ASU 2014-14, “Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Residential Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” Issued in August 2014, ASU 2014-14 requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under the claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. ASU 2014-14 also provides that upon foreclosure, the separate other receivable would be measured based on the current amount of the loan balance (principal and interest) expected to be recovered under the guarantee. The amendments of ASU 2014-14 are effective for interim and annual periods beginning after December 15, 2014, and may be applied using either a modified retrospective transition method or a prospective transition method as described in ASU 2014-14. The adoption of ASU 2014-14 is not expected to have a significant impact to Trustmark’s consolidated financial statements.
ASU 2014-11, “Transfers and Servicing (Topic 860) – Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.” Issued in June 2014, ASU 2014-11 changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting, and for repurchase financing arrangements requires separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. ASU 2014-11 also require disclosures for certain transactions comprising a transfer of a financial asset accounted for as a sale and an agreement with the same transferee entered into in contemplation of the initial transfer that results in the transferor retaining substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. ASU 2014-11 requires interim and annual disclosures for repurchase agreements, securities lending transactions and repurchase-to-maturity transactions that are accounted for as secured borrowings, which include a disaggregation of the gross obligation by class of collateral pledged; the remaining contractual tenor of the agreements; and a discussion of the potential risks associated with the agreements and the related collateral pledged, including obligations arising from a decline in the fair value of the collateral pledged and how those risks are managed. The accounting changes and disclosure requirements for certain transactions accounted for as a sale in ASU 2014-11 are effective for interim and annual periods beginning after December 15, 2014. The disclosures for transactions accounted for as secured borrowings are required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. Trustmark currently accounts for its repurchase agreements as secured borrowings; therefore, the adoption of ASU 2014-11 will be a change in presentation only for the newly required disclosures and will not have a significant impact to Trustmark’s consolidated financial statements.
ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” Issued in May 2014, ASU 2014-09 will add FASB ASC Topic 606, “Revenue from Contracts with Customers,” and will supersede revenue recognition requirements in FASB ASC Topic 605, “Revenue Recognition,” as well as certain cost guidance in FASB ASC Topic 605-35, “Revenue Recognition – Construction-Type and Production-Type Contracts.” ASU 2014-09 provides a framework for revenue recognition that replaces the existing industry and transaction specific requirements under the existing standards. ASU 2014-09 requires an entity to apply a five-step model to determine when to recognize revenue and at what amount. The model specifies that revenue should be recognized when (or as) an entity transfers control of goods or services to a customer at the amount in which the entity expects to be entitled. Depending on whether certain criteria are met, revenue should be recognized either over time, in manner that depicts the entity’s performance, or at a point in time, when control of the goods or services are transferred to the customer. ASU 2014-09 provides that an entity should apply the following steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. In addition, the existing requirements for the recognition of a gain or loss on the transfer of non-financial assets that are not in a contract with a customer are amended to be consistent with the guidance on recognition and measurement in ASU 2014-09. The amendments of ASU 2014-09 are effective for interim and annual periods beginning after December 15, 2016, and may be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application. If the transition method of application is elected, the entity should also provide the additional disclosures in reporting periods that include the date of initial application of (1) the amount by which each financial statement line item is affected in the current reporting period, as compared to the guidance that was in effect before the change, and (2) an explanation of the reasons for significant changes. Management is currently evaluating the impact this ASU will have on Trustmark’s consolidated financial statements as well as the most appropriate method of application; however, regardless of the method of application selected, the adoption of ASU 2014-01 is not expected to have a significant impact to Trustmark’s consolidated financial statements.
ASU 2014-04, “Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” Issued in January 2014, ASU 2014-04 clarifies when an “in substance repossession or foreclosure” occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loans, such that all or a portion of the loan should be derecognized and the real estate property recognized. ASU 2014-04 states that a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure, or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The amendments of ASU 2014-04 also require interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The amendments of ASU 2014-04 are effective for interim and annual periods beginning after December 15, 2014, and may be applied using either a modified retrospective transition method or a prospective transition method as described in ASU 2014-04. For Trustmark, the adoption of ASU 2014-04 will be change in presentation only for the newly required disclosures and is not expected to have a significant impact to Trustmark’s consolidated financial statements.
ASU 2014-01, “Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” Issued in January 2014, ASU 2014-01 permits reporting entities that invest in qualified affordable housing projects to elect to account for those investments using the “proportional amortization method” if certain conditions are met. Under this method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The decision to apply the proportional amortization method of accounting is an accounting policy decision and should be applied consistently to all qualifying affordable housing project investments. ASU 2014-01 should be applied retrospectively to all periods presented and is effective for annual and interim reporting periods beginning after December 15, 2014. Trustmark currently accounts for its tax credit investments utilizing the equity method of accounting and does not have a significant amount of investments in qualified affordable housing projects that qualify for the low income housing tax credit. Management will review Trustmark’s investments in qualified affordable housing projects to determine if these investments meet the conditions required for using the proportional amortization method of accounting and make a decision regarding the accounting policy. The adoption of ASU 2014-01 is not expected to have a significant impact to Trustmark’s consolidated financial statements.
ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force).” Issued in July 2013, ASU 2013-11 provides that an entity’s unrecognized tax benefit, or a portion of its unrecognized tax benefit, should be presented in its financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with one exception. The exception states that to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position, or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU 2013-11 applies prospectively for all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or tax credit carryforward exists at the reporting date. ASU 2013-11 became effective for Trustmark’s financial statements on January 1, 2014, and the adoption did not have a significant impact to Trustmark’s consolidated financial statements.
ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” Issued in February 2013, ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on net income line items only for those items that are reported in their entirety in net income in the period of reclassification. For these items, entities are required to disclose the effect of the reclassification on each line item of net income that is affected by the reclassification adjustment. For items that are not reclassified in their entirety into net income, an entity is required to add a cross-reference to the note that includes additional information about the effect of the reclassification. For entities that only have reclassifications into net income in their entirety, this information may be presented either in the notes or parenthetically on the face of the statement that reports net income as long as the required information is reported in a single location. Entities that have one or more reclassification items that are not presented in their entirety in net income in the period of reclassification must present this information in the notes to the financial statements. ASU 2013-02 became effective for Trustmark’s financial statements on January 1, 2013, and the adoption did not have a significant impact to Trustmark’s consolidated financial statements. The required disclosures are reported in Note 15 – Shareholders’ Equity.
ASU 2013-01. “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” Issued in January 2013, ASU 2013-01 clarifies that the scope of ASU 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities,” applies to derivatives accounted for in accordance with FASB ASC Topic 815, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreements. ASU 2013-01 became effective for Trustmark’s financial statements on January 1, 2013, and the adoption did not have a significant impact to Trustmark’s consolidated financial statements. The required disclosures are reported in Note 17 – Derivatives.
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
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 unaudited consolidated financial statements and the supplemental financial data included elsewhere in this report.
Description of Business
Trustmark, a Mississippi business corporation incorporated in 1968, is a bank holding company headquartered in Jackson, Mississippi. Trustmark’s principal subsidiary is Trustmark National Bank (TNB), initially chartered by the State of Mississippi in 1889. At September 30, 2014, TNB had total assets of $12.094 billion, which represented approximately 99.98% of the consolidated assets of Trustmark.
Through TNB and its other subsidiaries, Trustmark operates as a financial services organization providing banking and other financial solutions through 207 offices and 3,067 full-time equivalent associates located in the states of Alabama (primarily in the central and southern regions of that state, which are collectively referred to herein as Trustmark’s Alabama market), Florida (primarily in the northwest or “Panhandle” region of that state which is referred to herein as Trustmark’s Florida market), Mississippi, Tennessee (
in Memphis
and
the Northern Mississippi regions,
which are collectively referred to herein as
Trustmark’s Tennessee market), and Texas (primarily in Houston, which is referred to herein as Trustmark’s Texas market). The principal products produced and services rendered by TNB and Trustmark’s other subsidiaries are as follows:
Trustmark National Bank
Commercial Banking – TNB provides a full range of commercial banking services to corporations and other business customers. Loans are provided for a variety of general corporate purposes, including financing for commercial and industrial projects, income producing commercial real estate, owner-occupied real estate and construction and land development. TNB also provides deposit services, including checking, savings and money market accounts and certificates of deposit as well as treasury management services.
Consumer Banking – TNB provides banking services to consumers, including checking, savings, and money market accounts as well as certificates of deposit and individual retirement accounts. In addition, TNB provides consumer customers with installment and real estate loans and lines of credit.
Mortgage Banking – TNB provides mortgage banking services, including construction financing, production of conventional and government insured mortgages, secondary marketing and mortgage servicing. At September 30, 2014, TNB’s mortgage loan portfolio totaled approximately $1.074 billion, while its portfolio of mortgage loans serviced for others, including Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC) and Government National Mortgage Association (GNMA), totaled approximately $5.586 billion.
Insurance – TNB provides a competitive array of insurance solutions for business and individual risk management needs. Business insurance offerings include services and specialized products for medical professionals, construction, manufacturing, hospitality, real estate and group life and health plans. Individual customers are also provided life and health insurance, and personal line policies. TNB provides these services through Fisher Brown Bottrell Insurance, Inc. (FBBI), a Mississippi corporation which is based in Jackson, Mississippi.
Wealth Management and Trust Services – TNB offers specialized services and expertise in the
areas of wealth management, trust, investment and custodial services for corporate and individual customers. These services include the administration of personal trusts and estates as well as the management of investment accounts for individuals, employee benefit plans and charitable foundations. TNB also provides corporate trust and institutional custody, securities brokerage, financial and estate planning, retirement plan services as well as life insurance and other risk management services provided by FBBI. TNB’s wealth management division is also served by Trustmark Investment Advisors, Inc. (TIA), a Securities and Exchange Commission (SEC)-registered investment adviser. TIA provides customized investment management services for TNB customers. During the second quarter of 2014, TNB moved the administration of Private Banking, previously reported in the Wealth Management Division, to the General Banking Division, which encompasses TNB’s commercial, consumer and mortgage banking products and services. At September 30, 2014, TNB held assets under management and administration of $10.635 billion and brokerage assets of $1.601 billion.
New Market Tax Credits (NMTC) – TNB provides an intermediary vehicle for the provision of loans or investments in Low-Income Communities (LICs) through its subsidiary Southern Community Capital, LLC (SCC). SCC is a Mississippi single member limited liability company and a certified Community Development Entity (CDE). The primary mission of SCC is to provide investment capital for LICs, as defined by Section 45D of the Internal Revenue Code, or Low-Income Persons (LIPs). As a certified CDE, SCC is able to apply to the Community Development Financial Institutions Fund (CDFI Fund) to receive NMTC allocations to offer investors in exchange for equity investments in qualified projects.
Capital Trusts
Trustmark Preferred Capital Trust I (the Trust) is a Delaware trust affiliate formed in 2006 to facilitate a private placement of $60.0 million in trust preferred securities. As defined in applicable accounting standards, the Trust is considered a variable interest entity for which Trustmark is not the primary beneficiary. Accordingly, the accounts of the Trust are not included in Trustmark’s consolidated financial statements.
Executive Overview
Recent Economic and Industry Developments
The economy has continued to show moderate signs of improvement; however, lingering economic concerns remain as a result of the cumulative weight of soft U.S. labor markets, slowing growth in markets in Western Europe, as well as in China and other emerging markets, combined with uncertainty regarding the timing of the anticipated tightening of the monetary policy by the Federal Reserve Board. 2014 has been characterized by economic uncertainty and significant volatility in the global markets, which could continue through the remainder of this year. Doubts surrounding the near-term direction of global markets are expected to persist for some time.
