ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
The following provides a narrative discussion and analysis of Trustmark Corporation’s (Trustmark) financial condition and results of operations. This discussion should be read in conjunction with the consolidated financial statements and the supplemental financial data included elsewhere in this report.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Management’s Discussion and Analysis are not statements of historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements relating to anticipated future operating and financial performance measures, including net interest margin, credit quality, business initiatives, growth opportunities and growth rates, among other things and encompass any estimate, prediction, expectation, projection, opinion, anticipation, outlook or statement of belief included therein as well as the management assumptions underlying these forward-looking statements. Should one or more of these risks materialize, or should any such underlying assumptions prove to be significantly different, actual results may vary significantly from those anticipated, estimated, projected or expected.
These risks could cause actual results to differ materially from current expectations of Management and include, but are not limited to, changes in the level of nonperforming assets and charge offs, local, state and national economic and market conditions, material changes in market interest rates, the costs and effects of litigation and of unexpected or adverse outcomes in such litigation, competition in loan and deposit pricing, as well as the entry of new competitors into our markets through de novo expansion and acquisitions, changes in existing regulations or the adoption of new regulations, natural disasters, acts of war or terrorism, changes in consumer spending, borrowings and savings habits, technological changes, changes in the financial performance or condition of Trustmark’s borrowers, the ability to control expenses, changes in Trustmark’s compensation and benefit plans, greater than expected costs or difficulties related to the integration of new products and lines of business and other risks described in Trustmark’s filings with the Securities and Exchange Commission.
Although Management believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Trustmark undertakes no obligation to update or revise any of this information, whether as the result of new information, future events or developments or otherwise.
OVERVIEW
Business
Trustmark is a multi-bank holding company headquartered in Jackson, Mississippi, incorporated under the Mississippi Business Corporation Act on August 5, 1968. Trustmark commenced doing business in November 1968. Through its subsidiaries, Trustmark operates as a financial services organization providing banking and financial solutions through over 145 offices and 2,600 associates predominantly within the states of Florida, Mississippi, Tennessee and Texas.
Trustmark National Bank (TNB), Trustmark’s wholly-owned subsidiary, accounts for substantially all of the assets and revenues of Trustmark. Initially chartered by the state of Mississippi in 1889, TNB is also headquartered in Jackson, Mississippi. In addition to banking activities, TNB provides investment and insurance products and services to its customers through four wholly-owned subsidiaries, Trustmark Securities, Inc. (formerly Trustmark Financial Services, Inc.), Trustmark Investment Advisors, Inc., The Bottrell Insurance Agency, Inc. (Bottrell) and Fisher-Brown, Incorporated. In January 2005, Trustmark established a de novo subsidiary, TRMK Risk Management, Inc. (TRMI). TRMI commenced doing business on January 31, 2005, and engages in insurance agency activities as an agent for individual life, disability and long-term care insurance, and also as agent for the sale of fixed annuities. These activities were previously provided by Bottrell.
Trustmark also engages in banking activities through its wholly-owned subsidiary, Somerville Bank & Trust Company (Somerville), headquartered in Somerville, Tennessee. Somerville was acquired in a business combination during 2001 and presently has five locations in Somerville, Hickory Withe and Rossville, Tennessee. In addition to its banking subsidiaries, Trustmark also owns all of the stock of F. S. Corporation and First Building Corporation, both inactive nonbank Mississippi corporations. Neither Trustmark nor its subsidiaries have any foreign activities.
Financial Highlights
Net income for the three months ended September 30, 2005 and 2004, totaled $26.2 million and $28.1 million, respectively. Basic and diluted earnings per share were $0.46 for the third quarter of 2005, compared with basic and diluted earnings per share of $0.49 and $0.48, respectively, for the third quarter of 2004. Net income for the nine months ended September 30, 2005 and 2004, totaled $75.2 million and $87.9 million, respectively. Basic and diluted earnings per share for the nine months ended September 30, 2005 were $1.32 compared with basic and diluted earnings per share of $1.51 for the nine months ended September 30, 2004. At September 30, 2005, Trustmark reported gross loans of $5.873 billion, total assets of $8.329 billion, total deposits of $5.845 billion and shareholders’ equity of $732.6 million.
Management utilizes certain financial ratios to gauge Trustmark’s performance. Trustmark achieved a return on average assets of 1.27% and a return on average equity of 13.81% for the three months ended September 30, 2005. These compared with ratios of 1.35% for return on average assets and 15.26% for return on average equity for the three months ended September 30, 2004. For the nine months ended September 30, 2005, Trustmark achieved a return on average assets of 1.23% and a return on average equity of 13.36%. These compare to a return on average assets of 1.44% and a return on average equity of 16.34% for the same periods of 2004.
Significant Accounting Transactions
On August 29, 2005, Hurricane Katrina struck the Mississippi Gulf Coast, central and eastern Mississippi causing significant damages. Immediately following the storm, Trustmark initiated a process to assess the impact on its customers and on Trustmark’s consolidated financial statements. In accordance with Statement of Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies," Trustmark has determined, through reasonable estimates, that specific losses were probable and have been reflected in the consolidated financial statements as of September 30, 2005.
While no Trustmark facilities sustained significant damage, a number of Trustmark’s offices were temporarily closed until utility services were restored. Trustmark identified customers impacted by the storm in an effort to estimate the loss of collateral value and customer payment abilities. As a result of customer surveys, collateral inspections and a review of risk characteristics, management increased its allowance for loan losses due to the storm by $9.8 million, which reduced third quarter net income by $6.1 million. Trustmark also recorded mortgage related charges, including adjusted fair values on residential mortgage loans held for sale, mortgage servicing rights impairment for increases in prepayment speeds on mortgage loans and waived fees in the affected area, which collectively reduced third quarter net income by $1.4 million. Lower noninterest revenue as a result of waived retail account charges and hurricane relief efforts also reduced Trustmark’s third quarter net income by $839 thousand and $333 thousand, respectively.
Trustmark evaluated its strategic alternatives in payment processing systems and selected NOVA Information systems as its provider of card processing services for its commercial merchant services customers. In connection with this alliance, Trustmark sold its existing payment processing portfolio in the third quarter for a pre-tax gain of $5.75 million, which is included in other noninterest income.
Financial Performance | | | | | | | | | |
Net Income Adjusted for Specific Items (Non-GAAP) | | | | | | | |
| | | | | | | | | | |
| | | Quarter Ended 9/30/2005 | | Year-to-Date 9/30/2005 | | | |
| | | $ | | Basic EPS | | $ | | Basic EPS | |
| | | | | | | | | | | | |
Net Income as reported - GAAP | | $ | 26,221 | | $ | 0.465 | | $ | 75,208 | | $ | 1.322 | |
| | | | | | | | | | | | | | |
Adjustments (net of taxes): | | | | | | | | | | | | | |
Add charges related to Hurricane Katrina | | | | | | | | | | | | | |
| Provision for loan losses | | | 6,054 | | | 0.107 | | | 6,054 | | | 0.106 | |
| Mortgage related charges | | | 1,419 | | | 0.025 | | | 1,419 | | | 0.025 | |
| Non-interest income - lost revenues | | | 839 | | | 0.015 | | | 839 | | | 0.015 | |
| Non-interest expenses - additional expenses | | | 333 | | | 0.006 | | | 333 | | | 0.006 | |
| | | | 8,645 | | | 0.153 | | | 8,645 | | | 0.152 | |
| | | | | | | | | | | | | | |
Subtract sale of Merchant Service Portfolio | | | (3,551 | ) | | (0.063 | ) | | (3,551 | ) | | (0.062 | ) |
| | | | | | | | | | | | | | |
Net Income adjusted for specific items (Non-GAAP) | | $ | 31,315 | | $ | 0.555 | | $ | 80,302 | | $ | 1.412 | |
| | | | | | | | | | | | | | |
Management is presenting in the accompanying table adjustments to net income as reported in accordance with generally accepted accounting principles for significant items resulting from Hurricane Katrina and the sale of its merchant services portfolio. Management believes this information will help users compare Trustmark’s current results to prior periods.
CRITICAL ACCOUNTING POLICIES
Trustmark’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the financial services industry. Application of these accounting principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual financial results could differ from those estimates.
Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. These critical accounting policies are described in detail below.
Allowance for Loan Losses
The allowance for loan losses is established through provisions for estimated loan losses charged against earnings. The allowance for loan losses is maintained at a level believed adequate by management, based on estimated probable losses within the existing loan portfolio. Trustmark’s allowance for loan loss methodology is based on guidance provided by SEC Staff Accounting Bulletin No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues,” as well as other regulatory guidance. Accordingly, Trustmark’s methodology is based on historical loss experience by type of loan and internal risk rating, homogeneous risk pools and specific allocations, with adjustments considering current economic events and conditions. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.
Mortgage Servicing Rights
Mortgage servicing rights are rights to service mortgage loans for others, whether the loans were acquired through purchase or loan origination. Purchased mortgage servicing rights are capitalized at cost. For loans originated and sold where the servicing rights have been retained, Trustmark allocates the cost of the loan and the servicing right based on their relative fair value. Mortgage servicing rights are amortized over the estimated period of the related net servicing income.
Mortgage servicing rights are evaluated quarterly for impairment. Impairment occurs when the estimated fair value falls below the underlying carrying value. For purposes of evaluating impairment, Trustmark stratifies its mortgage servicing portfolio on the basis of certain risk characteristics including loan type, term and note rate. Changes in interest rates, prepayment speeds or other factors could result in impairment or recovery of the servicing asset. Impairment or impairment recovery is recognized through a valuation allowance with a corresponding charge to mortgage banking noninterest income.
Benefit Plans
Benefit plan assets, liabilities and pension costs are determined utilizing actuarially present value calculations. The valuation of the benefit obligation and net periodic expense is considered critical, as it requires Management and its actuaries to make estimates regarding the amount and timing of expected cash outflows including assumptions about mortality, expected service periods, rate of compensation increases and the long-term return on plan assets. Note 8 - Benefit Plans, included in the accompanying Notes to the Consolidated Financial Statements, provides further discussion on the accounting for Trustmark’s benefit plans (pension and supplemental retirement plan) and the estimates used in determining the actuarial present value of the benefit obligations and the net periodic benefit expense.
Fair Value Accounting Estimates
Generally accepted accounting principles require the use of fair values in determining the carrying values of certain assets and liabilities, as well as for specific disclosures. The most significant include securities, derivative instruments, loans held for sale, mortgage servicing rights and net assets acquired in a business combination. Certain of these assets do not have a readily available market to determine fair value and require an estimate based on specific parameters. When market prices are unavailable, Trustmark determines fair values utilizing parameters, which are constantly changing, including interest rates, duration, prepayment speeds and other specific conditions. In most cases, these specific parameters require a significant amount of judgment by Management.
Contingent Liabilities
Trustmark estimates contingent liabilities based on Management's evaluation of the probability of outcomes and their ability to estimate the range of exposure. As stated by Statement of Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies,” a liability is contingent if the amount is not presently known, but may become known in the future as a result of the occurrence of some uncertain future event. Accounting standards require that a liability be recorded if Management determines that it is probable that a loss has occurred and the loss can be reasonably estimated. In addition, it must be probable that the loss will be confirmed by some future event. As part of the estimation process, Management is required to make assumptions about matters that are, by their nature, highly uncertain. The assessment of contingent liabilities, including legal contingencies and income tax liabilities, involves the use of critical estimates, assumptions and judgments. Management's estimates are based on their belief that future events will validate the current assumptions regarding the ultimate outcome of these exposures. However, there can be no assurance that future events, such as court decisions or Internal Revenue Service positions, will not differ from Management's assessments. Whenever practicable, Management consults with outside experts (attorneys, independent accountants, claims administrators, etc.) to assist with the gathering and evaluation of information related to contingent liabilities.
BUSINESS COMBINATIONS
Trustmark’s strategic acquisition program is based on efforts to evaluate opportunities to expand and invest in higher-growth markets by implementing market-specific business initiatives. This approach is designed to maximize financial profitability, bolster growth prospects and enhance shareholder value. In the first quarter of 2004, Trustmark entered the dynamic Houston banking market with the purchase of five branch offices from Allied Houston Bank. The Houston MSA is among the largest and highest-growth markets in the country. In December 2004, Trustmark continued to expand insurance services, as well as its presence in the Florida Panhandle, with the acquisition of Fisher-Brown, Incorporated, Northwest Florida’s leading insurance agency, headquartered in Pensacola, with offices in Milton, Mary Esther, Destin and Panama City. This transaction enhances Trustmark’s strategic goal of becoming a more diversified financial services organization. For more information on these business combinations, please refer to Note 2 of the Notes to the Consolidated Financial Statements.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the principal component of Trustmark’s income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates, as well as volume and mix changes in earning assets and interest-bearing liabilities, can materially impact net interest income. The net interest margin (NIM) is computed by dividing fully taxable equivalent net interest income by average interest-earning assets and measures how effectively Trustmark utilizes its interest-earning assets in relationship to the interest cost of funding them. The accompanying Yield/Rate Analysis Table shows the average balances for all assets and liabilities of Trustmark and the interest income or expense associated with earning assets and interest-bearing liabilities. The yields and rates have been computed based upon interest income and expense adjusted to a fully taxable equivalent (FTE) basis using a 35% federal marginal tax rate for all periods shown. Nonaccruing loans have been included in the average loan balances, and interest collected prior to these loans having been placed on nonaccrual has been included in interest income. Loan fees included in interest associated with the average loan balances are immaterial.
Net interest income-FTE for the three-month and nine-month periods of 2005 decreased $946 thousand, or 1.3%, and $2.7 million, or 1.3%, when compared with the same periods of 2004. Increases in the target fed funds rate of 275 basis points throughout 2004 and the first nine months of 2005 resulted in increased interest income-FTE and interest expense. While interest expense on interest-bearing liabilities, primarily federal funds purchased, repurchase agreements and borrowings, increased substantially, the increase in interest income on earning assets was sufficient to offset the additional interest expense. The combination of these factors resulted in a nominal decline in the NIM of 4 basis points for the nine months ended September 30, 2005 and 1 basis point for the quarter ended September 30, 2005 when compared with the same period in 2004. For additional discussion, see Market/Interest Rate Risk Management included later in the Management’s Discussion and Analysis.
