment reports.

 

74



 

ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK



 



Interest Rate Risk Management



 



Market risk arises from changes in interest rates, exchange rates,
commodity prices and equity prices.  The
Bank’s market risk exposure is primarily that of interest rate risk, and it has
established policies and procedures to monitor and limit earnings and balance
sheet exposure to changes in interest rates. 
The Bank does not engage in trading of financial instruments, nor does
the Bank have any exposure to exchange rates.



 



The principal objective of interest rate risk management (often
referred to as “asset/liability management”) is to manage the financial
components of the Company in a manner that will optimize the risk/reward
equation for earnings and capital in relation to changing interest rates.  To identify areas of potential exposure to
rate changes, the Bank uses modeling software to perform an earnings simulation
analysis and a market value of portfolio equity calculation on a quarterly
basis.  This identifies more dynamic
interest rate risk exposures than those apparent in standard re-pricing gap
analyses.



 



BancWare modeling software is used for asset/liability management in
order to simulate the effects of potential interest rate changes on the Company’s
primary subsidiary, Nevada Security Bank and its net interest margin.  These simulations can also provide both
static and dynamic information on the projected fair market values of the Bank’s
financial instruments under different interest rate scenarios.  The simulation



 



72
















 



program utilizes Bank specific loan, deposit and investment data, and
incorporates assumptions on the re-pricing characteristics of embedded options
to determine the effects of a given interest rate change on the subsidiary bank’s
interest income and interest expense. 
Rate scenarios consisting of key rate and yield curve projections are
run against the Bank’s investment, loan, deposit and borrowed funds
portfolios.  These rate projections can
be shocked (an immediate and sustained change in rates, up or down), ramped (an
incremental increase or decrease in rates over a specified time period),
economic (based on current trends and econometric models) or stable (unchanged
from current actual levels).  The Bank
typically uses seven standard interest rate scenarios in conducting its
simulations, four of which are provided in Appendix 13.



 



The Bank’s policy is to target the change in the Bank’s net interest
income for the next 12 months to plus or minus 7% based on a 100 basis point
(b.p.) shock, plus or minus 14% based on a 200 b.p. shock, and plus or minus
21% based on a 300 b.p. shock in interest rates.



 



See Appendix 13 for information on the Bank’s estimated net interest
income sensitivity profile as of December 31, 2007.  The table illustrates that if there were an
immediate downward adjustment of 100 basis points in interest rates and the
Bank did nothing further with regard to the active management of its assets or
liabilities, net interest income would likely decrease by around $44,000, or
approximately 0.01%, over the next twelve months.  By the same token, if there were an immediate
increase of 100 basis points in interest rates, the Bank’s net interest income
would decrease by $281,000 or 0.05% over the next year.  Management expects current rates to fall
further over the next twelve months. 
While the simulations as of December 31, 2007 show declines in net
interest income in all scenarios, the impact in earnings is negligible.  The Company’s balance sheet is fairly well
insulated to interest rate risk and management is proactive in addressing the
maintenance of the Company’s net interest margin.  However, the preceding interest rate
simulation model discussion does not represent a financial forecast and should
not be relied upon as being indicative of future results.



 



One
lesser utilized method of reviewing an institution’s likely changes in net
interest income is to analyze its “gap” position.  That is, to look at the dollar volume of
assets and liabilities whose interest rates earned and paid, will be repricing
in various base periods.  This repricing
information is also used in the liquidity management.  These repricing characteristics are the time
frames within which the interest bearing assets and liabilities are currently
subject to change in interest rates, either at replacement, repricing or
maturity during the life of the instruments. 
Interest rate sensitivity management focuses on the repricing characteristics
and the maturity structure of assets and liabilities during periods of changes
in market interest rates.  Effective
interest rate sensitivity management seeks to examine how and when assets and
liabilities respond to changes in interest rates, and quantify the impact of
interest rate changes on net interest income. 
Interest rate sensitivity is measured as the difference between the
volumes of assets and liabilities in our current portfolios that are subject to
repricing at various time horizons: immediate; within three months; over three
to twelve months; one to five years; over five years, and on a cumulative
basis.  The differences are known as
interest rate sensitivity gaps.