Estimated employment growth in the United States for the first nine months of 2014 was reported to average approximately 227,000 jobs created per month. The unemployment rate declined to 5.9% as of September 2014, which reflected a decline in the number of jobs lost as well as a decrease in the number of people who rejoined the labor force, which is a less positive driver than job growth. Consumer confidence reported marginal improvement in the third quarter of 2014, as consumer confidence reported a considerable decline in September 2014 after four consecutive months of improvement. Consumers reportedly were less optimistic about the current job market as well as the outlook for future job prospects and the overall economy. In the October 2014 “Summary of Commentary on Current Economic Conditions by Federal Reserve Districts,” the twelve Federal Reserve Districts’ reports suggested overall economic activity continued to expand at a moderate pace during the third quarter reporting period. According to the Federal Reserve Districts’ reports, overall consumer spending in most districts increased, and activity in the nonfinancial services sector continued to expand in several districts at a moderate pace. According to the Federal Reserve Districts’ reports, real estate activity varied with most districts reporting low inventories, increasing home prices and mixed demand, while commercial construction activity was generally stronger across the districts reportedly due to higher demand and low vacancy rates. According to the Federal Reserve Districts’ reports, most districts reported slight to moderate increases in loan volumes while credit quality remained stable or improved slightly during the third quarter reporting period.
The impact of increases in interest rates during the second half of 2013 remained evident in the year-over-year earnings comparisons across the banking industry during the first nine months of 2014. In the Federal Deposit Insurance Corporation’s (FDIC) second quarter 2014 “Quarterly Banking Profile” (published August 28, 2014), insured institutions reported, in the aggregate, an increase in net income of 5.3% when the second quarter of 2014 is compared to the second quarter of 2013; however, net operating revenue (the sum of net interest income and total noninterest income) for the second quarter of 2014 was reported to be 0.9% lower than the second quarter of 2013, as declines in mortgage revenue and realized gains on securities caused by higher interest rates outweighed the gains in net interest income resulting from a steeper yield curve. FDIC insured institutions also reported in the second quarter 2014 “Quarterly Banking Profile,” in the aggregate, the lowest quarterly total for net charge-offs since the second quarter of 2007 as charge-offs in all major loan categories, except auto loans, had year-over-year declines; improved noncurrent levels across all major loan categories, except auto loans; declines in loan-loss reserves for the seventeenth consecutive quarter as net charge-offs taken out of reserves exceeded the provisions added to reserves; and increased equity capital as the industry’s core capital (leverage) ratio and the Tier 1 risk-based capital ratio rose to record levels for the industry. FDIC insured institutions reported in the second quarter 2014 “Quarterly Banking Profile,” in the aggregate, the largest quarterly increase in loan balances since the fourth quarter of 2007 as all major loan categories posted increases during the quarter with the exception of home equity lines of credit. As noted above, recent market volatility, evidencing uncertainty across a range of metrics, has resulted in significant short-term changes in the interest rate environment, making it all the more difficult to attempt to draw conclusions as to the future interest rate environment for the banking industry from the historical data summarized above.
Financial Highlights
Trustmark continued to achieve solid financial results in the third quarter of 2014, including the sixth consecutive quarter of growth in the loans held for investment (LHFI) portfolio as well as growth in the revenues generated by the Insurance and Wealth Management Divisions. Trustmark reported net income of $33.6 million, or basic and diluted earnings per share of $0.50 in the third quarter of 2014, compared to $33.0 million, or basic and diluted earnings per share of $0.49 in the third quarter of 2013. Trustmark’s performance during the quarter ended September 30, 2014, produced a return on average tangible equity of 13.70% and a return on average assets of 1.10% compared to a return on average tangible equity of 14.92% and a return on average assets of 1.11% during the quarter ended September 30, 2013. For the nine months ended September 30, 2014, Trustmark report net income of $95.5 million, or basic and diluted earnings per share of $1.42 and $1.41, respectively, compared to $89.0 million, or basic and diluted earnings per share of $1.33, for the nine months ended September 30, 2013. Trustmark’s performance for the nine months ended September 30, 2014, produced a return on average tangible equity of 13.52% and a return on average assets of 1.06% compared to a return on average tangible equity of 13.25% and a return on average assets of 1.04% for the nine months ended September 30, 2013. Trustmark’s Board of Directors declared a quarterly cash dividend of $0.23 per share. The dividend is payable December 15, 2014, to shareholders of record on December 1, 2014.
Net income for the first nine months of 2014 increased $6.5 million, or 7.3%, compared to the same time period in 2013. The $19.8 million, or 6.9%, increase in net interest income, primarily resulted from increases in interest and fees on acquired loans and taxable interest on securities of $10.3 million and $4.7 million, respectively, and a decrease in interest expense on deposits of $3.0 million. The growth in net interest income during the period was partially offset by the $14.0 million increase in the provision for loan losses on LHFI, primarily due to a reduction in the amount of reserves release as compared to the same time period in 2013, and the $3.1 million increase in the provision for loan losses on acquired loans, primarily due to acquired loans in which a debt settlement or foreclosure occurred during the second quarter of 2014 for an amount which exceeded the previous loss expectations to date. Total noninterest income decreased $4.1 million, or 3.0%, as declines in mortgage banking, net, service charges on deposit accounts and bank card and other fees offset gains in all other categories. The $6.3 million, or 2.0%, decrease in noninterest expense for the first nine months of 2014 was primarily due to a decrease in other noninterest expense as a result of non-routine transaction expenses from the acquisition of BancTrust Financial Group, Inc. (BancTrust) and settlement of the non-sufficient funds and overdraft fees litigation incurred during the first nine months of 2013 as well as a decline in ORE/foreclosure expense during 2014. Please see the section captioned “Results of Operations” below for a more complete overview of Trustmark’s financial performance for the first nine months of 2014.
Trustmark’s provision for loan losses, LHFI, for the nine months ended September 30, 2014 totaled $2.6 million, an increase of $14.0 million when compared to a negative provision for loan losses, LHFI of $11.4 million for the nine months ended September 30, 2013. The increase in the provision for loan losses, LHFI during the first nine months of 2014 reflects a decrease in the amount of established reserves being released compared to the same period in 2013 for both new and existing impaired LHFI as well as an increase in the reserve for commercial LHFI portfolio changes and the revised allowance for loan loss methodology for consumer LHFI, which was partially offset by net recoveries of LHFI, changes in the quantitative and qualitative reserve factors, and improved credit quality. Please see the section captioned “Provision for Loan Losses, LHFI,” for additional information regarding the provision for loan losses, LHFI. At September 30, 2014, nonperforming assets, excluding acquired loans and covered other real estate, totaled $185.4 million, an increase of $13.6 million, or 7.9%, compared to December 31, 2013. Total nonaccrual LHFI were $88.3 million at September 30, 2014, representing an increase of $23.1 million, or 35.4%, relative to December 31, 2013, principally due to one substandard credit migrating to nonaccrual status during the second quarter of 2014 and two substandard credits migrating to nonaccrual status during the third quarter of 2014, which totaled $24.8 million at September 30, 2014. Total net recoveries of LHFI for the nine months ended September 30, 2014 and 2013 were $1.1 million and $1.3 million, respectively, a decrease of $250 thousand, or 18.8%.
Management has continued to carefully monitor the impact of illiquidity in the financial markets, values of securities and other assets, loan performance, default rates and other financial and macro-economic indicators, in order to navigate the challenging economic environment. Trustmark has continued to experience improvements in credit quality on LHFI. As of September 30, 2014, classified LHFI balances decreased $38.8 million, or 15.9%, while criticized LHFI balances decreased $27.4 million, or 9.7%, when compared to balances at September 30, 2013. The volume of classified and criticized LHFI decreased year-over-year primarily as a result of improvement in repayment capacity of borrowers and subsequent upgrade of those credits to a pass category as well as repayment of several credits of significant size.
Trustmark did not make significant changes to its loan underwriting standards during the first nine months of 2014. Trustmark’s willingness to make loans to qualified applicants that meet its traditional, prudent lending standards has not changed. Trustmark adheres to interagency guidelines regarding concentration limits of commercial real estate loans. As a result of the economic downturn, Trustmark remains cautious in granting credit involving certain categories of real estate as well as making exceptions to its loan policy.
Management has continued its practice of maintaining excess funding capacity to provide Trustmark with adequate liquidity for its ongoing operations. In this regard, Trustmark benefits from its strong deposit base, its highly liquid investment portfolio and its access to funding from a variety of external funding sources such as upstream federal funds lines and Federal Home Loan Bank (FHLB) advances.
At close of business on December 31, 2013, Trustmark consolidated its wholly owned subsidiary Somerville Bank & Trust Company (Somerville) into TNB. TNB and Somerville were both wholly owned subsidiaries of Trustmark; as such, the merger represented a business reorganization between affiliates under common control. Trustmark anticipates that this consolidation will enhance productivity and efficiency with elimination of duplicate functions and operating systems as well as support revenue growth with the addition of a broader product line for Somerville’s customers. Trustmark is committed to investments to support profitable revenue growth as well as reengineering and efficiency opportunities to enhance shareholder value.
Critical Accounting Policies
Trustmark’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP) 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. There have been no significant changes in Trustmark’s critical accounting policies during the first nine months of 2014.
Recent Legislative and Regulatory Developments
In early July 2013, the Federal Reserve Board (FRB), FDIC and the Office of the Comptroller of the Currency (OCC) jointly promulgated a final rule revising regulatory capital requirements to address perceived shortcomings in the existing regulatory capital requirements that became evident during the recent financial crisis by implementing capital requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and international capital regulatory standards by the Basel Committee. The new final capital rule adopts a new common equity Tier 1 requirement, higher minimum Tier 1 requirements, new risk-weight calculation methods for the “standardized” denominator, revised regulatory components and calculations, required capital buffers above the minimum risk-based capital requirements for certain banking organizations, and more generally restructures the agencies’ capital rules. Many of the final rules apply to all depository institutions, and bank holding companies with assets of $500 million or more, and savings and loan holding companies. The final rules also addressed the relevant provisions of the Dodd-Frank Act, including removal of references to credit ratings in the capital rules and implementation of a capital floor, known as the “Collins Amendment.” Importantly, the new final capital rule does not change the current treatment of residential mortgage exposures. Also, banking organizations that are not subject to the advanced approaches capital rules can opt not to incorporate most amounts reported as accumulated other comprehensive income (loss) (AOCI) in the calculation of their regulatory capital, which is consistent with the treatment of AOCI under the current rules. Finally, smaller depository institution holding companies (those with assets less than $15 billion) and most mutual holding companies will be allowed to continue to count as Tier 1 capital most existing trust preferred securities that were issued prior to May 19, 2010 rather than phasing such securities out of regulatory capital. Trustmark currently has outstanding such securities that it counts as Tier 1 capital. Most banking organizations will be required to apply the new capital rules on January 1, 2015. It is expected that banking organizations subject to the new final capital rules, including Trustmark, will be required to hold a greater amount of capital and a greater amount of common equity than they are currently required to hold. Management is currently evaluating the impact the new final capital rules will have on Trustmark.