Yield/Rate Analysis Table | | | | | | | | | | | | | | |
($ in thousands) | | | | | | | | | | | | | | |
| | | For the Three Months Ended September 30, | |
| | | 2005 | | | 2004 | |
| | | Average | | | | Yield/ | | | Average | | | | Yield/ | |
| | | Balance | | Interest | | Rate | | | Balance | | Interest | | Rate | |
Assets | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | |
| Federal funds sold and securities | | | | | | | | | | | | | | |
| purchased under reverse | | | | | | | | | | | | | | |
| repurchase agreements | | $ | 31,152 | | $ | 287 | | | 3.66 | % | | $ | 30,574 | | $ | 120 | | | 1.56 | % |
| Securities - taxable | | | 1,341,939 | | | 13,358 | | | 3.95 | % | | | 1,967,154 | | | 16,162 | | | 3.27 | % |
| Securities - nontaxable | | | 154,886 | | | 2,846 | | | 7.29 | % | | | 156,955 | | | 2,961 | | | 7.51 | % |
| Gross loans, including loans held for sale | | | 5,914,589 | | | 92,604 | | | 6.21 | % | | | 5,386,084 | | | 75,711 | | | 5.59 | % |
| Total interest-earning assets | | | 7,442,566 | | | 109,095 | | | 5.82 | % | | | 7,540,767 | | | 94,954 | | | 5.01 | % |
| Cash and due from banks | | | 313,434 | | | | | | | | | | 334,298 | | | | | | | |
| Other assets | | | 527,897 | | | | | | | | | | 488,363 | | | | | | | |
| Allowance for loan losses | | | (66,120 | ) | | | | | | | | | (74,228 | ) | | | | | | |
Total Assets | | $ | 8,217,777 | | | | | | | | | $ | 8,289,200 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders' Equity | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits | | $ | 4,316,518 | | | 21,415 | | | 1.97 | % | | $ | 4,006,694 | | | 13,547 | | | 1.35 | % |
| Federal funds purchased and | | | | | | | | | | | | | | | | | | | | |
| securities sold under | | | | | | | | | | | | | | | | | | | | |
| repurchase agreements | | | 637,923 | | | 5,050 | | | 3.14 | % | | | 966,420 | | | 3,243 | | | 1.33 | % |
| Borrowings | | | 1,165,417 | | | 11,591 | | | 3.95 | % | | | 1,241,519 | | | 6,179 | | | 1.98 | % |
| Total interest-bearing liabilities | | | 6,119,858 | | | 38,056 | | | 2.47 | % | | | 6,214,633 | | | 22,969 | | | 1.47 | % |
| Noninterest-bearing demand deposits | | | 1,245,573 | | | | | | | | | | 1,262,756 | | | | | | | |
| Other liabilities | | | 99,102 | | | | | | | | | | 79,427 | | | | | | | |
| Shareholders' equity | | | 753,244 | | | | | | | | | | 732,384 | | | | | | | |
Total Liabilities and | | | | | | | | | | | | | | | | | | | | |
Shareholders' Equity | | $ | 8,217,777 | | | | | | | | | $ | 8,289,200 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Net Interest Margin | | | | | | 71,039 | | | 3.79 | % | | | | | | 71,985 | | | 3.80 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Less tax equivalent adjustment | | | | | | 2,052 | | | | | | | | | | 2,062 | | | | |
Net Interest Margin per Consolidated | | | | | | | | | | | | | | | | | | | | |
Statements of Income | | | | | $ | 68,987 | | | | | | | | | $ | 69,923 | | | | |
Average interest-earning assets for the first nine months of 2005 were $7.404 billion, compared with $7.412 billion for the first nine months of 2004, a decrease of $7.8 million, or 0.1%. Growth in average loans, which increased $446.0 million, or 8.5%, was offset by a decrease in average securities of $462.3 million, or 21.6%, when the first nine months of 2005 and 2004 are compared. Since the fourth quarter of 2003, Management has been adjusting the balance sheet in anticipation of the risk of rising rates. This strategy has been well founded as short-term rates have risen 275 basis points over that time period. However, the upward shift in the short-term rates without a proportionate upward shift in long-term rates has diminished the profitability of holding long-term assets. If ignored, persistent interest rate behavior of this nature could lead to significant negative impact on margin. In preparation for potential adverse risks to margin, Management implemented a strategy of exiting certain assets and reducing balances of funding sources that would bear the highest costs in such a rate environment. This began in the fourth quarter of 2004, with the sale of $304 million in mortgage-related and U. S. Treasury securities and continued during the second quarter of 2005 when Trustmark sold $256 million in U. S. Government Agency and U. S. Treasury securities. Projected funding costs to carry these investments to their remaining maturity may have generated a greater negative margin impact than the actual losses incurred at sale. Proceeds from these sales were used to reduce balances of higher-cost funding sources. In addition, the flat yield curve experienced during the third quarter of 2005 along with expectations of higher rates provided limited opportunity to carry securities profitably, therefore, Management utilized the liquidity generated by maturing securities to fund additional loan growth as well as reduce balances of higher-cost funding sources during that time period.
Yield/Rate Analysis Table | | | | | | | | | | | | | | |
($ in thousands) | | | | | | | | | | | | | | |
| | | For the Nine Months Ended September 30, | |
| | | 2005 | | | 2004 | |
| | | Average | | | | Yield/ | | | Average | | | | Yield/ | |
| | | Balance | | Interest | | Rate | | | Balance | | Interest | | Rate | |
Assets | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | |
| Federal funds sold and securities | | | | | | | | | | | | | | |
| purchased under reverse | | | | | | | | | | | | | | |
| repurchase agreements | | $ | 32,435 | | $ | 703 | | | 2.90 | % | | $ | 24,005 | | $ | 226 | | | 1.26 | % |
| Securities - taxable | | | 1,524,537 | | | 43,085 | | | 3.78 | % | | | 1,982,676 | | | 47,183 | | | 3.18 | % |
| Securities - nontaxable | | | 154,792 | | | 8,626 | | | 7.45 | % | | | 158,912 | | | 9,058 | | | 7.61 | % |
| Gross loans, including loans held for sale | | | 5,692,465 | | | 257,331 | | | 6.04 | % | | | 5,246,443 | | | 221,082 | | | 5.63 | % |
| Total interest-earning assets | | | 7,404,229 | | | 309,745 | | | 5.59 | % | | | 7,412,036 | | | 277,549 | | | 5.00 | % |
| Cash and due from banks | | | 334,988 | | | | | | | | | | 336,210 | | | | | | | |
| Other assets | | | 530,551 | | | | | | | | | | 480,195 | | | | | | | |
| Allowance for loan losses | | | (65,754 | ) | | | | | | | | | (74,270 | ) | | | | | | |
Total Assets | | $ | 8,204,014 | | | | | | | | | $ | 8,154,171 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders' Equity | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits | | $ | 4,288,085 | | | 56,109 | | | 1.75 | % | | $ | 4,036,538 | | | 40,259 | | | 1.33 | % |
| Federal funds purchased and | | | | | | | | | | | | | | | | | | | | |
| securities sold under | | | | | | | | | | | | | | | | | | | | |
| repurchase agreements | | | 690,482 | | | 13,693 | | | 2.65 | % | | | 917,772 | | | 7,503 | | | 1.09 | % |
| Borrowings | | | 1,115,280 | | | 28,501 | | | 3.42 | % | | | 1,150,630 | | | 15,663 | | | 1.82 | % |
| Total interest-bearing liabilities | | | 6,093,847 | | | 98,303 | | | 2.16 | % | | | 6,104,940 | | | 63,425 | | | 1.39 | % |
| Noninterest-bearing demand deposits | | | 1,274,571 | | | | | | | | | | 1,267,936 | | | | | | | |
| Other liabilities | | | 82,766 | | | | | | | | | | 63,134 | | | | | | | |
| Shareholders' equity | | | 752,830 | | | | | | | | | | 718,161 | | | | | | | |
Total Liabilities and | | | | | | | | | | | | | | | | | | | | |
Shareholders' Equity | | $ | 8,204,014 | | | | | | | | | $ | 8,154,171 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Net Interest Margin | | | | | | 211,442 | | | 3.82 | % | | | | | | 214,124 | | | 3.86 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Less tax equivalent adjustment | | | | | | 6,137 | | | | | | | | | | 6,294 | | | | |
Net Interest Margin per Consolidated | | | | | | | | | | | | | | | | | | | | |
Statements of Income | | | | | $ | 205,305 | | | | | | | | | $ | 207,830 | | | | |
The rising interest rate environment positively impacted yields on average earning as seen by the improvement from 5.00% during the first nine months of 2004 to 5.59% for the first nine months of 2005, an increase of 59 basis points. The combination of larger loan balances and higher interest rates resulted in an increase in interest income-FTE during the first nine months of 2005 of $32.2 million, or 11.6%, when compared with the first nine months of 2004.
Average interest-bearing liabilities for the first nine months of 2005 totaled $6.094 billion, compared with $6.105 billion for the same time period in 2004, a decrease of $11.1 million, or 0.2%. Average interest-bearing deposits and short-term borrowings increased $472.5 million during the first nine months of 2005 offsetting decreases of $483.6 million in federal funds purchased, repurchase agreements and long-term FHLB advances. Management has made a concerted effort to promote funding from growth in core deposits, rather than other higher-cost funding sources, as a major component in improving the net interest margin and, ultimately, profitability.
The rising interest rate environment also impacted yields on interest-bearing liabilities as seen in the increase in rates on interest-bearing deposits (42 basis points), federal funds purchased and repurchase agreements (156 basis points) and borrowings (160 basis points) when the first nine months of 2005 and 2004 are compared. The average rates on interest-bearing liabilities for the first nine months of 2005 and 2004 were 2.16% and 1.39%, respectively, representing an increase of 77 basis points during 2005. As a result of these factors, total interest expense for the first nine months of 2005 increased $34.9 million, or 55.0%, when compared with the first nine months of 2004.