 



As
shown in Appendix 14, Interest Rate Sensitivity Gap, during the first three
months of 2008, approximately 64% of interest bearing liabilities could
reprice, compared with 46% of all interest earning assets.  This would be characterized as a negative
gap, that is, more liabilities reprice in this period than assets.  A positive gap implies that more assets than
liabilities reprice in a given time frame, and the intuitive reaction would be
that in a falling rate environment, it would be more beneficial to be
negatively gapped; that is, interest bearing liabilities drop in price faster
than interest earning assets, and in a rising interest rate environment it
would be better to have interest earning assets reprice quicker than interest
bearing liabilities, thereby creating additional short-term income.



 



A
short term positive net interest income effect would occur in either instance,
based on the positive gap in a falling rate environment, or a negative gap in a
rising interest rate environment, at least until all interest



 



73
















 



bearing
liabilities or assets are repriced in respect to their maturities, and the
enhanced net interest margin is reduced. 
However, loan and deposit portfolio repricing periods do not bring
automatic short-term increases or decreases in the net interest margin, because
rates may not be adjusted concurrently with market condition changes, and may
be “sticky” in either direction.



 



Further
changes in the mix of earning assets or interest bearing liabilities can either
increase or decrease the net interest margin without affecting interest rate
sensitivity.  In addition, the interest
rate spread between an asset and its supporting liability can vary
significantly while the timing of repricing for both the asset and the
liability remains the same, thereby impacting net interest income.  This characteristic is referred to as basis
risk and in general relates to the possibility that the repricing
characteristics of short-term assets tied to various indices are different from
those of funding sources.  Varying
interest rate environments can create unexpected changes in prepayment volumes
of assets, and pre-maturity demands for liabilities that are not reflected in
the interest rate sensitivity analysis. 
These customer originated prepayments or pre-maturities may have a
significant impact on our net interest margin. 
Because of these factors, an interest rate sensitivity gap analysis may
not provide an accurate assessment of our exposure to changes in interest rates
and we use modeling software to more accurately reflect interest rate risk.



 



The economic (or “fair”) value of financial instruments on the Company’s
balance sheet will also vary under the interest rate scenarios previously
discussed.  Economic values for financial
instruments are estimated by discounting projected cash flows (principal and
interest) at current replacement rates for each account type, while the fair
value of non-financial accounts is assumed to equal book value and does not
vary with interest rate fluctuations.  An
economic value simulation is a static measure for balance sheet accounts at a
given point in time, but this measurement can change substantially over time as
the characteristics of the Company’s balance sheet evolve and as interest rate
and yield curve assumptions are updated. 
At the current time, the Company determines the economic value of equity
(“EVE”) on a quarterly basis, and has established guidelines for such variances
based on historical economic and Company trends.



 



Federal Taxation



 



The Company files a consolidated federal tax return for all entities,
using the accrual method of accounting. 
All required tax returns have been filed when due. Financial
institutions are subject to the provisions of the Internal Revenue Code of
1986, as amended in the same general manner as other corporations.  See NOTE 9 to the Consolidated Financial
Statements for additional information.



 



State Taxation



 



Under Nevada law, financial institutions are subject to employment and
branch location taxes but not income taxes. 
The employment tax is calculated 2.0% of total salaries and wages, while
the branch location fee is $7,000 per branch location, per year.  Montana and California impose state income
taxes.  In these states the Company files
a tax return based on allocated income that is calculated pursuant to income
allocation criteria.  These criteria are:



 



·   Property Factor.  Real and personal property, rent or lease
expense and loan and credit card receivables sourced on the location;



 



·   Revenue Factor.  Interest, fees and penalties secured by real
property sourced to the state where the property is located; and



 



·   Payroll Factor.  Payroll consists of salaries, wages and other
compensation by state tied to Federal 940 reports or state unemployment
reports.