On January 18, 2013, the Consumer Financial Protection Bureau (CFPB), FRB, FDIC, OCC, Federal Housing Finance Agency, and National Credit Union Administration, issued a final rule implementing amendments to the Truth in Lending Act (TILA) made by the Dodd-Frank Act. The final rule imposes heightened appraisal requirements for higher-priced mortgage loans and became mandatory on January 18, 2014. After notice and comment, the six agencies subsequently issued a final rule on December 12, 2013, that created exemptions from these appraisal requirements for loans of $25,000 or less, certain “streamlined” refinancings, and certain loans secured by manufactured housing. The final rule, as revised, is intended to provide creditors with some relief from the mortgage appraisal requirements. Trustmark has implemented the appropriate policies, procedures, and training to assure compliance with these new rules. Trustmark’s operations and consolidated financial statements were not impacted by the implementation of these new rules.
In October 2012, the FRB, FDIC and OCC published final rules implementing the company-run stress test requirements mandated by the Dodd-Frank Act. The final rules require institutions with average total consolidated assets between $10 billion and $50 billion to conduct an annual company-run stress test using data as of September 30 of each year under one base and at least two stress scenarios as provided by the agencies. Stress test results must be provided to the agencies by March 31 of the following year. Because Trustmark did not exceed the $10 billion threshold until February 2013, it will not be subject to these stress test requirements until September 2014, with a formal filing requirement of March 2015. On October 17, 2014, the FRB issued a notice of final rulemaking to switch the testing dates to match the calendar year so that stress tests would use year-end data and capital planning would follow for the next calendar year. The FRB’s final rule, beginning with the January 1, 2016 annual stress test cycle, requires institutions with total consolidated assets between $10 billion and $50 billion to conduct an annual company-run stress test using data as of December 31 of the preceding year, provide results to the agencies by July 31 of each year and publicly disclose results in October of each year. Trustmark anticipates that the capital ratios, as reflected in the stress test calculations under the required stress test scenarios, will be an important factor considered by the agencies in evaluating the capital adequacy of Trustmark and TNB and whether proposed payments of dividends or stock repurchases are consistent with prudential expectations.
| | | | | | | | | | | | |
($ in thousands, except per share data) | | | | | | | | | | | | |
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | 2014 | | | 2013 | |
Consolidated Statements of Income | | | | | | | | | | | | |
Total interest income | | $ | 111,440 | | | $ | 104,894 | | | $ | 322,891 | | | $ | 306,249 | |
Total interest expense | | | 5,211 | | | | 6,465 | | | | 16,470 | | | | 19,617 | |
Net interest income | | | 106,229 | | | | 98,429 | | | | 306,421 | | | | 286,632 | |
Provision for loan losses, LHFI | | | 3,058 | | | | (3,624 | ) | | | 2,604 | | | | (11,438 | ) |
Provision for loan losses, acquired loans | | | 1,145 | | | | 3,292 | | | | 4,992 | | | | 1,870 | |
Noninterest income | | | 42,893 | | | | 47,133 | | | | 131,111 | | | | 135,186 | |
Noninterest expense | | | 100,194 | | | | 101,524 | | | | 304,573 | | | | 310,864 | |
Income before income taxes | | | 44,725 | | | | 44,370 | | | | 125,363 | | | | 120,522 | |
Income taxes | | | 11,136 | | | | 11,336 | | | | 29,874 | | | | 31,501 | |
Net Income | | $ | 33,589 | | | $ | 33,034 | | | $ | 95,489 | | | $ | 89,021 | |
| | | | | | | | | | | | | | | | |
Per Share Data | | | | | | | | | | | | | | | | |
Basic earnings per share | | $ | 0.50 | | | $ | 0.49 | | | $ | 1.42 | | | $ | 1.33 | |
Diluted earnings per share | | | 0.50 | | | | 0.49 | | | | 1.41 | | | | 1.33 | |
Cash dividends per share | | | 0.23 | | | | 0.23 | | | | 0.69 | | | | 0.69 | |
| | | | | | | | | | | | | | | | |
Performance Ratios | | | | | | | | | | | | | | | | |
Return on average equity | | | 9.43 | % | | | 9.83 | % | | | 9.18 | % | | | 8.92 | % |
Return on average tangible equity | | | 13.70 | % | | | 14.92 | % | | | 13.52 | % | | | 13.25 | % |
Return on average assets | | | 1.10 | % | | | 1.11 | % | | | 1.06 | % | | | 1.04 | % |
Net interest margin (fully taxable equivalent) | | | 4.14 | % | | | 3.94 | % | | | 4.09 | % | | | 3.98 | % |
| | | | | | | | | | | | | | | | |
Credit Quality Ratios (1) | | | | | | | | | | | | | | | | |
Net charge-offs/average loans | | | -0.03 | % | | | 0.04 | % | | | -0.02 | % | | | -0.03 | % |
Provision for loan losses/average loans | | | 0.19 | % | | | -0.25 | % | | | 0.06 | % | | | -0.27 | % |
Nonperforming loans/total loans (incl LHFS*) | | | 1.37 | % | | | 1.26 | % | | | | | | | | |
Nonperforming assets/total loans (incl LHFS*) plus ORE** | | | 2.82 | % | | | 3.20 | % | | | | | | | | |
Allowance for loan losses/total loans (excl LHFS*) | | | 1.11 | % | | | 1.20 | % | | | | | | | | |
September 30, | | | 2014 | | | 2013 | |
Consolidated Balance Sheets | | | | | | | |
Total assets | | | $ | 12,096,316 | | | $ | 11,805,197 | |
Securities | | | | 3,533,535 | | | | 3,442,081 | |
Loans held for investment and acquired loans (including LHFS*) | | | 7,061,362 | | | | 6,691,752 | |
Deposits | | | | 9,513,225 | | | | 9,787,234 | |
Total shareholders' equity | | | | 1,415,098 | | | | 1,329,514 | |
| | | | | | | | | |
Stock Performance | | | | | | | | | |
Market value - close | | | $ | 23.04 | | | $ | 25.60 | |
Book value | | | | 20.98 | | | | 19.79 | |
Tangible book value | | | | 15.04 | | | | 13.58 | |
| | | | | | | | | |
Capital Ratios | | | | | | | | | |
Total equity/total assets | | | | 11.70 | % | | | 11.26 | % |
Tangible equity/tangible assets | | | | 8.67 | % | | | 8.01 | % |
Tangible equity/risk-weighted assets | | | 12.24 | % | | | 11.66 | % |
Tier 1 leverage ratio | | | | 9.54 | % | | | 8.78 | % |
Tier 1 common risk-based capital ratio | | | 12.74 | % | | | 11.92 | % |
Tier 1 risk-based capital ratio | | | 13.47 | % | | | 12.69 | % |
Total risk-based capital ratio | | | 14.70 | % | | | 14.02 | % |
(1) - Excludes Acquired Loans and Covered Other Real Estate.
* - LHFS is Loans Held for Sale.
** - ORE is Other Real Estate.
Non-GAAP Financial Measures
In addition to capital ratios defined by GAAP and banking regulators, Trustmark utilizes various tangible equity measures when evaluating capital utilization and adequacy. Tangible equity, as defined by Trustmark, represents shareholders’ equity less goodwill and identifiable intangible assets.
Trustmark believes these measures are important because they reflect the level of capital available to withstand unexpected market conditions. Additionally, presentation of these measures allows readers to compare certain aspects of Trustmark’s capitalization to other organizations. These ratios differ from capital measures defined by banking regulators principally in that the numerator excludes shareholders’ equity associated with preferred securities, the nature and extent of which varies across organizations.
These calculations are intended to complement the capital ratios defined by GAAP and banking regulators. Because GAAP does not include these capital ratio measures, Trustmark believes there are no comparable GAAP financial measures to these tangible equity ratios. Despite the importance of these measures to Trustmark, there are no standardized definitions for them and, as a result, Trustmark’s calculations may not be comparable with other organizations. In addition, there may be limits in the usefulness of these measures to investors. As a result, Trustmark encourages readers to consider its consolidated financial statements and the notes related thereto in their entirety and not to rely on any single financial measure. The following table reconciles Trustmark’s calculation of these measures to amounts reported under GAAP for the periods presented ($ in thousands, except per share data):
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2014 | | | 2013 | | | 2014 | | | 2013 | |
TANGIBLE EQUITY | | | | | | | | | | | | |
AVERAGE BALANCES | | | | | | | | | | | | | |
Total shareholders' equity | | | $ | 1,412,857 | | | $ | 1,333,356 | | | $ | 1,391,085 | | | $ | 1,334,437 | |
Less: Goodwill | | | | (365,500 | ) | | | (368,482 | ) | | | (367,880 | ) | | | (353,485 | ) |
Identifiable intangible assets | | | | (36,553 | ) | | | (45,988 | ) | | | (38,743 | ) | | | (43,232 | ) |
Total average tangible equity | | | $ | 1,010,804 | | | $ | 918,886 | | | $ | 984,462 | | | $ | 937,720 | |
| | | | | | | | | | | | | | | | | |
PERIOD END BALANCES | | | | | | | | | | | | | | | | | |
Total shareholders' equity | | | $ | 1,415,098 | | | $ | 1,329,514 | | | | | | | | | |
Less: Goodwill | | | | (365,500 | ) | | | (372,463 | ) | | | | | | | | |
Identifiable intangible assets | | | | (35,357 | ) | | | (44,424 | ) | | | | | | | | |
Total tangible equity | (a) | | $ | 1,014,241 | | | $ | 912,627 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
TANGIBLE ASSETS | | | | | | | | | | | | | | | | |
Total assets | | | $ | 12,096,316 | | | $ | 11,805,197 | | | | | | | | | |
Less: Goodwill | | | | (365,500 | ) | | | (372,463 | ) | | | | | | | | |
Identifiable intangible assets | | | | (35,357 | ) | | | (44,424 | ) | | | | | | | | |
Total tangible assets | (b) | | $ | 11,695,459 | | | $ | 11,388,310 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Risk-weighted assets | (c) | | $ | 8,287,608 | | | $ | 7,825,839 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
NET INCOME ADJUSTED FOR INTANGIBLE AMORTIZATION | | | | | | | | | | | | | | | | |
Net income | | | $ | 33,589 | | | $ | 33,034 | | | $ | 95,489 | | | $ | 89,021 | |
Plus: Intangible amortization net of tax | | | | 1,328 | | | | 1,523 | | | | 4,098 | | | | 3,939 | |
Net income adjusted for intangible amortization | | | $ | 34,917 | | | $ | 34,557 | | | $ | 99,587 | | | $ | 92,960 | |
| | | | | | | | | | | | | | | | | |
Period end common shares outstanding | (d) | | | 67,439,788 | | | | 67,181,694 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
TANGIBLE EQUITY MEASUREMENTS | | | | | | | | | | | | | | | | | |
Return on average tangible equity 1 | | | | 13.70 | % | | | 14.92 | % | | | 13.52 | % | | | 13.25 | % |
Tangible equity/tangible assets | (a)/(b) | | | 8.67 | % | | | 8.01 | % | | | | | | | | |
Tangible equity/risk-weighted assets | (a)/(c) | | | 12.24 | % | | | 11.66 | % | | | | | | | | |
Tangible book value | (a)/(d)*1,000 | | $ | 15.04 | | | $ | 13.58 | | | | | | | | | |
| | | September 30, | |
TIER 1 COMMON RISK-BASED CAPITAL | | | 2014 | | | 2013 | |
Total shareholders' equity | | | $ | 1,415,098 | | | $ | 1,329,514 | |
Eliminate qualifying AOCI | | | | 34,365 | | | | 52,226 | |
Qualifying tier 1 capital | | | | 60,000 | | | | 60,000 | |
Disallowed goodwill | | | | (365,500 | ) | | | (372,463 | ) |
Adjustment to goodwill allowed for deferred taxes | | | 15,503 | | | | 14,093 | |
Other disallowed intangibles | | | | (35,357 | ) | | | (44,424 | ) |
Disallowed servicing intangible | | | | (6,709 | ) | | | (6,315 | ) |
Disallowed deferred taxes | | | | (1,234 | ) | | | (39,476 | ) |
Total tier 1 capital | | | $ | 1,116,166 | | | $ | 993,155 | |
Less: Qualifying tier 1 capital | | | | (60,000 | ) | | | (60,000 | ) |
Total tier 1 common capital | (e) | | $ | 1,056,166 | | | $ | 933,155 | |
| | | | | | | | | |
Tier 1 common risk-based capital ratio | (e)/(c) | | | 12.74 | % | | | 11.92 | % |
1 Calculation = ((net income adjusted for intangible amortization/number of days in period)*number of days in year)/total average tangible common equity
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 is computed by dividing fully taxable equivalent (FTE) 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 Tables show 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 FTE basis using a 35% federal marginal tax rate for all periods shown. Loans on nonaccrual 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 nine months ended September 30, 2014, increased $20.3 million, or 6.8%, when compared with the same period in 2013. The net interest margin increased 11 basis points to 4.09% for the first nine months of 2014, compared with the same time period in 2013. The increase in the net interest margin was primarily a result of a $7.3 million increase in recoveries on loan pay-offs on acquired loans, which are included in net interest income, and lower deposit costs, which were partially offset by a downward repricing of LHFI in response to increased competitive pricing pressures. Trustmark anticipates that recoveries on loan pay-offs on acquired loans will continue to impact the net interest margin during the fourth quarter of 2014; however, the amount of impact these recoveries will have is difficult to determine. Trustmark's net interest margin decreased 7 basis points when the third quarter of 2014 is compared to the second quarter of 2014 primarily due to the current interest rate environment and increased competition, both of which are reflected in the decline in yield on LHFI and loans held for sale (LHFS). The net interest margin excluding acquired loans, which equals the reported net interest income-FTE excluding interest and fees on acquired loans, annualized, as a percentage of average earning assets excluding average acquired loans, for the first nine months of 2014 was 3.52%, a decrease of 5 basis points when compared to the same time period in 2013. Based on the current interest rate environment, Trustmark anticipates that the net interest margin, excluding acquired loans, to remain relatively stable during the fourth quarter of 2014.