Provision for Loan Losses
The provision for loan losses is determined by Management as the amount to adjust the allowance for loan losses to a level, which, in Management’s best estimate, is necessary to absorb probable losses within the existing loan portfolio. The provision for loan losses for the three and nine months ended September 30, 2005, totaled $12.1 million and $16.4 million, respectively, compared with $1.2 million and $3.9 million, respectively, for the same periods of 2004. In the aftermath of Hurricane Katrina, Trustmark identified customers impacted by the storm in an effort to estimate the loss of collateral value and customer payment abilities. As a result of customer surveys, collateral inspections and review of risk characteristics, Trustmark has increased its allowance for loan losses through provision for loan losses by $9.8 million on a pre-tax basis. As a percentage of average loans, the provision was 0.38% for the first nine months of 2005 and 0.10% for the same period of 2004. These charges are based on Management’s estimates, assumptions and judgments based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from those estimates. See the section captioned “Loans and Allowance for Loan Losses” elsewhere in this discussion for further analysis of the provision for loan losses.
Noninterest Income
Noninterest income (NII) consists of revenues generated from a broad range of banking and financial services. NII totaled $108.7 million in the first nine months of 2005 compared with $96.1 million in the first nine months of 2004. The comparative components of noninterest income for the nine months ended September 30, 2005 and 2004 are shown in the accompanying table.
Noninterest Income | | | | | | | | | |
($ in thousands) | | | | | | | | | |
| | | Nine Months Ended September 30, | | | | | |
| | | 2005 | | 2004 | | $ Change | | % Change |
| Service charges on deposit accounts | | $ | 38,950 | | $ | 42,295 | | $ | (3,345 | ) | | -7.9 | % |
| Insurance commissions | | | 25,526 | | | 12,728 | | | 12,798 | | | 100.5 | % |
| Wealth management | | | 15,950 | | | 15,054 | | | 896 | | | 6.0 | % |
| Retail banking - other | | | 15,262 | | | 13,495 | | | 1,767 | | | 13.1 | % |
| Mortgage banking, net | | | 3,895 | | | 6,267 | | | (2,372 | ) | | -37.8 | % |
| Other, net | | | 13,125 | | | 6,271 | | | 6,854 | | | 109.3 | % |
| Securities (losses) gains | | | (4,009 | ) | | 21 | | | (4,030 | ) | | n/m |
| Total Noninterest Income | | $ | 108,699 | | $ | 96,131 | | $ | 12,568 | | | 13.1 | % |
n/m - not meaningful | | | | | | | | | | | | | |
The single largest component of noninterest income continues to be service charges for deposit products and services, which decreased $3.3 million, or 7.9%, when the first nine months of 2005 are compared with the same period in 2004. Included in the decrease are $990 thousand of lost service charges and NSF fees related to the impact of Hurricane Katrina. The primary reason for the remaining decrease in service charges is a decline in fees earned on deposit accounts as a result of increased usage of accounts that do not charge a monthly service fee. An additional component of this decrease relates to increases in earnings credits earned by commercial depositors as a result of the rising interest rate environment, which has negatively impacted the overall service charges earned on these accounts.
Insurance commissions were $25.5 million in the first nine months of 2005, compared with $12.7 million in the first nine months of 2004, an increase of $12.8 million or 100.5%. The increase in insurance commissions is primarily due to the Fisher-Brown acquisition, which occurred during the fourth quarter of 2004 and contributed approximately $12.5 million, or 98% of the increase.
Wealth management income was $16.0 million during the first nine months of 2005, compared with $15.1 million in the first nine months of 2004. Wealth management consists of income related to trust and advisory services, including income generated from Trustmark Securities, Inc. and Trustmark Investment Advisors, Inc. The growth in wealth management income is largely attributed to an increase in trust fee income resulting from new account growth, asset appreciation on existing accounts and changes in the fee structure related to certain managed accounts. In addition, the increased presence of wealth management teams in Florida, Houston and Memphis and the creation of the Wealth Management Center in Jackson have begun to positively impact income. At September 30, 2005, Trustmark held trust assets under administration of $6.2 billion, brokerage assets of $1.1 billion and fixed annuity assets of $194 million and remained one of the largest providers of asset management services in Mississippi.
Retail banking - other totaled $15.3 million for the nine months ended September 30, 2005, an increase of $1.8 million, or 13.1%, when compared with the same period of 2004. Retail banking - other income consists primarily of ATM fees, fees from the sale of checks, bank card fees and safe deposit box fees. This growth is a result of increased fees related to electronic transactions such as ACH and debit card transactions resulting from increased transaction volume.
Mortgage banking income was $3.9 million for the first nine months of 2005, compared to $6.3 million for the first nine months of 2004, as shown in the accompanying table. Net mortgage servicing income has remained constant, resulting from consistent balances in the mortgage servicing portfolio. Loans serviced for others totaled $3.6 billion and $3.4 billion at September 30, 2005 and 2004, respectively. As a result, the factors that drive the change in mortgage banking income are primarily those factors that are sensitive to changes in interest rates such as amortization and impairment of mortgage servicing rights as well as gains on sales of loans.
Amortization of mortgage servicing rights decreased to $8.0 million for the first nine months of 2005 when compared with $9.1 million for the same period in 2004, as the expected life of the portfolio has lengthened in response to a rise in interest rates from the historically low environment of the first quarter of 2004. During the third quarter of 2005, impairment charges of $785 thousand were recognized relating to Hurricane Katrina. Future changes in amortization and impairment of mortgage servicing rights will continue to be closely tied to fluctuations in long-term mortgage rates. Gain on sales of loans decreased from $3.9 million during the nine months ended September 30, 2004, to $644 thousand during the nine months ended September 30, 2005. The overall total of loan sales from secondary marketing activities increased from $636.0 million during the first nine months of 2004 to $692.6 million in the first nine months of 2005; however, the interest rate environment experienced during 2005 presented fewer gain on sale opportunities when compared to the first half of 2004. The impact of Hurricane Katrina resulted in losses on sales of loans of $770 thousand, which further reduced the gain on sale of loans for the nine months ended September 30, 2005. Other, net includes hurricane related charges totaling $728 thousand, which reduced mortgage banking income for the nine months ended September 30, 2005. These charges primarily relate to loans held for sale.
The accompanying table illustrates the components of mortgage banking included in noninterest income in the accompanying income statements.
Mortgage Banking Income | | | | | |
($ in thousands) | | | | | |
| | | Nine Months Ended September 30, | |
| | | 2005 | | 2004 | |
| Mortgage servicing income | | $ | 12,600 | | $ | 12,612 | |
| Mortgage guaranty fees | | | (3,346 | ) | | (3,302 | ) |
| Mortgage servicing, net | | | 9,254 | | | 9,310 | |
| Amortization of mortgage servicing rights | | | (7,990 | ) | | (9,076 | ) |
| Recovery of mortgage servicing rights, net | | | 1,638 | | | 1,516 | |
| Gain on sales of loans | | | 644 | | | 3,926 | |
| Other, net | | | 349 | | | 591 | |
| Mortgage banking, net | | $ | 3,895 | | $ | 6,267 | |
Other income totaled $13.1 million for the nine months ended September 30, 2005, compared with $6.3 million for the same period of 2004. During the third quarter of 2005, Trustmark evaluated its strategic alternatives in payment processing systems and selected NOVA Information systems as its provider of card processing services for its commercial merchant services customers. In connection with this alliance, Trustmark sold its existing payment processing portfolio in the third quarter for a pre-tax gain of $5.75 million.
Securities losses totaled $4.0 million during the nine months ended September 30, 2005, compared with securities gains of $21 thousand during the same period of 2004. The losses for the nine months ended September 30, 2005, primarily resulted from the sale of $256 million in U.S. Government Agency and U.S. Treasury securities during the second quarter of 2005. The sale of these securities resulted from an intentional reduction in the investment portfolio due to the declining profitability of holding longer-term investment securities.