 



74
















 



This excerpt taken from the TBHS 10-Q filed Nov 7, 2007.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

 

This excerpt taken from the TBHS 10-Q filed Aug 14, 2007.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

This excerpt taken from the TBHS 10-Q filed May 15, 2007.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

This excerpt taken from the TBHS 10-K filed Apr 2, 2007.
ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk Management

Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices.  The Bank’s market risk exposure is primarily that of interest rate risk, and it has established policies and procedures to monitor and limit earnings and balance sheet exposure to changes in interest rates.  The Bank does not engage in trading of financial instruments, nor does the Bank have any exposure to exchange rates.

The principal objective of interest rate risk management (often referred to as “asset/liability management”) is to manage the financial components of the Company in a manner that will optimize the risk/reward equation for earnings and capital in relation to changing interest rates.  To identify areas of potential exposure to rate changes, the Bank uses modeling software to perform an earnings simulation analysis and a market value of portfolio equity calculation on a quarterly basis.  This identifies more dynamic interest rate risk exposures than those apparent in standard re-pricing gap analyses.

BancWare modeling software is used for asset/liability management in order to simulate the effects of potential interest rate changes on the Company’s primary subsidiary, Nevada Security Bank and its net interest margin.  These simulations can also provide both static and dynamic information on the projected fair market values of the Bank’s financial instruments under different interest rate scenarios.  The simulation program utilizes Bank specific loan, deposit and investment data, and incorporates assumptions on the re-pricing characteristics of embedded options to determine the effects of a given interest rate change on the subsidiary bank’s interest income and interest expense.  Rate scenarios consisting of key rate and yield curve projections are run against the Bank’s investment, loan, deposit and borrowed funds portfolios.  These rate projections can be shocked (an immediate and sustained change in rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels).  The Bank typically uses seven standard interest rate scenarios in conducting its simulations, four of which are provided in Appendix 13.

The Bank’s policy is to target the change in the Bank’s net interest income for the next 12 months to plus or minus 7% based on a 100 basis point (b.p.) shock, plus or minus 14% based on a 200 b.p. shock, and plus or minus 21% based on a 300 b.p. shock in interest rates.

See Appendix 13 for information on the Bank’s estimated net interest income profile as of December 31, 2006.  The table illustrates that if there were an immediate downward adjustment of 100 basis points in interest rates and the Bank did nothing further with regard to the active management of its assets or liabilities, net interest income would likely decrease by around $955,000, or approximately 7.42%, over the next twelve months.  By

66




the same token, if there were an immediate increase of 100 basis points in interest rates, the Bank’s net interest income would increase by $728,000 or 5.65% over the next year.  The exposure to declining rates appears disproportionate in these simulations, however, because most of the Bank’s deposit rates have escalated over the past year as a result of FOMC actions.  In reality, management does not expect current rates to fall significantly.  In addition, the preceding interest rate simulation model does not represent a financial forecast and should not be relied upon as being indicative of future results.

One lesser utilized method of reviewing an institution’s likely changes in net interest income is to analyze its “gap” position.  That is, to look at the dollar volume of assets and liabilities whose interest rates earned and paid, will be repricing in various base periods.  This repricing information is also used in the liquidity management.  These repricing characteristics are the time frames within which the interest bearing assets and liabilities are currently subject to change in interest rates, either at replacement, repricing or maturity during the life of the instruments.  Interest rate sensitivity management focuses on the repricing characteristics and the maturity structure of assets and liabilities during periods of changes in market interest rates.  Effective interest rate sensitivity management seeks to examine how and when assets and liabilities respond to changes in interest rates, and quantify the impact of interest rate changes on net interest income.  Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in our current portfolios that are subject to repricing at various time horizons: immediate; within three months; over three to twelve months; one to five years; over five years, and on a cumulative basis.  The differences are known as interest rate sensitivity gaps.