Average interest-earning assets for the first nine months of 2014 were $10.390 billion compared to $9.998 billion for the same time period in 2013, an increase of $391.9 million, or 3.9%. The growth in average earning assets was primarily due to an increase in average securities-taxable of $121.0 million, or 3.8%, and average loans (LHFI and LHFS) of $414.1 million, or 7.2%, during the first nine months of 2014. The increase in average securities-taxable was primarily attributable to purchases of U.S Government-sponsored agency (GSE) guaranteed securities, partially offset by maturities and pay-downs of the loans underlying these securities, as well as inclusion of the securities acquired in the BancTrust acquisition for the entire first nine months of 2014. The increase in average total loans (LHFI and LHFS) was primarily attributable to growth in the LHFI portfolio. See the section captioned “LHFI and Allowance for Loan Losses, LHFI” elsewhere in this discussion for further analysis of the changes in the LHFI portfolio.
During the first nine months of 2014, interest on securities-taxable increased $4.7 million, or 8.8%, as the yield on taxable securities increased 11 basis points to 2.37% when compared with the same time period in 2013 due to re-investments in higher yielding securities. During the first nine months of 2014, interest and fees on LHFS and LHFI-FTE increased $2.4 million, or 1.2%, while the yield on loans (LHFS & LHFI) fell 26 basis points to 4.47% when compared to the same time period in 2013 due to downward repricing of LHFI due to the current interest rate environment and increased competitive pressures. During the first nine months of 2014, interest and fees on acquired loans increased $10.3 million, or 19.4%, due principally to a $13.0 million increase in recoveries on loan pay-offs of BancTrust acquired loans, which was partially offset by the $5.6 million decrease in recoveries on loans acquired in the April 2011 acquisition of Heritage Banking Group (Heritage), as well as interest earned on the BancTrust acquired loans for a full nine months. During the first nine months of 2014, the yield on acquired loans increased to 12.11% compared to 8.48% during the same time period in 2013 due primarily to the increase in recoveries on loan pay-offs of the BancTrust acquired loans. As a result of these factors, interest income-FTE increased $17.2 million, or 5.4%, when the first nine months of 2014 is compared with the same time period in 2013. The impact of these changes is also illustrated by the growth in the yield on total earning assets, which increased from 4.24% for the first nine months of 2013 to 4.30% for the same time period in 2014, an increase of 6 basis points.
Average interest-bearing liabilities for the first nine months of 2014 totaled $7.781 billion compared to $7.563 billion for the same time period in 2013, an increase of $217.8 million, or 2.9%. During the first nine months of 2014, average interest-bearing deposits increased $96.8 million, or 1.4%, as a result of growth in savings and interest-bearing demand deposits, partially offset by declines in certificates of deposits. The combination of federal funds purchased, securities sold under repurchase agreements and other borrowings increased by $120.9 million, or 23.9%, during the first nine months of 2014, which was primarily attributable to increased balances of federal funds purchased and securities sold under repurchase agreements as well as short-term FHLB advances obtained from the FHLB of Dallas during the third quarter of 2014. Total interest expense for the first nine months of 2014 decreased $3.1 million, or 16.0%, when compared with the same time period in 2013, principally due to the $3.0 million, or 20.1%, decrease in interest expense on deposit accounts as a result of a reduction in rates paid on certificates of deposit. As a result of these factors, the overall yield on interest-bearing liabilities declined 7 basis points to 0.28% when the first nine months of 2014 is compared with the same time period in 2013.
Yield/Rate Analysis Table | | | | | | | | | | | | | | | | | | |
($ in thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | |
| | 2014 | | | 2013 | |
| | | | | | | | | | | | | | | | | | |
| | | | | Interest | | | | | | | | | Interest | | | | |
Assets | | | | | | | | | | | | | | | | | | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | |
Federal funds sold and securities purchased under reverse repurchase agreements | | $ | 4,228 | | | $ | 9 | | | | 0.84 | % | | $ | 8,978 | | | $ | 8 | | | | 0.35 | % |
Securities - taxable | | | 3,328,329 | | | | 19,712 | | | | 2.35 | % | | | 3,338,774 | | | | 18,654 | | | | 2.22 | % |
Securities - nontaxable | | | 174,419 | | | | 1,845 | | | | 4.20 | % | | | 183,079 | | | | 1,960 | | | | 4.25 | % |
Loans (including LHFS) | | | 6,387,251 | | | | 70,197 | | | | 4.36 | % | | | 5,784,170 | | | | 68,417 | | | | 4.69 | % |
Acquired loans | | | 614,646 | | | | 23,200 | | | | 14.98 | % | | | 928,444 | | | | 19,183 | | | | 8.20 | % |
Other earning assets | | | 41,871 | | | | 386 | | | | 3.66 | % | | | 38,226 | | | | 372 | | | | 3.86 | % |
Total interest-earning assets | | | 10,550,744 | | | | 115,349 | | | | 4.34 | % | | | 10,281,671 | | | | 108,594 | | | | 4.19 | % |
Cash and due from banks | | | 272,925 | | | | | | | | | | | | 272,320 | | | | | | | | | |
Other assets | | | 1,345,771 | | | | | | | | | | | | 1,284,813 | | | | | | | | | |
Allowance for loan losses, net | | | (78,227 | ) | | | | | | | | | | | (79,696 | ) | | | | | | | | |
Total Assets | | $ | 12,091,213 | | | | | | | | | | | $ | 11,759,108 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders' Equity | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing deposits | | $ | 6,921,580 | | | | 3,606 | | | | 0.21 | % | | $ | 7,212,391 | | | | 4,970 | | | | 0.27 | % |
Federal funds purchased and securities sold under repurchase agreements | | | 540,870 | | | | 180 | | | | 0.13 | % | | | 364,446 | | | | 106 | | | | 0.12 | % |
Other borrowings | | | 300,943 | | | | 1,425 | | | | 1.88 | % | | | 179,690 | | | | 1,389 | | | | 3.07 | % |
Total interest-bearing liabilities | | | 7,763,393 | | | | 5,211 | | | | 0.27 | % | | | 7,756,527 | | | | 6,465 | | | | 0.33 | % |
Noninterest-bearing demand deposits | | | 2,774,745 | | | | | | | | | | | | 2,479,082 | | | | | | | | | |
Other liabilities | | | 140,218 | | | | | | | | | | | | 190,143 | | | | | | | | | |
Shareholders' equity | | | 1,412,857 | | | | | | | | | | | | 1,333,356 | | | | | | | | | |
Total Liabilities and Shareholders' Equity | | $ | 12,091,213 | | | | | | | | | | | $ | 11,759,108 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net Interest Margin | | | | | | | 110,138 | | | | 4.14 | % | | | | | | | 102,129 | | | | 3.94 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Less tax equivalent adjustment | | | | | | | 3,909 | | | | | | | | | | | | 3,700 | | | | | |
Net Interest Margin per Consolidated Statements of Income | | | | | | $ | 106,229 | | | | | | | | | | | $ | 98,429 | | | | | |
Yield/Rate Analysis Table | | | | | | | | | | | | | | | | | | |
($ in thousands) | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | |
| | | | | | | | | | | | | | | | | | |
| | | | | Interest | | | | | | | | | Interest | | | | |
Assets | | | | | | | | | | | | | | | | | | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | |
Federal funds sold and securities purchased under reverse repurchase agreements | | $ | 4,437 | | | $ | 20 | | | | 0.60 | % | | $ | 7,477 | | | $ | 17 | | | | 0.30 | % |
Securities - taxable | | | 3,303,357 | | | | 58,454 | | | | 2.37 | % | | | 3,182,404 | | | | 53,740 | | | | 2.26 | % |
Securities - nontaxable | | | 178,213 | | | | 5,677 | | | | 4.26 | % | | | 183,659 | | | | 5,952 | | | | 4.33 | % |
Loans (including LHFS) | | | 6,167,850 | | | | 206,000 | | | | 4.47 | % | | | 5,753,759 | | | | 203,579 | | | | 4.73 | % |
Acquired loans | | | 698,051 | | | | 63,236 | | | | 12.11 | % | | | 835,172 | | | | 52,952 | | | | 8.48 | % |
Other earning assets | | | 38,335 | | | | 1,140 | | | | 3.98 | % | | | 35,893 | | | | 1,099 | | | | 4.09 | % |
Total interest-earning assets | | | 10,390,243 | | | | 334,527 | | | | 4.30 | % | | | 9,998,364 | | | | 317,339 | | | | 4.24 | % |
Cash and due from banks | | | 327,657 | | | | | | | | | | | | 275,711 | | | | | | | | | |
Other assets | | | 1,354,948 | | | | | | | | | | | | 1,260,227 | | | | | | | | | |
Allowance for loan losses, net | | | (78,533 | ) | | | | | | | | | | | (83,547 | ) | | | | | | | | |
Total Assets | | $ | 11,994,315 | | | | | | | | | | | $ | 11,450,755 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders' Equity | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing deposits | | $ | 7,154,232 | | | | 11,941 | | | | 0.22 | % | | $ | 7,057,428 | | | | 14,950 | | | | 0.28 | % |
Federal funds purchased and securities sold under repurchase agreements | | | 404,604 | | | | 366 | | | | 0.12 | % | | | 315,113 | | | | 275 | | | | 0.12 | % |
Other borrowings | | | 222,307 | | | | 4,163 | | | | 2.50 | % | | | 190,850 | | | | 4,392 | | | | 3.08 | % |
Total interest-bearing liabilities | | | 7,781,143 | | | | 16,470 | | | | 0.28 | % | | | 7,563,391 | | | | 19,617 | | | | 0.35 | % |
Noninterest-bearing demand deposits | | | 2,694,673 | | | | | | | | | | | | 2,377,583 | | | | | | | | | |
Other liabilities | | | 127,414 | | | | | | | | | | | | 175,344 | | | | | | | | | |
Shareholders' equity | | | 1,391,085 | | | | | | | | | | | | 1,334,437 | | | | | | | | | |
Total Liabilities and Shareholders' Equity | | $ | 11,994,315 | | | | | | | | | | | $ | 11,450,755 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net Interest Margin | | | | | | | 318,057 | | | | 4.09 | % | | | | | | | 297,722 | | | | 3.98 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Less tax equivalent adjustment | | | | | | | 11,636 | | | | | | | | | | | | 11,090 | | | | | |
Net Interest Margin per Consolidated Statements of Income | | | | | | $ | 306,421 | | | | | | | | | | | $ | 286,632 | | | | | |
Provision for Loan Losses, LHFI
The provision for loan losses, LHFI is determined by Management as the amount necessary to adjust the allowance for loan losses, LHFI 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, LHFI reflects loan quality trends, including the levels of and trends related to nonaccrual LHFI, past due LHFI, potential problem LHFI, criticized LHFI, net charge-offs or recoveries and growth in the LHFI portfolio among other factors. Accordingly, the amount of the provision reflects the necessary increases in the allowance for loan losses, LHFI related to newly identified criticized LHFI, as well as the actions taken related to other LHFI including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools. The provision for loan losses, LHFI for the first nine months of 2014 totaled 0.06% of average LHFI, compared with -0.27% of average LHFI for the same time period in 2013. The increase in the provision during the first nine months of 2014 was primarily a result of a decrease in the amount of established reserves being released compared to the same period in 2013 for both new and existing impaired LHFI, changes in the quantitative and qualitative reserve factors and other changes in the LHFI portfolio (i.e., balance changes due to pay-offs and risk rate changes).