Noninterest Expense
Trustmark’s noninterest expense increased $16.4 million, or 9.9%, in the first nine months of 2005 to $182.4 million, compared with $165.9 million in the same period of 2004. Excluding the Fisher-Brown acquisition and Allied Houston branch purchase, noninterest expense for the first nine months of 2005 would total $169.5 million, an increase of $5.9 million, or 3.6%, compared with the same period of 2004. Additional expenses in the third quarter of 2005 resulting from Hurricane Katrina were estimated to be approximately $539 thousand. Management continues to consider expense control a major component of improving shareholder value. The comparative components of noninterest expense for the nine months ended September 30, 2005 and 2004 are shown in the accompanying table.
Noninterest Expense | | | | | | | | | |
($ in thousands) | | | | | | | | | |
| | | Nine Months Ended September 30, | | | | | |
| | | 2005 | | 2004 | | $ Change | | % Change | |
| Salaries and employee benefits | | $ | 112,412 | | $ | 97,300 | | $ | 15,112 | | | 15.5 | % |
| Services and fees | | | 25,331 | | | 26,415 | | | (1,084 | ) | | -4.1 | % |
| Net occupancy - premises | | | 11,308 | | | 10,773 | | | 535 | | | 5.0 | % |
| Equipment expense | | | 11,461 | | | 11,122 | | | 339 | | | 3.0 | % |
| Other expense | | | 21,870 | | | 20,332 | | | 1,538 | | | 7.6 | % |
| Total Noninterest Expense | | $ | 182,382 | | $ | 165,942 | | $ | 16,440 | | | 9.9 | % |
During the first nine months of 2005, net occupancy-premises expense increased $535 thousand, or 5.0%. The increase during the first nine months of 2005 is attributable to occupancy costs associated with facilities acquired in the Fisher-Brown acquisition and Allied Houston branch purchase. Business combinations accounted for substantially all of the increase.
Equipment expense totaled $11.5 million for the nine months ended September 30, 2005, compared with $11.1 million for the same period of 2004, an increase of $339 thousand or 3.0%. Business combinations accounted for substantially all of the increase.
During the nine months ended September 30, 2005, other expense increased $1.5 million, or 7.6%. This increase is attributable to processing and collection costs associated with additional loan volume as well as increased amortization of insurance intangibles resulting from the Fisher-Brown acquisition. This increase includes $532 thousand of Hurricane Katrina related expenses.
Income Taxes
For the nine months ended September 30, 2005, Trustmark’s combined effective tax rate was 34.8%, compared with 34.5% for the first nine months of 2004. The slight increase in Trustmark’s effective tax rate for 2005 is due to immaterial changes in permanent items as a percentage of pretax income.
LIQUIDITY
Liquidity is the ability to meet asset funding requirements and operational cash outflows in a timely manner, in sufficient amount and without excess cost. Consistent cash flows from operations and adequate capital provide internally generated liquidity. Furthermore, Management maintains funding capacity from a variety of external sources to meet daily funding needs, such as those required to meet deposit withdrawals, loan disbursements and security settlements. Liquidity strategy also includes the use of wholesale funding sources to provide for the seasonal fluctuations of deposit and loan demand and the cyclical fluctuations of the economy that impact the availability of funds. Management keeps excess funding capacity available to meet potential demands associated with adverse circumstances.
The primary source of liquidity on the asset side of the balance sheet are maturities and cash flows from both loans and securities, as well as the ability to sell certain loans and securities. Liquidity on the liability side of the balance sheet is generated primarily through growth in core deposits. To provide additional liquidity, Trustmark utilizes economical short-term wholesale funding arrangements for federal funds purchased and securities sold under repurchase agreements in both regional and national markets. At September 30, 2005, Trustmark estimated gross fed funds borrowing capacity at $1.327 billion, compared to $1.137 billion at December 31, 2004. In addition, Trustmark maintains a borrowing relationship with the FHLB, which provided $575.0 million in short-term advances and $205.8 million in long-term advances at September 30, 2005, compared with $650.0 million in short-term advances and $180.9 million in long-term advances at December 31, 2004. These advances are collateralized by a blanket lien on Trustmark’s single-family, multi-family, home equity and commercial mortgage loans. Under the existing borrowing agreement, Trustmark has $1.038 billion available in unused FHLB advances. Another borrowing source is the Federal Reserve Discount Window (Discount Window). At September 30, 2005, Trustmark had approximately $554.7 million available in collateral capacity at the Discount Window from pledges of auto loans and securities, compared with $597.5 million available at December 31, 2004. In September 2004, Trustmark entered into a two-year revolving credit arrangement enabling borrowings of up to $50.0 million, subject to certain financial covenants. At September 30, 2005, Trustmark was in compliance with all financial covenants and had borrowings on this line of credit that totaled $11.0 million.
During 2003, Trustmark filed a registration statement on Form S-3 with the Securities and Exchange Commission (SEC) utilizing a “shelf” registration process. Under this shelf process, Trustmark may offer from time to time any combination of securities described in the prospectus in one or more offerings up to a total amount of $200 million. The securities described in the prospectus include common and preferred stock, depositary shares, debt securities, junior subordinated debt securities and trust preferred securities. Net proceeds from the sale of the offered securities may be used to redeem or repurchase outstanding securities, repay outstanding debt, finance acquisitions of companies and other assets and provide working capital.
The Board of Directors currently has the authority to issue up to 20 million preferred shares with no par value. The ability to issue preferred shares in the future will provide Trustmark with additional financial and management flexibility for general corporate and acquisition purposes. At September 30, 2005, no such shares have been issued.
Liquidity position and strategy are reviewed regularly by the Asset/Liability Committee and continuously adjusted in relationship to Trustmark’s overall strategy. Management believes that Trustmark has sufficient liquidity and capital resources to meet presently known cash flow requirements arising from ongoing business transactions.
CAPITAL RESOURCES
At September 30, 2005, Trustmark’s shareholders’ equity was $732.6 million, a decrease of $17.8 million, or 2.4%, from its level at December 31, 2004. This decrease is primarily related to dividends of $34.0 million, shares repurchased at a cost of $55.9 million and a net increase in accumulated other comprehensive loss of $6.3 million being offset by net income of $75.2 million for the first nine months of 2005. Management will continue to hold sufficient capital to provide for growth opportunities, protect the balance sheet against sudden adverse market conditions and maintain an attractive return on equity to shareholders.
Common Stock Repurchase Program
At September 30, 2005, Trustmark had remaining authorization for the repurchase of up to 958 thousand shares of its common stock. In October 2005, the Board of Directors authorized the repurchase of up to an additional 5%, or approximately 2.8 million shares, of the Corporation’s common stock. When combined with the previously existing share repurchase program, Trustmark now has authorization to repurchase up to an additional 3.8 million shares. Collectively, the capital management plans adopted by Trustmark since 1998 have authorized the repurchase of 24.3 million shares of common stock. Pursuant to these plans, Trustmark has repurchased approximately 20.5 million shares for $455.5 million, including 838 thousand shares during the third quarter of 2005 and 2.0 million shares for the nine months ended September 30, 2005.
Dividends
Dividends for the first nine months of 2005 were $0.60 per share, increasing 5.3% when compared with dividends of $0.57 per share in the first nine months of 2004. During October 2005, the Board of Directors of Trustmark announced a 5.0% increase in its regular quarterly dividend to $0.21 per share from $0.20 per share. The Board declared the dividend payable on December 15 to shareholders of record as of December 1, 2005. This action raises the indicated annual dividend rate to $0.84 per share from $0.80 per share.
