First Federal Bancshares

The ability to maximize net interest income is largely dependent upon achieving a positive interest rate spread that can be sustained during fluctuations in prevailing interest rates. Interest rate sensitivity is a measure of the difference between amounts of interest-earning assets and interest-bearing liabilities that either reprice or mature within a given period of time. The difference, or the interest rate repricing “gap,” provides an indication of the extent to which an institution’s interest-rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities and is considered negative when the amount of interest-rate liabilities exceeds the amount of interest-rate sensitive assets.

Generally, during a period of rising interest rates, a negative gap within shorter maturities would adversely affect net interest income, while a positive gap within shorter maturities would result in an increase in net interest income and during a period of falling interest rates, a negative gap within shorter maturities would result in an increase in net interest income while a positive gap within shorter maturities would have the opposite effect.

As of Dec. 31, the bank estimates that the ratio of its one-year gap to total assets was a negative 14.8 percent and its ratio of interest-earning assets to interest-bearing liabilities maturing or repricing within one year was 68 percent.

To minimize the potential for adverse effects of material and prolonged increases in interest rates on the company’s results of operations, management has implemented and continues to monitor asset and liability management policies to better match the maturities and repricing terms of the bank’s interest-earning assets and interest-bearing liabilities.

Such policies have consided primarily of emphasizing the origination of adjustable-rate mortgage loans and lengthening the maturity on deposits by offering longer term certificates of deposit. Currently, deposits into such CDs are minimal due to the prevailing low interest rate environment.

The bank’s lending activities are focused on the origination of one-, three- and seven-year adjustable-rate residential mortgage loans. Although adjustable-rate loans involve certain risks, including increased payments and the potential for default in an increasing interest rate environment, such loans decrease the risks associated with changes in interest rates. As a result of the bank’s efforts, as of Dec. 31, $236 million, or 63.6 percent of the bank’s portfolio of one- to four-family residential mortgage loans, consisted of ARMs, including $198.3 million in seven-year ARMs.

The company’s investment securities portfolio amounted to $95.5 million, or 17.4 percent of the company’s total assets at Dec. 31. Of such amount, $12 million, or 12.6 percent, is contractually due within one year and $25.3 million, or 26.5 percent, is contractually due after one to five years. However, actual maturities are normally shorter than contractual maturies due to the ability of borrowers to call or prepay such obligations without call or prepayment penalties.

As of Dec. 31, there were approximately $71 million of investment securities with call options held by the issuer, of which approximately $60 million are callable within one year.