During the second quarter of 2014, Trustmark revised the qualitative portion of the allowance for loan loss methodology for consumer LHFI to incorporate the use of consumer credit bureau scores which reflects the customer’s historical willingness and ability to service their debt. The implementation of this consumer qualitative factor will allow Trustmark to better monitor shifts in risk that are represented in the retail portfolio and ensure that it is reflective in the allowance for loan loss calculation. An additional provision of approximately $1.4 million was recorded in the second quarter of 2014 as a result of this revision to the qualitative portion of the allowance for loan loss methodology for consumer LHFI. During the third quarter 2014, Trustmark revised the qualitative portion of the allowance for loan loss methodology for commercial LHFI to incorporate an additional reserve component for commercial nonaccrual loans under $500 thousand. A LHFI is considered impaired when, based on current information and events, it is probable that Trustmark will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. A formal impairment analysis is performed on all commercial nonaccrual LHFI with an outstanding balance of $500 thousand or more, and based upon this analysis LHFI are written down to net realizable value. These commercial nonaccrual credits under $500 thousand are generally not currently protected by an identified source of repayment or any viable secondary means of repayment and do not have collateral sufficient to extinguish the credit. For such loans, it is currently unlikely that full repayment of both principal and interest will be realized. An additional provision of approximately $822 thousand was recorded in the third quarter of 2014 as a result of this revision to the qualitative portion of the allowance for loan loss methodology for commercial LHFI. See the section captioned “LHFI and Allowance for Loan Losses, LHFI” elsewhere in this discussion for further analysis of the changes in the allowance for loan losses, LHFI.
The provision for loan losses, LHFI for the Mississippi market region for the three months ended September 30, 2014 increased $5.7 million when compared to the same time period in 2013, primarily due to approximately $2.0 million of reserves provided due to changes in the LHFI portfolio, such as balance changes due to pay-off or pay-down and risk rate changes and $1.7 million in additional reserves related to newly impaired LHFI. The provision for loan losses, LHFI for the Mississippi market region for the nine months ended September 30, 2014 increased $13.0 million when compared to the same time period in 2013, primarily due to net charge-offs not related to current period impaired loans; a decrease in the amount of established reserves being released compared to the same period in 2013 for both new and existing impaired LHFI; additional reserves resulting from the change to the allowance for loan loss methodology for consumer LHFI during the second quarter of 2014 and changes in the commercial LHFI portfolio and qualitative and quantitative reserve factor measurements.
The following table presents the provision for loan losses, LHFI, by geographic market region for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | 2014 | | | 2013 | |
Alabama | | $ | 1,093 | | | $ | 550 | | | $ | 2,261 | | | $ | 1,458 | |
Florida | | | (147 | ) | | | (2,642 | ) | | | (5,660 | ) | | | (9,742 | ) |
Mississippi (1) | | | 4,679 | | | | (1,051 | ) | | | 9,539 | | | | (3,491 | ) |
Tennessee (2) | | | 244 | | | | (150 | ) | | | (948 | ) | | | (863 | ) |
Texas | | | (2,811 | ) | | | (331 | ) | | | (2,588 | ) | | | 1,200 | |
Total provision for loan losses, LHFI | | $ | 3,058 | | | $ | (3,624 | ) | | $ | 2,604 | | | $ | (11,438 | ) |
(1) Mississippi includes Central and Southern Mississippi Regions
(2) Tennessee includes Memphis, Tennessee and Northern Mississippi Regions
Trustmark continues to devote significant resources to managing credit risks resulting from the slowdown in residential real estate developments. Management believes that the construction and land development portfolio is appropriately risk rated and adequately reserved based on current conditions.
See the section captioned “LHFI and Allowance for Loan Losses, LHFI” elsewhere in this discussion for further analysis of the provision for loan losses, LHFI, which includes the table of nonperforming assets, excluding acquired loans and covered other real estate.
Provision for Loan Losses, Acquired Loans
The provision for loan losses, acquired loans is recognized subsequent to acquisition to the extent it is probable that Trustmark will be unable to collect all cash flows expected at acquisition plus additional cash flows expected to be collected arising from changes in estimates after acquisition, considering both the timing and amount of those expected cash flows. Provisions may be required when actual losses of unpaid principal incurred exceed previous loss expectations to date, or future cash flows previously expected to be collectible are no longer probable of collection. The provision for loan losses, acquired loans is reflected as a valuation allowance netted against the carrying value of the acquired loans accounted for under Federal Accounting Standards Board (FASB) Accounting Standard Codification (ASC) Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality.” The provision for loan losses, acquired loans for the three months ended September 30, 2014 declined $2.1 million when compared to the same time period in 2013, primarily due to improvements in expected cash flows for which a provision was recorded in a prior period related to loans acquired in the March 2012 acquisition of Bay Bank & Trust Company (Bay Bank) and loans acquired from Heritage. The provision for loan losses, acquired loans for the first nine months of 2014 increased $3.1 million when compared to the same time period in 2013, primarily due to BancTrust acquired loans in which a debt settlement or foreclosure occurred during the second quarter of 2014 for an amount which exceeded the previous loss expectations to date as well as changes in expectations based on the periodic re-estimations performed during the period.
The following table presents the provision for loan losses, acquired loans, by acquisition for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | 2014 | | | 2013 | |
BancTrust | | $ | 1,976 | | | $ | 2,321 | | | $ | 5,221 | | | $ | 2,547 | |
Bay Bank | | | (280 | ) | | | 800 | | | | 363 | | | | 440 | |
Heritage | | | (551 | ) | | | 171 | | | | (592 | ) | | | (1,117 | ) |
Total provision for loan losses, acquired loans | | $ | 1,145 | | | $ | 3,292 | | | $ | 4,992 | | | $ | 1,870 | |
Noninterest Income
The following table presents the comparative components of noninterest income for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | $ Change | | | % Change | | | 2014 | | | 2013 | | | $ Change | | | % Change | |
Service charges on deposit accounts | | $ | 12,743 | | | $ | 13,852 | | | $ | (1,109 | ) | | | -8.0 | % | | $ | 36,157 | | | $ | 38,462 | | | $ | (2,305 | ) | | | -6.0 | % |
Bank card and other fees | | | 7,279 | | | | 8,929 | | | | (1,650 | ) | | | -18.5 | % | | | 26,254 | | | | 26,381 | | | | (127 | ) | | | -0.5 | % |
Insurance commissions | | | 9,240 | | | | 8,227 | | | | 1,013 | | | | 12.3 | % | | | 25,637 | | | | 23,483 | | | | 2,154 | | | | 9.2 | % |
Wealth management | | | 8,038 | | | | 7,520 | | | | 518 | | | | 6.9 | % | | | 23,883 | | | | 21,335 | | | | 2,548 | | | | 11.9 | % |
Mortgage banking, net | | | 5,842 | | | | 8,440 | | | | (2,598 | ) | | | -30.8 | % | | | 18,862 | | | | 28,318 | | | | (9,456 | ) | | | -33.4 | % |
Other, net | | | (160 | ) | | | 165 | | | | (325 | ) | | | n/ | m | | | 18 | | | | (3,171 | ) | | | 3,189 | | | | n/ | m |
Total Noninterest Income before securities gains, net | | | 42,982 | | | | 47,133 | | | | (4,151 | ) | | | -8.8 | % | | | 130,811 | | | | 134,808 | | | | (3,997 | ) | | | -3.0 | % |
Security (losses) gains, net | | | (89 | ) | | | - | | | | (89 | ) | | | n/ | m | | | 300 | | | | 378 | | | | (78 | ) | | | -20.6 | % |
Total Noninterest Income | | $ | 42,893 | | | $ | 47,133 | | | $ | (4,240 | ) | | | -9.0 | % | | $ | 131,111 | | | $ | 135,186 | | | $ | (4,075 | ) | | | -3.0 | % |
n/m - percentage changes greater than +/- 100% are not considered meaningful
Noninterest income represented 28.8% and 29.9% of total revenue, before securities (losses) gains, net for the three and nine months ended September 30, 2014, and 32.4% and 32.0% of total revenue, before securities (losses) gains, net for the three and nine months ended September 30, 2013, respectively.