Regulatory Capital Table | | | |
($ in thousands) | | | |
| | | September 30, 2005 | |
| | | Actual Regulatory Capital | | | Minimum Regulatory Capital Required | | | Minimum Regulatory Provision to be Well Capitalized | |
| | | Amount | | Ratio | | | Amount | | Ratio | | | Amount | | Ratio | |
| Total Capital (to Risk Weighted Assets) | | | | | | | | | | | | | | | |
| Trustmark Corporation | | $ | 642,813 | | | 10.68 | % | | $ | 481,663 | | | 8.00 | % | | | - | | | - | |
| Trustmark National Bank | | | 618,608 | | | 10.45 | % | | | 473,588 | | | 8.00 | % | | $ | 591,985 | | | 10.00 | % |
| Tier 1 Capital (to Risk Weighted Assets) | | | | | | | | | | | | | | | | | | | | | |
| Trustmark Corporation | | $ | 567,547 | | | 9.43 | % | | $ | 240,831 | | | 4.00 | % | | | - | | | - | |
| Trustmark National Bank | | | 545,444 | | | 9.21 | % | | | 236,794 | | | 4.00 | % | | $ | 355,191 | | | 6.00 | % |
| Tier 1 Capital (to Average Assets) | | | | | | | | | | | | | | | | | | | | | |
| Trustmark Corporation | | $ | 567,547 | | | 7.05 | % | | $ | 241,354 | | | 3.00 | % | | | - | | | - | |
| Trustmark National Bank | | | 545,444 | | | 6.90 | % | | | 236,983 | | | 3.00 | % | | $ | 394,971 | | | 5.00 | % |
Regulatory Capital
Trustmark and TNB are subject to minimum capital requirements, which are administered by various federal regulatory agencies. These capital requirements, as defined by federal guidelines, involve quantitative and qualitative measures of assets, liabilities and certain off-balance sheet instruments. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the financial statements of both Trustmark and TNB. Trustmark aims not only to exceed the minimum capital standards but also the well-capitalized guidelines for regulatory capital. Management believes, as of September 30, 2005, that Trustmark and TNB have met or exceeded all of the minimum capital standards for the parent company and its primary banking subsidiary as established by regulatory requirements. At
September 30, 2005, the most recent notification from the Office of the Comptroller of the Currency (OCC), TNB’s primary federal banking regulator, categorized TNB as well capitalized. To be categorized in this manner, TNB must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios (defined in applicable regulations) as set forth in the accompanying table. There are no significant conditions or events that have occurred since the OCC’s notification that Management believes have affected TNB’s present classification.
EARNING ASSETS
Earning assets serve as the primary revenue streams for Trustmark and are comprised of securities, loans, federal funds sold and securities purchased under resale agreements. At September 30, 2005, earning assets were $7.457 billion, or 89.5% of total assets, compared with $7.235 billion, or 89.8% of total assets at December 31, 2004, an increase of $222.1 million, or 3.1%.
Securities
Interest-bearing investment securities are held to provide a stable alternative source of interest income and to collateralize public deposits and repurchase agreements. Trustmark’s portfolio of investment securities also supports liquidity and profitability strategies and may be used to offset potential market risks in the various segments. The primary objective of the investment portfolio is to make an adequate contribution to net interest income. Management evaluates this contribution in relation to potential adverse market value risk that may impact strategic flexibility, liquidity or future earnings. During the fourth quarter of 2004, Management implemented a strategy of exiting certain assets and reducing balances of funding sources that would bear the highest costs in a rising interest rate environment. This strategy is illustrated by the sale of $304 million in mortgage-related and U. S. Treasury securities during the fourth quarter of 2004, which generated losses of $4.7 million, and continued during the second quarter of 2005 when Trustmark sold $256 million in U. S. Government Agency and U. S. Treasury securities, which incurred losses of $4.1 million. The average maturity of these securities was 2.14 years with an average book yield of 2.94%. Management believes projected funding costs to carry these investments to their remaining maturity may have generated a greater negative margin impact than the actual losses incurred at sale. Proceeds from sales were used to reduce balances of higher-cost funding sources. During the third quarter of 2005, Trustmark continued to deemphasize the holding of investment securities as seen by the decrease in overall balance of $76.8 million when compared to June 30, 2005. Trustmark intends to maintain lower balances in investment securities and reduce dependency on wholesale funding until market conditions provide more attractive opportunities. At September 30, 2005, Trustmark’s securities portfolio totaled $1.440 billion compared with $1.717 billion at December 31, 2004, a decrease of $276.6 million, or 16.1%.
The securities portfolio can serve as a powerful tool that Management uses to control exposure to interest rate risk. Interest rate risk can be adjusted by altering both the duration of the portfolio and the balance of the portfolio. Trustmark has maintained a strategy of offsetting potential exposure to higher interest rates by keeping both the duration and the balances of investment securities at relatively low levels. The estimated duration of the portfolio was 2.42 years at September 30, 2005, 2.47 years at December 31, 2004, and 2.30 years at September 30, 2004. Management intends to keep duration near historically low levels during 2005.
AFS securities are carried at their estimated fair value with unrealized gains or losses recognized, net of taxes, in accumulated other comprehensive loss, a separate component of shareholders’ equity. At September 30, 2005, AFS securities totaled $1.144 billion, which represented 79.4% of the securities portfolio, compared to $1.580 billion, or 92.0%, at December 31, 2004. At September 30, 2005, unrealized losses on AFS securities of $12.4 million, net of $4.7 million of deferred income taxes, were included in accumulated other comprehensive loss, compared with unrealized losses of $2.2 million, net of $841 thousand in deferred income taxes, at December 31, 2004. At September 30, 2005, AFS securities consisted of U.S. Treasury securities, obligations of states and political subdivisions, mortgage related securities, corporate securities and other securities, primarily Federal Reserve Bank and FHLB stock.
Held to maturity (HTM) securities are carried at amortized cost and represent those securities that Trustmark both intends and has the ability to hold to maturity. At September 30, 2005, HTM securities totaled $297.0 million and represented 20.6% of the total portfolio, compared with $136.8 million, or 8.0%, at the end of 2004.
During the third quarter of 2005, Trustmark moved $4.5 million in book value of held to maturity (HTM) securities to available for sale (AFS) as allowed by paragraph 8 of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” These securities were general obligation municipal bonds issued by seven different entities along the Mississippi Gulf Coast that incurred serious damage by Hurricane Katrina. These entities are facing severe fiscal and economic strain which has resulted in a material deterioration in their financial stability, at least in the short-term. Transferring these securities to AFS will provide a more transparent impact of the current value of the bonds in Trustmark’s consolidated financial statements and give Management more flexibility in managing the exposure to these entities as additional information emerges on their creditworthiness.
Management continues to focus on asset quality as one of the strategic goals of the securities portfolio, which is evidenced by the investment of over 85% of the portfolio in U.S. Treasury, U.S. Government agencies obligations and other AAA rated securities.
Loans and Allowance for Loan Losses
Loans represented 78.8% of earning assets at September 30, 2005, compared with 73.8% at December 31, 2004. At September 30, 2005, loans totaled $5.873 billion, a 10.2% increase from its level of $5.330 billion at December 31, 2004, due in part to growth in Trustmark’s Florida Gulf Coast, Mortgage Banking, Commercial Real Estate and Indirect Auto portfolios.
Trustmark makes loans in the normal course of business to certain directors, including their immediate families and companies in which they are principal owners. Such loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility at the time of the transaction.
Trustmark's lending policies have resulted in consistently sound asset quality. One measure of asset quality in the financial services industry is the level of nonperforming assets. The details of Trustmark’s nonperforming assets at September 30, 2005 and December 31, 2004, are shown in the accompanying table.
Nonperforming Assets and Past Due Loans | | | | | |
($ in thousands) | | | | | |
| | | September 30, | | December 31, | |
| | | 2005 | | 2004 | |
| Nonaccrual and restructured loans | | $ | 27,153 | | $ | 21,864 | |
| Other real estate (ORE) | | | 2,649 | | | 5,615 | |
| Total nonperforming assets | | $ | 29,802 | | $ | 27,479 | |
| | | | | | | | |
| Loans past due 90 days or more: | | | | | | | |
| Loan portfolio | | $ | 1,655 | | $ | 5,284 | |
| Loans held for sale | | | 8,434 | | | - | |
| Total loans past due 90 days or more | | $ | 10,089 | | $ | 5,284 | |
| | | | | | | | |
| Nonperforming assets/total loans and ORE | | | 0.51 | % | | 0.51 | % |
Total nonperforming assets increased $2.3 million, or 8.5%, during the first nine months of 2005. The increase from December 31, 2004, is primarily attributable to a single commercial credit of approximately $14.9 million, of which $11.9 million remained on nonaccrual at September 30, 2005. Nonperforming assets at September 30, 2005, were not affected by credit quality issues resulting from Hurricane Katrina. The allowance coverage of nonperforming loans was 278.97% at September 30, 2005. Loans held for sale past due 90 days or more includes $8.4 million in loans serviced by Trustmark and fully guaranteed by the Government National Mortgage Association that are eligible for repurchase.