As shown in Appendix 14 Interest Rate Sensitivity Gap, during the first three months of 2007, approximately 66% of interest bearing liabilities could reprice, compared with 50% of all interest earning assets.  This would be characterized as a negative gap, that is, more liabilities reprice in this period than assets.  A positive gap implies that more assets than liabilities reprice in a given time frame, and the intuitive reaction would be that in a falling rate environment, it would be more beneficial to be negatively gapped; that is, interest bearing liabilities drop in price faster than interest earning assets, and in a rising interest rate environment it would be better to have interest earning assets reprice quicker than interest bearing liabilities, thereby creating additional short-term income.

A short term positive net interest income effect would occur in either instance, based on the positive gap in a falling rate environment, or a negative gap in a rising interest rate environment, at least until all interest bearing liabilities or assets are repriced in respect to their maturities, and the enhanced net interest margin is reduced.  However, loan and deposit portfolio repricing periods do not bring automatic short-term increases or decreases in the net interest margin, because rates may not be adjusted concurrently with market condition changes, and may be “sticky” in either direction.

Further changes in the mix of earning assets or interest bearing liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity.  In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing for both the asset and the liability remains the same, thereby impacting net interest income.  This characteristic is referred to as basis risk and in general relates to the possibility that the repricing characteristics of short-term assets tied to various indices are different from those of funding sources.  Varying interest rate environments can create unexpected changes in prepayment volumes of assets, and pre-maturity demands for liabilities that are not reflected in the interest rate sensitivity analysis.  These customer originated prepayments or pre-maturities may have a significant impact on our net interest margin.  Because of these factors, an interest rate sensitivity gap analysis may not provide an accurate assessment of our exposure to changes in interest rates and we use modeling software to more accurately reflect interest rate risk.

The economic (or “fair”) value of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed.  Economic values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while the fair value of non-financial accounts is assumed to equal book value and does not vary with interest rate fluctuations.  An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of the Company’s

67




balance sheet evolve and as interest rate and yield curve assumptions are updated.  At the current time, the Company determines the economic value of equity (“EVE”) on a quarterly basis, and is establishing guidelines for such variances based on historical economic and Company trends, after an evaluative period with includes the substantial increases in FOMC rates changes over the past year.  Such guidelines will be further refined, formalized and documented during the year 2007.

Federal Taxation

The Company files a consolidated federal tax return for all entities except Granite Exchange, using the accrual method of accounting.  All required tax returns have been filed. Financial institutions are subject to the provisions of the Internal Revenue Code of 1986, as amended in the same general manner as other corporations.  See Note 9 to the Consolidated Financial Statements for additional information.

State Taxation

Under Nevada law, financial institutions are subject to employment and branch location taxes but not income taxes.  The employment tax is calculated 2.0% of total salaries and wages, while the branch location fee is $7,000 per branch location, per year.  Montana and California impose state income taxes.  In these states the Company files a tax return, based on allocated income that is calculated pursuant to income allocation criteria.
These criteria are:

·     Property Factor.  Real and personal property, rent or lease expense and loan and credit card receivables sourced on the location;

·     Revenue Factor.  Interest, fees and penalties secured by real property sourced to the state where the property is located; and

·     Payroll Factor.  Payroll consists of salaries, wages and other compensation by state tied to Federal 940 reports or state unemployment reports.

This excerpt taken from the TBHS 10-Q filed Jan 19, 2007.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

This excerpt taken from the TBHS 10-Q filed Jan 19, 2007.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

This excerpt taken from the TBHS 10-Q filed Jan 5, 2007.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

This excerpt taken from the TBHS 10-Q filed Jan 5, 2007.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

This excerpt taken from the TBHS 10-Q filed Nov 14, 2006.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

This excerpt taken from the TBHS 10-Q filed Aug 15, 2006.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Refer to the discussion on “Market Risk” contained in Management’s Discussion and Analysis section of this 10-Q.

 

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