The decrease in noninterest income during the three months ended September 30, 2014 when compared to the same time period in 2013 was primarily the result of declines in mortgage banking revenues due principally to lower gains on secondary marketing loan sales resulting from lower spreads and volumes, declines in bank card and other fees resulting from lower interchange income and declines in service charges on deposit accounts resulting from lower non-sufficient funds and overdraft fees, which were partially offset by growth in insurance commissions principally due to increases in commission on property and casualty and group health policies and growth in wealth management revenues due primarily to trust management fees, brokerage services income and fixed annuity income. The decrease in noninterest income during the nine months ended September 30, 2014 when compared to the same time period in 2013 was primarily the result of declines in mortgage banking revenues due principally to lower gains on secondary marketing loan sales resulting from lower spreads and volumes and declines in service charges on deposit accounts resulting from lower non-sufficient funds and overdraft fees. These declines were partially offset by growth in other noninterest income resulting from increases in the cash surrender value of bank-owned life insurance policies and decreases in the net reduction of the FDIC indemnification asset, growth in insurance commissions principally due to increases in commission on property and casualty and group health policies and growth in wealth management revenues due primarily to trust management fees and fixed annuity income. For further analysis of Trustmark’s insurance commissions and wealth management income, please see the section captioned “Segment Information” located elsewhere in this report.
Service Charges on Deposit Accounts
The decrease in service charges on deposit accounts when comparing the three and nine months ended September 30, 2014 with the same time periods in 2013 was primarily due to declines in non-sufficient funds and overdraft fees on consumer demand deposit accounts. The declines in the non-sufficient funds and overdraft fees primarily resulted from a decrease in the number of occurrences of non-sufficient funds and overdrafts as Trustmark made enhancements to provide customers with access to information regarding pending debit card signature transactions and extended the hours customers are capable of making deposits at Trustmark ATMs.
Bank Card and Other Fees
Bank card and other fees consist primarily of fees earned on bank card products as well as fees on various bank products and services and safe deposit box fees. The decrease in bank card and other fees when the three months ended September 30, 2014 is compared with the same time period in 2013 was principally due to the decrease in interchange income and miscellaneous other bank fees, which was partially offset by an increase in the fair value of Trustmark's proprietary position in interest rate swaps entered into with qualified commercial borrowing customers. The decrease in bank card and other fees for the first nine months of 2014 when compared to the first nine months of 2013 was primarily the result of declines in the fair value of Trustmark's proprietary position in interest rate swaps entered into with qualified commercial borrowing customers, which was partially offset by growth in miscellaneous other bank fees. See the section captioned “Derivatives” elsewhere in this discussion for additional information related to the derivative products offered to qualified commercial borrowing customers.
On June 29, 2011, the FRB issued a final rule (Regulation II - Debit Card Interchange Fees and Routing) establishing standards for debit card interchange fees, which limited the maximum permissible interchange fee that an issuer may receive for an electronic debit transaction to the sum of 21 cents per transaction and five basis points multiplied by the value of the transaction. In addition, the FRB also approved an interim rule that allows for an upward adjustment of no more than one cent to an issuer's debit card interchange fee if the issuer develops and implements policies and procedures reasonably designed to achieve the fraud-prevention standards set out in the interim rule. The provisions regarding debit card interchange fees were effective as of October 1, 2011. On July 31, 2013, however, the United States District Court for the District of Columbia held that, in determining the debit card interchange fee standard in the final rule, the FRB improperly considered costs it was prohibited by the Electronic Fund Transfer Act (EFTA) from considering. The court, accordingly, remanded to the FRB with instructions to vacate the final rule, but stayed the order to vacate to provide the FRB an opportunity to replace the invalid portions of the final rule. On March 21, 2014, the D.C. Circuit Court of Appeals overturned the lower court decision finding that the FRB’s final rule was based on a reasonable interpretation of the statute. The retailers challenging the FRB’s rule filed a petition for a writ of certiorari with the Supreme Court of the United States on August 18, 2014 seeking review of this holding. The Supreme Court has not yet announced whether it will hear the appeal. Management will continue to closely monitor developments related to this ruling. Any revision to the debit card interchange fee standard would affect the accuracy of Management’s prediction of the impact of the interchange fee rule on Trustmark’s results of operations.
In accordance with the statute, issuers that, together with their affiliates, have assets of less than $10.0 billion on the annual measurement date (December 31) are exempt from the debit card interchange fee standards. At December 31, 2013, the annual measurement date, Trustmark had assets greater than $10.0 billion; and, therefore, was required to comply with the debit card interchange fee standards by July 1, 2014. Management estimated that the effect of the FRB final rule as issued on June 29, 2011 could reduce noninterest income by approximately $10.0 million to $11.0 million on an annual basis given Trustmark's current debit card volumes. Trustmark's noninterest interest income declined $2.6 million during the three months ended September 30, 2014 as a result of the FRB final rule. Management has identified a number of strategic priorities, such as process improvement and expense management, that when combined with current fee improvement options being evaluated within various areas of Trustmark's retail banking section are expected to offset, in whole or in part, the impact of the FRB final rule.
Mortgage Banking, Net
The following table illustrates the components of mortgage banking income included in noninterest income for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | $ Change | | | % Change | | | 2014 | | | 2013 | | | $ Change | | | % Change | |
Mortgage servicing income, net | | $ | 4,674 | | | $ | 4,552 | | | $ | 122 | | | | 2.7 | % | | $ | 13,805 | | | $ | 13,204 | | | $ | 601 | | | | 4.6 | % |
Change in fair value-MSR from runoff | | | (2,364 | ) | | | (2,407 | ) | | | 43 | | | | 1.8 | % | | | (6,567 | ) | | | (7,623 | ) | | | 1,056 | | | | 13.9 | % |
Gain on sales of loans, net | | | 3,272 | | | | 6,465 | | | | (3,193 | ) | | | -49.4 | % | | | 7,860 | | | | 24,227 | | | | (16,367 | ) | | | -67.6 | % |
Other, net | | | (323 | ) | | | (1,485 | ) | | | 1,162 | | | | 78.2 | % | | | 772 | | | | (4,186 | ) | | | 4,958 | | | | n/ | m |
Mortgage banking income before hedge ineffectiveness | | | 5,259 | | | | 7,125 | | | | (1,866 | ) | | | -26.2 | % | | | 15,870 | | | | 25,622 | | | | (9,752 | ) | | | -38.1 | % |
Change in fair value-MSR from market changes | | | 700 | | | | 287 | | | | 413 | | | | n/ | m | | | (3,061 | ) | | | 7,881 | | | | (10,942 | ) | | | n/ | m |
Change in fair value of derivatives | | | (117 | ) | | | 1,028 | | | | (1,145 | ) | | | n/ | m | | | 6,053 | | | | (5,185 | ) | | | 11,238 | | | | n/ | m |
Net positive hedge ineffectiveness | | | 583 | | | | 1,315 | | | | (732 | ) | | | -55.7 | % | | | 2,992 | | | | 2,696 | | | | 296 | | | | 11.0 | % |
Mortgage banking, net | | $ | 5,842 | | | $ | 8,440 | | | $ | (2,598 | ) | | | -30.8 | % | | $ | 18,862 | | | $ | 28,318 | | | $ | (9,456 | ) | | | -33.4 | % |
n/m - percentage changes greater than +/- 100% are not considered meaningful
The decrease in net revenue from mortgage banking during the three and nine months ended September 30, 2014 was principally due to lower gains on secondary marketing sales, which was partially offset by the net valuation increase in the fair value of loans held for sale, interest rate lock commitments and forward sale contracts. Mortgage loan production for the three and nine months ended September 30, 2014 was $345.4 million and $898.0 million, a decrease of $12.4 million, or 3.5%, and $276.2 million, or 23.5%, when compared to $357.8 million and $1.174 billion for the three and nine months ended September 30, 2013, respectively, reflecting the industry-wide decline in refinance activity following an extended low interest rate environment. With the mortgage banking industry facing projected rising interest rates coupled with reduced mortgage loan production during 2014, Trustmark’s revenues from mortgage banking could continue to be reduced in the fourth quarter of 2014 and thereafter from recent historical levels. Loans serviced for others totaled $5.586 billion at September 30, 2014, compared with $5.435 billion at September 30, 2013.
Representing a significant component of mortgage banking income is gain on the sales of loans, net. The decrease in the gain on sales of loans, net when the three and nine months ended September 30, 2014 is compared to the same time period in 2013 resulted from declines in the volume of loan sales and lower profit margins from secondary marketing activities due to the tightening of interest rate spreads during the period. Loan sales totaled $273.3 million and $671.2 million during the three and nine months ended September 30, 2014, a decrease of $74.8 million and $460.9 million, respectively, when compared with the same time period in 2013.
During the first quarter of 2013, Trustmark exercised its option to repurchase approximately $57.4 million delinquent loans serviced for GNMA. These loans were subsequently sold to a third party under different repurchase provisions. Trustmark retained the servicing for these loans, which are fully guaranteed by FHA/VA. As a result of this repurchase and sale, the loans are no longer carried as LHFS. The transaction resulted in a gain of $534 thousand, which is included in gain on sales of loans, net for the first nine months of 2013. For additional information, please see “Loans Held for Sale (LHFS)” included elsewhere in this report.
As part of Trustmark’s risk management strategy, exchange-traded derivative instruments are utilized to offset changes in the fair value of mortgage servicing rights (MSR) attributable to changes in interest rates. Changes in the fair value of these exchange-traded derivative instruments are recorded in noninterest income in mortgage banking, net and are offset by the changes in the fair value of MSR. The MSR fair value represents the present value of future cash flows, which among other things includes decay and the effect of changes in interest rates. Ineffectiveness of hedging the MSR fair value is measured by comparing the change in value of hedge instruments to the change in the fair value of the MSR asset attributable to changes in interest rates and other market driven changes in valuation inputs and assumptions. The impact of this strategy resulted in a net positive ineffectiveness of $583 thousand and $1.3 million for the three months ended September 30, 2014 and 2013, respectively, and a net positive ineffectiveness of $3.0 million and $2.7 million for the nine months ended September 30, 2014 and 2013, respectively. The net positive ineffectiveness primarily resulted from the hedge income produced by a positively-sloped yield curve and net option premium, which are both core components of the MSR hedge strategy.
Other mortgage banking income, net includes the net valuation adjustment recognized in income in accordance with FASB ASC Topic 815, “Derivatives and Hedging,” for the fair value of loans held for sale, interest rate lock commitments and forward sale contracts as well as income from other miscellaneous mortgage charges. The increase in other mortgage banking income, net when comparing the three months ended September 30, 2014 with the same period in 2013 primarily resulted from a lower net negative valuation adjustment to the fair value of loans held for sale, interest rate lock commitments, and forward sale contracts during the period. The increase in other mortgage banking income, net when comparing the nine months ended September 30, 2014 with the same period in 2013 primarily resulted from the positive valuation adjustments to the fair value of loans held for sale and interest rate lock commitments, which was partially offset by the negative valuation adjustment to the fair value of forward sale contracts during the period. See the section captioned “Derivatives” elsewhere in this report for further discussion of the mortgage related derivative instruments.