The allowance for loan losses is established through provisions for estimated loan losses charged against earnings. The allowance for loan losses is maintained at a level believed adequate by Management, based on estimated probable losses within the existing loan portfolio. Trustmark’s allowance for loan loss methodology is based on guidance provided by the SEC Staff Accounting Bulletin No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues,” as well as other regulatory guidance. Accordingly, Trustmark’s methodology is based on historical loss experience by type of loan and internal risk rating, homogeneous risk pools and specific allocations, with adjustments considering current economic events and conditions.
The allowance for loan losses consists of three elements: (i) specific valuation allowances established for probable losses on specific loans; (ii) historical valuation allowances calculated based on historical loan experience for similar loans with similar characteristics and trends and (iii) unallocated general valuation allowances determined based on general economic conditions and other qualitative risk factors, both internal and external, to Trustmark.
In an effort to estimate the loss of collateral value and customer payment abilities, Trustmark identified customers specifically impacted by Hurricane Katrina. As a result of customer surveys, collateral inspections and review of risk characteristics, Trustmark has increased its allowance for loan losses through provision for loan losses by $9.8 million on a pre-tax basis. Specifically, $3.5 million and $1.5 million have been allocated for losses due to collateral impairment on 1-4 residential mortgages and consumer loans, respectively. General reserves of $4.8 million for consumer and commercial loans have been allocated for losses due to economic disruption caused by the storm. These charges are based on Management’s estimates, assumptions and judgments based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from those estimates.
At September 30, 2005, the allowance for loan losses was $75.8 million compared with $64.8 million at December 31, 2004, an increase of $11.0 million primarily resulting from an additional provision for loan losses of $9.8 million related to the impact of Hurricane Katrina on affected Trustmark loan customers. The allowance represented 1.29% of total loans outstanding at September 30, 2005, compared to 1.21% at December 31, 2004. Net charge-offs for the first nine months of 2005 totaled $5.4 million compared to $4.0 million for the same period of 2004. As of September 30, 2005, Management believes that the allowance for loan losses provides adequate protection in regards to charge-off experience and the current level of nonperforming assets. Loans identified as losses by Management, internal loan review and/or bank examiners are charged-off against the allowance, while consumer loans are charged-off based on regulatory requirements.
Other Earning Assets
Federal funds sold and securities purchased under reverse repurchase agreements were $15.7 million at September 30, 2005, a decrease of $70.5 million when compared with December 31, 2004. Trustmark utilizes these products as a short-term investment alternative whenever it has excess liquidity.
DEPOSITS AND OTHER INTEREST-BEARING LIABILITIES
Trustmark’s deposit base is its primary source of funding and consists of core deposits from the communities served by Trustmark. Deposits include interest-bearing and noninterest-bearing demand accounts, savings, money market, certificates of deposit, individual retirement accounts and brokered CDs. Total deposits were $5.845 billion at September 30, 2005, compared with $5.450 billion at December 31, 2004, an increase of $395.3 million, or 7.3%. Noninterest-bearing deposits have increased $3.4 million during the first nine months of 2005, while interest-bearing deposits have increased $391.9 million during the same time period. Management has continued to focus on increasing core deposit relationships under attractive terms as a tool to fuel growth throughout Trustmark’s four-state banking franchise. At September 30, 2005, brokered CDs totaled $250.7 million, an increase of $27.0 million when compared to December 31, 2004. Trustmark will continue to utilize a brokered CD program to provide additional deposit funding.
Trustmark uses short-term borrowings and long-term FHLB advances to fund growth of earning assets in excess of deposit growth. Short-term borrowings consist of federal funds purchased, securities sold under repurchase agreements, short-term FHLB advances and the treasury tax and loan note option account. Short-term borrowings totaled $1.446 billion at September 30, 2005, a decrease of $152.1 million, compared with $1.598 billion at December 31, 2004. Long-term FHLB advances totaled $205.8 million at September 30, 2005, an increase of $24.9 million from December 31, 2004. On a consolidated basis, total borrowings have decreased $127.2 million when compared to December 31, 2004, as Trustmark utilized liquidity from the sale and maturity of securities to reduce Trustmark’s dependency on wholesale funding products.
LEGAL ENVIRONMENT
Trustmark and its subsidiaries are parties to lawsuits and other claims that arise in the ordinary course of business. Some of the lawsuits assert claims related to the lending, collection, servicing, investment, trust and other business activities, and some of the lawsuits allege substantial claims for damages. The cases are being vigorously contested. In the regular course of business, Management evaluates estimated losses or costs related to litigation, and provision is made for anticipated losses whenever Management believes that such losses are probable and can be reasonably estimated. In recent years, the legal environment in Mississippi has been considered by many to be adverse to business interests, with regards to the overall treatment of tort and contract litigation as well as the award of punitive damages. However, tort reform legislation that became effective during recent years may reduce the likelihood of unexpected, sizable awards. At the present time, Management believes, based on the advice of legal counsel and Management’s evaluation, that the final resolution of pending legal proceedings will not have a material impact on Trustmark’s consolidated financial position or results of operations; however, Management is unable to estimate a range of potential loss on these matters because of the nature of the legal environment in states where Trustmark conducts business.
OFF-BALANCE SHEET ARRANGEMENTS
Trustmark makes commitments to extend credit and issues standby and commercial letters of credit in the normal course of business in order to fulfill the financing needs of its customers. These loan commitments and letters of credit are off-balance sheet arrangements.
Commitments to extend credit are agreements to lend money to customers pursuant to certain specified conditions. Commitments generally have fixed expiration dates or other termination clauses. Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Trustmark applies the same credit policies and standards as it does in the lending process when making these commitments. The collateral obtained is based upon the assessed creditworthiness of the borrower. At September 30, 2005 and 2004, Trustmark had commitments to extend credit of $1.565 billion and $1.344 billion, respectively.
Standby and commercial letters of credit are conditional commitments issued by Trustmark to insure the performance of a customer to a third party. When issuing letters of credit, Trustmark uses essentially the same policies regarding credit risk and collateral which are followed in the lending process. At September 30, 2005 and 2004, Trustmark’s maximum exposure to credit loss in the event of nonperformance by the other party for letters of credit was $111.5 million and $95.5 million, respectively. These amounts consist primarily of commitments with maturities of less than three years. Trustmark holds collateral to support certain letters of credit when deemed necessary.
ASSET/LIABILITY MANAGEMENT
Overview
Market risk is the risk of loss arising from adverse changes in market prices and rates. Trustmark has risk management policies to monitor and limit exposure to market risk. Trustmark’s market risk is comprised primarily of interest rate risk created by core banking activities. Interest rate risk is the risk to net interest income represented by the impact of higher or lower interest rates. Management continually develops and applies cost-effective strategies to manage these risks. The Asset/Liability Committee sets the day-to-day operating guidelines, approves strategies affecting net interest income and coordinates activities within policy limits established by the Board of Directors. A key objective of the asset/liability management program is to quantify, monitor and manage interest rate risk and to assist Management in maintaining stability in the net interest margin under varying interest rate environments.
Market/Interest Rate Risk Management
The primary purpose in managing interest rate risk is to invest capital effectively and preserve the value created by the core banking business. This is accomplished through the development and implementation of lending, funding, pricing and hedging strategies designed to maximize net interest income performance under varying interest rate environments subject to specific liquidity and interest rate risk guidelines.