Other Income, Net
The following table illustrates the components of other income, net included in noninterest income for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | $ Change | | | % Change | | | 2014 | | | 2013 | | | $ Change | | | % Change | |
Partnership amortization for tax credit purposes | | $ | (3,006 | ) | | $ | (2,388 | ) | | $ | (618 | ) | | | -25.9 | % | | $ | (9,018 | ) | | $ | (6,726 | ) | | $ | (2,292 | ) | | | -34.1 | % |
(Decrease) Increase in FDIC indemnification asset | | | (452 | ) | | | 211 | | | | (663 | ) | | | n/ | m | | | (2,139 | ) | | | (3,471 | ) | | | 1,332 | | | | 38.4 | % |
Other miscellaneous income | | | 3,298 | | | | 2,342 | | | | 956 | | | | 40.8 | % | | | 11,175 | | | | 7,026 | | | | 4,149 | | | | 59.1 | % |
Total other, net | | $ | (160 | ) | | $ | 165 | | | $ | (325 | ) | | | n/ | m | | $ | 18 | | | $ | (3,171 | ) | | $ | 3,189 | | | | n/ | m |
n/m - percentage changes greater than +/- 100% are not considered meaningful
The increase in other income, net for the nine months ended September 30, 2014 when compared to the same time period in 2013 was primarily the result of an increase in the cash surrender value of bank-owned life insurance of $3.4 million, principally due to Trustmark’s $100.0 million investment in bank-owned life insurance in September 2013, and the decrease in the net reduction of the FDIC indemnification asset resulting from loan pay-offs and changes in expected cash flows and loss expectations of acquired covered loans. These gains were partially offset by the increase in partnership amortization as a result of $29.0 million in new tax credit investments entered into by Trustmark since the third quarter of 2013. During 2013, Trustmark continued to grow its investments in partnerships that provide income tax credits on a Federal and/or State basis. The increased partnership amortization was more than offset by the income tax credits received during the first nine months of 2014 which reduced income tax expense.
Noninterest Expense
The following table presents the comparative components of noninterest expense for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | $ Change | | | % Change | | | 2014 | | | 2013 | | | $ Change | | | % Change | |
Salaries and employee benefits | | $ | 56,675 | | | $ | 56,043 | | | $ | 632 | | | | 1.1 | % | | $ | 169,535 | | | $ | 165,040 | | | $ | 4,495 | | | | 2.7 | % |
Services and fees | | | 14,489 | | | | 13,580 | | | | 909 | | | | 6.7 | % | | | 42,197 | | | | 39,428 | | | | 2,769 | | | | 7.0 | % |
Net occupancy-premises | | | 6,817 | | | | 6,644 | | | | 173 | | | | 2.6 | % | | | 19,836 | | | | 19,302 | | | | 534 | | | | 2.8 | % |
Equipment expense | | | 5,675 | | | | 6,271 | | | | (596 | ) | | | -9.5 | % | | | 17,949 | | | | 18,138 | | | | (189 | ) | | | -1.0 | % |
ORE/Foreclosure expense: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Writedowns | | | 1,498 | | | | 1,769 | | | | (271 | ) | | | -15.3 | % | | | 5,624 | | | | 6,820 | | | | (1,196 | ) | | | -17.5 | % |
Carrying costs | | | (568 | ) | | | 1,310 | | | | (1,878 | ) | | | n/ | m | | | 2,457 | | | | 5,210 | | | | (2,753 | ) | | | -52.8 | % |
Total ORE/Foreclosure expense | | | 930 | | | | 3,079 | | | | (2,149 | ) | | | -69.8 | % | | | 8,081 | | | | 12,030 | | | | (3,949 | ) | | | -32.8 | % |
FDIC assessment expense | | | 2,644 | | | | 2,376 | | | | 268 | | | | 11.3 | % | | | 7,528 | | | | 6,773 | | | | 755 | | | | 11.1 | % |
Other expense | | | 12,964 | | | | 13,531 | | | | (567 | ) | | | -4.2 | % | | | 39,447 | | | | 50,153 | | | | (10,706 | ) | | | -21.3 | % |
Total noninterest expense | | $ | 100,194 | | | $ | 101,524 | | | $ | (1,330 | ) | | | -1.3 | % | | $ | 304,573 | | | $ | 310,864 | | | $ | (6,291 | ) | | | -2.0 | % |
n/m - percentage changes greater than +/- 100% are not considered meaningful
The decrease in noninterest expense for the three months ended September 30, 2014 when compared to the same time period in 2013 was primarily attributable to a decrease in other real estate carrying costs. The decrease in noninterest expense for the first nine months of 2014 when compared to the same time period in 2013 was primarily attributable to decreases in other expense and ORE/foreclosure expense, which was partially offset by increases in salaries and employee benefits and services and fees. Management considers disciplined expense management a key area of focus in the support of improving shareholder value.
Salaries and Employee Benefits
The increase in salaries and employee benefits, the largest category of noninterest expense, for the three months ended September 30, 2014 when compared to the same time period in 2013 primarily resulted from modest general merit increases, higher commissions expense resulting from improved performance in Trustmark’s Insurance and Wealth Management Divisions and increases in general performance incentives expense, which was partially offset by a decrease in Trustmark’s Capital Accumulation Plan pension expense due to lower actuarially-determined rates and the termination of the BancTrust Pension Plan. The increase in salaries and employee benefits for the nine months ended September 30, 2014 when compared with the same time period in 2013 primarily reflects salaries and employee benefits attributable to the BancTrust operations for a full nine months, modest general merit increases, higher commissions expense resulting from improved performance in Trustmark’s Insurance and Wealth Management Divisions, and increases in general performance incentives expense. These increases in salaries and employee benefits were partially offset by a decrease in Trustmark’s Capital Accumulation Plan pension expense due to lower actuarially-determined rates, a decline in severance expenses due to non-routine transaction expenses from the acquisition of BancTrust incurred during the first nine months of 2013 and a decrease in commission expense resulting from declines in mortgage loan originations. Excluding the decline in pension expense due to actuarially-determined rates and the termination of the BancTrust Pension Plans and the decline in severance expenses due to non-routine transaction expenses from the acquisition of BancTrust, salaries and employee benefits for the three and nine months ended September 30, 2014 increased $2.3 million, or 4.1%, and $7.9 million, or 4.8%, relative to the same time periods in 2013, respectively.
Services and Fees
The increase in services and fees for the three months ended September 30, 2014 when compared to the same time period in 2013 was attributable to net increases in all categories of services and fees expense. The increase in services and fees for the first nine months of 2014 when compared to the same time period in 2013 was primarily due to increases in advertising expense, professional services and fees, data processing expense related to software and communications expense, which was partially offset by a decline in legal expense.
ORE/Foreclosure Expense
The decrease in ORE/foreclosure expense (includes expenses related to covered other real estate) for the three months ended September 30, 2014 when compared to the same time period in 2013 was primarily due to a net gain on sale of other real estate of $2.2 million during the third quarter of 2014 compared to a net gain on sale of other real estate of $50 thousand during the third quarter of 2013. The decrease in ORE/foreclosure expense for the first nine months of 2014 compared to the first nine months of 2013 was primarily due to the increase in the net gain on the sale of other real estate and a decrease in write-downs of other real estate. The net gain on sale of other real estate for the first nine months of 2014 totaled $2.7 million, compared to a net loss on the sale of other real estate for the first nine months of 2013 of $212 thousand. For additional analysis of other real estate and foreclosure expenses, please see the sections captioned “Nonperforming Assets, excluding Acquired Loans and Covered Other Real Estate” and “Covered Other Real Estate,” located elsewhere in this report.
FDIC Assessment Expense
The increase in FDIC assessment expense for the three and nine months ended September 30, 2014 compared to the same time periods of 2013 primarily resulted from the increase in Trustmark’s assessment base, which was principally due to the BancTrust acquisition. As required by the Dodd-Frank Act, the FDIC revised the deposit insurance assessment system to base assessments on the average total consolidated assets of insured depository institutions less the average tangible equity during the assessment period. In addition, the Dodd-Frank Act requires the minimum reserve ratio for the Deposit Insurance Fund be increased from 1.15% to 1.35% of estimated insurable deposits, or the comparable percentage of the assessment base, by September 30, 2020. The FDIC must offset the effect of the increase in the minimum reserve ratio on insured depository institutions with total consolidated assets of less than $10.0 billion. With total assets greater than $10.0 billion at December 31, 2013, Trustmark lost the benefit of this offset beginning in the second quarter 2014. The change in the assessment methodology was immaterial to Trustmark’s results of operations.
Other Expense
The following table presents the comparative components of other noninterest expense for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | $ Change | | | % Change | | | 2014 | | | 2013 | | | $ Change | | | % Change | |
Loan expense | | $ | 3,070 | | | $ | 3,390 | | | $ | (320 | ) | | | -9.4 | % | | $ | 9,641 | | | $ | 10,652 | | | $ | (1,011 | ) | | | -9.5 | % |
Non-routine transaction expenses on acquisition | | | - | | | | - | | | | - | | | | - | | | | - | | | | 7,920 | | | | (7,920 | ) | | | -100.0 | % |
Amortization of intangibles | | | 2,150 | | | | 2,466 | | | | (316 | ) | | | -12.8 | % | | | 6,633 | | | | 6,380 | | | | 253 | | | | 4.0 | % |
Other miscellaneous expense | | | 7,744 | | | | 7,675 | | | | 69 | | | | 0.9 | % | | | 23,173 | | | | 25,201 | | | | (2,028 | ) | | | -8.0 | % |
Total other expense | | $ | 12,964 | | | $ | 13,531 | | | $ | (567 | ) | | | -4.2 | % | | $ | 39,447 | | | $ | 50,153 | | | $ | (10,706 | ) | | | -21.3 | % |
The decline in other expenses during the first nine months of 2014 when compared to the same time period in 2013 was primarily due to declines in non-routine transaction expenses on acquisition, which were incurred during the first nine months of 2013 as a result of the acquisition of BancTrust, other miscellaneous expense and loan expense. The decrease in other miscellaneous expense for the first nine months of 2014 when compared to the first nine months of 2013 was principally due to the non-routine litigation expense related to the settlement of the NSF and overdraft litigation incurred during the first nine months of 2013, which was partially offset by increases in other miscellaneous expenses due primarily to increases in ATM and debit card processing expenses, sponsorships and charitable contributions and insurance expenses. The decrease in loan expense for the nine months ended September 30, 2014 when compared to the same time period in 2013 was primarily due to declines in other loan expense, mortgage loan putback expense and mortgage loan compensatory fees.
Trustmark is subject to losses in its loan servicing portfolio due to loan foreclosures. Trustmark has obligations to either repurchase the outstanding principal balance of a loan or make the purchaser whole for the economic benefits of a loan if it is determined that the loan sold was in violation of representations or warranties made by Trustmark at the time of the sale, herein referred to as mortgage loan servicing putback expenses. Such representations and warranties typically include those made regarding loans that had missing or insufficient file documentation, loans that do not meet investor guidelines, loans in which the appraisal does not support the value and/or loans obtained through fraud by the borrowers or other third parties. Generally, putback requests may be made until the loan is paid in full. However, mortgage loans delivered to FNMA and FHLMC on or after January 1, 2013 are subject to the Lending and Selling Representations and Warranties Framework updated in May 2014, which provides certain instances in which a mortgage loan is eligible for relief from selling representations and warranties, such as payment history and quality control review.