The primary tool utilized by the Asset/Liability Committee is a third-party modeling system, which is widely accepted in the financial institutions industry. This system provides information used to evaluate exposure to interest rate risk, project earnings and manage balance sheet growth. This modeling system utilizes the following scenarios in order to give Management a method of evaluating Trustmark’s interest rate, basis and prepayment risk under different conditions:
| v | Rate shocked scenarios of up-and-down 100, 200 and 300 basis points. |
| v | Yield curve twist of +/- two standard deviations of the change in spread of the three-month Treasury bill and the 10-year Treasury note yields. |
| v | Basis risk scenarios where federal funds/LIBOR spread widens and tightens to the high and low spread determined by using two standard deviations. |
| v | Prepayment risk scenarios where projected prepayment speeds in up-and-down 200 basis point rate scenarios are compared to current projected prepayment speeds. |
Based on the results of the simulation models using static balances at September 30, 2005, it is estimated that net interest income may decrease 0.25%, in a one-year, shocked, up 200 basis point rate shift scenario, compared to a base case, flat rate scenario for the same time period. This minor change in forecasted net interest income illustrates Management’s strategy to mitigate Trustmark’s exposure to cyclical increases in rates by maintaining a neutral position in its interest rate risk position. This projection does not contemplate any additional actions Trustmark could undertake in response to changes in interest rates. In the event of a 100 basis point decrease in interest rates (utilized in place of a 200 basis point drop scenario due to the historically low interest rate environment), it is estimated net interest income may decrease by 0.97%. Management cannot provide any assurance about the actual effect of changes in interest rates on net interest income. The estimates provided do not include the effects of possible strategic changes in the balances of various assets and liabilities throughout 2005. Management will continue to prudently manage the balance sheet in an effort to control interest rate risk and maintain profitability over the long term.
As part of Trustmark’s risk management strategy in the mortgage banking area, various derivative instruments such as interest rate lock commitments and forward sales contracts are utilized. Forward contracts are agreements to purchase or sell securities or other money market instruments at a future specified date at a specified price or yield. Trustmark’s obligations under forward contracts consist of commitments to deliver mortgage loans, originated and/or purchased, in the secondary market at a future date. As permitted by Statement of Financial Accounting Standards (SFAS) No. 133, during 2003 Trustmark redesignated these derivative instruments as fair value hedges. In accordance with SFAS No. 133, changes in the values of derivatives designated as fair value hedges are recognized in earnings. In this case, Trustmark recognizes changes in the values of the designated derivatives in earnings simultaneously with changes in the values of the designated hedged loans. To the extent changes in the values of the derivatives are 100% effective in offsetting changes in the values of hedged loans, the fair value adjustments on the derivatives and hedged loans would offset one another. Management anticipates that this change will help mitigate the potential for earnings volatility related to the valuation of these hedging instruments in the future. The fair value of these derivatives was $276 thousand at September 30, 2005.
Trustmark continued a risk controlling strategy utilizing caps and floors, which may be further implemented over time. As of September 30, 2005, Trustmark was not utilizing interest rate floors but had interest rate cap contracts with notional amounts totaling $300 million, which mature in 2006. The intent of utilizing these financial instruments is to reduce the risk associated with the effects of significant movements in interest rates. Caps and floors, which are not designated as hedging instruments for accounting purposes, are options linked to a notional principal amount and an underlying indexed interest rate. Exposure to loss on these options will increase or decrease as interest rates fluctuate. At September 30, 2005, the fair value of these contracts was $57 thousand.
Another tool used for interest rate risk management is interest rate swaps. Interest rate swaps are derivative contracts under which two parties agree to make interest payments on a notional principal amount. In a generic swap, one party pays a fixed interest rate and receives a floating interest rate while the other party receives a fixed interest rate and pays a floating interest rate. During April 2003, Trustmark initiated four separate interest rate swaps with a total notional principal amount of $100 million. During July 2003, Trustmark added another interest rate swap with a notional principal amount of $25 million. In September 2005, an interest rate swap with a notional principal amount of $25 million matured. These swaps are designated as fair value hedges. Trustmark initiated these swaps to mitigate the effects of further changes in the fair value of specific noncallable, fixed rate advances from the FHLB by agreeing to pay a floating interest rate tied to LIBOR. Although this strategy exposes Trustmark somewhat to a rising rate environment, Management felt this was more economical in light of the significant prepayment charges associated with these advances. The swap contracts are tied to the maturity of four separate FHLB advances maturing between 2005 and 2006. The fair value of these interest rate swaps at September 30, 2005 was negative $561 thousand.
RECENT PRONOUNCEMENTS
In May 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 is a replacement of Accounting Principles Board Opinion (APB) No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. This statement applies to voluntary changes in accounting principle as well as changes required by an accounting pronouncement that provide no specific transition provisions. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The effects of this statement are not expected to have a material impact on Trustmark’s statement of position or results of operations.
In December 2004, the FASB issued a revision of SFAS No. 123 (SFAS No. 123r), “Share-Based Payment.” This Statement revises SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123r establishes standards for the accounting for transactions in which a company exchanges equity instruments for goods or services. This statement requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. As of the required effective date, public companies using the fair-value-based method for recognition or disclosure under SFAS No. 123, will apply this statement using a modified version of prospective application. Trustmark adopted the provisions of SFAS No. 123 effective January 1, 2003; therefore, Trustmark will recognize compensation cost for the portion of outstanding awards for which the requisite service has not yet been rendered (unvested awards). For public companies, this statement is effective as of the beginning of the first annual reporting period beginning after June 15, 2005. The effects of this statement are not expected to have a material impact on Trustmark’s statement of position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is included in the discussion of Market/Interest Rate Risk Management found in Management’s Discussion and Analysis.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Trustmark, under the supervision and with the participation of its management, including the Chief Executive Officer and the Treasurer (Principal Financial Officer), evaluated the effectiveness of the design and operation of Trustmark’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Principal Financial Officer concluded that as of the end of the third quarter of 2005, Trustmark’s disclosure controls and procedures were effective in ensuring that information required to be disclosed in the reports Trustmark files and submits under the Securities Exchange Act of 1934 are recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Changes in Internal Control over Financial Reporting
There has been no change in Trustmark’s internal control over financial reporting during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, Trustmark’s internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There were no material developments for the quarter ended September 30, 2005, other than those disclosed in the Notes to Consolidated Financial Statements and Management’s Discussion and Analysis of this Form 10-Q.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table shows information relating to the repurchase of common shares by Trustmark Corporation during the three months ended September 30, 2005:
| | | | | | | Total Number of | | Maximum Number | |
| | | | | | | Shares Purchased | | of Shares that May | |
| | | Total Number | | Average | | as Part of Publicly | | Yet be Purchased | |
| | | of Shares | | Price Paid | | Announced Plans | | Under the Plans | |
| Period | | Purchased | | Per Share | | or Programs | | or Programs | |
| July 1, 2005 through | | | | | | | | | |
| July 30, 2005 | | | 3,300 | | $ | 28.33 | | | 3,300 | | | 1,792,969 | |
| | | | | | | | | | | | | | |
| August 1, 2005 through | | | | | | | | | | | | | |
| August 31, 2005 | | | 596,870 | | $ | 28.09 | | | 596,870 | | | 1,196,099 | |
| | | | | | | | | | | | | | |
| September 1, 2005 through | | | | | | | | | | | | | |
| September 30, 2005 | | | 238,260 | | $ | 27.58 | | | 238,260 | | | 957,839 | |
| | | | | | | | | | | | | | |
| Total | | | 838,430 | | | | | | 838,430 | | | | |
On October 18, 2005, the Board of Directors of Trustmark authorized a plan to repurchase 5% of current shares outstanding, or 2,792,334 shares. As seen in the table above, Trustmark has remaining authorization to purchase 957,839 shares from a repurchase plan implemented on July 15, 2003. When combined, Trustmark now has authorization to repurchase up to an additional 3,750,173 of its shares. The repurchase program is subject to Management’s discretion and will continue to be implemented through open market purchases or privately negotiated transactions.
ITEM 6. EXHIBITS
The exhibits listed in the Exhibit Index are filed herewith or are incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
TRUSTMARK CORPORATION
| BY: | /s/ Richard G. Hickson | | BY: | /s/ Zach L. Wasson |
| | Richard G. Hickson | | | Zach L. Wasson |
| | Chairman of the Board, President | | | Treasurer (Principal Financial Officer) |
| | & Chief Executive Officer | | | |
| | | | | |
| DATE: | November 9, 2005 | | DATE: | November 9, 2005 |
| | | | | |
EXHIBIT INDEX
3-b | By-Laws, as amended, effective October 18, 2005 |
31-a | Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31-b | Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32-a | Certification by Chief Executive Officer pursuant to 18 U.S.C. ss. 1350. |
32-b | Certification by Chief Financial Officer pursuant to 18 U.S.C. ss. 1350. |
All other exhibits are omitted, as they are inapplicable or not required by the related instructions.