The total mortgage loan servicing putback expenses, included in loan expense, incurred by Trustmark during the three and nine months ended September 30, 2014 were $150 thousand and $450 thousand, compared to $147 thousand and $1.0 million for the three and nine months ended September 30, 2013, respectively. During November 2013, Trustmark finalized its agreement with FNMA (the “Resolution Agreement”) to resolve its existing and future repurchase and make whole obligations (collectively “Repurchase Obligations”) related to mortgage loans originated between January 1, 2000 and December 31, 2008 and delivered to FNMA. Under the terms of the Resolution Agreement, Trustmark paid FNMA approximately $3.6 million with respect to the Repurchase Obligations. Trustmark believes that it was in its best interests to execute the Resolution Agreement in order to bring finality to the loss reimbursement exposure with FNMA for these years and reduce the resources spent on individual file reviews and defending loss reimbursement requests. The Repurchase Obligations were covered by Trustmark’s existing reserve for mortgage loan servicing putback expenses. The reserve for mortgage loan servicing putback expenses for FNMA loans in periods not covered by the Resolution Agreement and to other entities totaled $1.1 million at September 30, 2014 and December 31, 2013.
Mortgage loans covered by the Resolution Agreement executed with FNMA are only subject to putback risk due to borrower fraud or systemic risk. Trustmark’s exposure to putback requests for loans sold to FNMA, which were originated after 2008, has improved as a result of industry-wide guidelines and process enhancements implemented since that time. Trustmark’s exposure to putback requests for loans sold to GNMA has improved as a result of declining delinquency ratios. Please see “Loans Held for Sale (LHFS)” located elsewhere in this report for additional information regarding mortgage loans sold to GNMA.
There is inherent uncertainty in reasonably estimating the requirement for reserves against future mortgage loan servicing putback expenses. Future putback expenses are dependent on many subjective factors, including the review procedures of the purchasers and the potential refinance activity on loans sold with servicing released and the subsequent consequences under the representations and warranties. Trustmark believes that it has appropriately reserved for potential mortgage loan servicing putback requests.
Segment Information
Results of Segment Operations
Trustmark’s operations are managed along three operating segments: General Banking Division, Wealth Management Division and Insurance Division. During the second quarter of 2014, Trustmark revised the composition of its operating segments by moving the Private Banking group from the Wealth Management Division to the General Banking Division, which provided a more accurate reflection of the manner in which Trustmark manages these operating segments. For financial information by reportable segment, please see Note 18 – Segment Information in the accompanying notes to the consolidated financial statements included elsewhere in this report. Prior period financial information by reportable segment includes the appropriate reclassifications to conform to the current period presentation. The following discusses changes in the financial results of each reportable segment for the nine months ended September 30, 2014 and 2013.
General Banking
The General Banking Division is responsible for all traditional banking products and services including a full range of commercial and consumer banking services such as checking accounts, savings programs, overdraft facilities, commercial, installment and real estate loans, home equity loans and lines of credit, drive-in and night deposit services and safe deposit facilities offered through 207 offices in Alabama, Florida, Mississippi, Tennessee and Texas. The General Banking Division also consists of internal operations that include Human Resources, Executive Administration, Treasury (Funds Management), Public Affairs and Corporate Finance. Included in these operational units are expenses related to mergers, mark-to-market adjustments on loans and deposits, general incentives, restricted stock, supplemental retirement and amortization of core deposits. Other than Treasury, these business units are support-based in nature and are largely responsible for general overhead expenditures that are not allocated.
Net interest income for the General Banking Division increased $19.5 million, or 6.8%, during the nine months ended September 30, 2014 compared with the same time period in 2013. The growth in net interest income was mostly due to the increase in interest and fees on acquired loans due principally to the BancTrust acquisition, an increase in taxable interest on securities as well as modest declines in the cost of interest-bearing deposits. The provision for loan losses, net for the nine months ended September 30, 2014 totaled $7.6 million compared to a negative $9.6 million for the same period in 2013, reflecting an increase of $17.2 million. For more information on these net interest income items, please see the sections captioned “Financial Highlights” and “Results of Operations,” located elsewhere in this report.
Noninterest income for the General Banking Division decreased $8.7 million, or 9.6%, during the first nine months of 2014 compared to the same time period in 2013. Noninterest income for the General Banking Division represented 21.1% of total revenues for the first nine months of 2014 as opposed to 24.0% for the same time period in 2013. Noninterest income for the General Banking Division includes service charges on deposit accounts, bank card and other fees, mortgage banking, net, other, net and securities (losses) gains, net. For more information on these noninterest income items, please see the analysis of Noninterest Income located elsewhere in this report.
Noninterest expense for the General Banking Division decreased $9.5 million, or 3.5%, during the first nine months of 2014 when compared with the same time period in 2013. For more information on these noninterest expense items, please see the analysis of Noninterest Expense located elsewhere in this report.
Wealth Management
The Wealth Management Division has been strategically organized to serve Trustmark’s customers as a financial partner providing reliable guidance and sound, practical advice for accumulating, preserving, and transferring wealth. The Investment Services group and the Trust group are the primary service providers in this segment. TIA, a wholly owned subsidiary of TNB that is included in the Wealth Management Division, is a registered investment adviser that provides investment management services to individual and institutional accounts.
During the first nine months of 2014, net income for the Wealth Management Division increased $1.1 million, or 43.7%, when compared to the same time period in 2013. Noninterest income, which includes income related to investment management, trust and brokerage services, increased $2.4 million, or 11.5%, when the first nine months of 2014 are compared to the same time period in 2013. The increase in noninterest income was primarily attributable to trust management fees on new business (principally in the personal trust group), the addition of BancTrust for a full nine months and fixed annuity income generated by the brokerage services unit. Noninterest expense increased $1.1 million, or 6.2%, during the first nine months of 2014 compared to the same time period in 2013 primarily due to increases in salaries and employee benefits expense. The increase in salaries and benefits expense for the Wealth Management Division was primarily due to modest general merit increases as well as higher commission expense and trust incentive expense resulting from improved performance in the Wealth Management Division. At September 30, 2014 and 2013, Trustmark held assets under management and administration of $10.635 billion and $10.447 billion, respectively, and brokerage assets of $1.601 billion and $1.288 billion, respectively.
Insurance
Trustmark’s Insurance Division provides a full range of retail insurance products, including commercial risk management products, bonding, group benefits and personal lines coverage through FBBI, a Mississippi corporation and subsidiary of TNB.
During the first nine months of 2014, net income for the Insurance Division increased $58 thousand, or 1.6%, when compared to the same time period in 2013, as growth in noninterest income was offset by the increases in noninterest expense. Noninterest income for the Insurance Division increased $2.1 million, or 9.1%, when the first nine months of 2014 are compared to the same time period in 2013. The increase in noninterest income was due to new business commission volume primarily in group health and commercial property and casualty coverage. General business activity continues to improve marginally, resulting in increases in the demand for coverage on inventories, property, equipment, general liability and workers’ compensation. Noninterest expense increased $2.1 million, or 11.4%, during the first nine months of 2014 compared to the same time period in 2013 primarily due to higher commissions expense resulting from improved performance in the Insurance Division.
Income Taxes
For the three and nine months ended September 30, 2014, Trustmark’s combined effective tax rate was 24.9% and 23.8%, respectively, compared to 25.5% and 26.1% for the same time periods in 2013, respectively. Trustmark invests in partnerships that provide income tax credits on a Federal and/or State basis (i.e., new market tax credits, low income housing tax credits or historical tax credits). These investments are recorded based on the equity method of accounting, which requires the equity in partnership losses to be recognized when incurred and recorded as a reduction in other income. The income tax credits related to these partnerships are utilized as specifically allowed by income tax law and are recorded as a reduction in income tax expense. The decrease in Trustmark's effective tax rate in 2014 is mainly due to increased investments in these partnerships along with the appropriate tax credits.
Earning Assets
Earning assets serve as the primary revenue streams for Trustmark and are comprised of securities, loans, federal funds sold, securities purchased under reverse repurchase agreements and other earning assets. Average earning assets totaled $10.390 billion, or 86.6% of total average assets, for the nine months ended September 30, 2014, compared with $9.998 billion, or 87.3% of total average assets, for the nine months ended September 30, 2013, an increase of $391.9 million, or 3.9%.
Securities
The securities portfolio is utilized by Management to manage interest rate risk, generate interest income, provide liquidity and use as collateral for public deposits and wholesale funding. Risk and return can be adjusted by altering duration, composition and/or balance of the portfolio. The weighted-average life of the portfolio decreased slightly to 4.3 years at September 30, 2014, compared to 4.8 years at December 31, 2013.
When compared with December 31, 2013, total investment securities increased by $170.7 million during the first nine months of 2014. This increase resulted primarily from purchases of U.S. Government-sponsored agency (GSE) guaranteed securities, partially offset by maturities and pay-downs of the loans underlying these securities. During the first nine months of 2014, Trustmark sold approximately $56.5 million in securities, generating a net gain of $300 thousand, compared to $67.2 million sold during the first nine months of 2013, which generating a net gain of $378 thousand. During the first quarter of 2014, Trustmark sold $25.9 million of Collateralized Loan Obligations (CLO) securities due to uncertainty related to the Volker Rule. These securities were identified as available for sale and had been carried in the asset-backed securities and structured financial products line item.
During the fourth quarter of 2013, Trustmark reclassified approximately $1.099 billion of securities available for sale as securities held to maturity to mitigate the potential adverse impact of a rising interest rate environment on the fair value of the available for sale securities and the related impact on tangible common equity. The securities were transferred at fair value, which became the cost basis for the securities held to maturity. At the date of transfer, the net unrealized holding loss on the available for sale securities totaled approximately $46.6 million. The net unrealized holding loss is amortized over the remaining life of the securities as a yield adjustment in a manner consistent with the amortization or accretion of the original purchase premium or discount on the associated security. There were no gains or losses recognized as a result of the transfer. At September 30, 2014, the net unamortized, unrealized loss on the transferred securities included in AOCI in the accompanying balance sheets totaled approximately $41.9 million ($25.9 million net of tax) compared to approximately $46.4 million ($28.6 million net of tax) at December 31, 2013.
Available for sale securities are carried at their estimated fair value with unrealized gains or losses recognized, net of taxes, in AOCI, a separate component of shareholders’ equity. At September 30, 2014, available for sale securities totaled $2.364 billion, which represented 66.9% of the securities portfolio, compared to $2.194 billion, or 65.2%, at December 31, 2013. At September 30, 2014, unrealized gains, net on available for sale securities totaled $14.3 million compared to $5.1 million at December 31, 2013. At September 30, 2014, available for sale securities consisted of U.S. Treasury securities, obligations of states and political subdivisions, GSE guaranteed mortgage-related securities, direct obligations of government agencies and GSEs and asset-backed securities and structured financial products.
Held to maturity 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, 2014, held to maturity securities totaled $1.170 billion and represented 33.1% of the total securities portfolio, compared with $1.169 billion, or 34.8%, at December 31, 2013.
Management continues to focus on asset quality as one of the strategic goals of the securities portfolio, which is evidenced by the investment of approximately 93% of the portfolio in GSE-backed obligations and other Aaa-rated securities as determined by Moody’s Investors Services (Moody’s). None of the securities owned by Trustmark are collateralized by assets which are considered sub-prime. Furthermore, outside of stock ownership in the FHLB of Dallas, FHLB of Atlanta and Federal Reserve Bank, Trustmark does not hold any other equity investment in a GSE.
As of September 30, 2014, Trustmark did not hold securities of any one issuer with a carrying value exceeding ten percent of total shareholders’ equity, other than certain GSEs which are exempt from inclusion. Management continues to closely monitor the credit quality as well as the ratings of the debt and mortgage-backed securities issued by the GSEs and held in Trustmark’s securities portfolio in light of issues currently facing these entities.
The following tables present Trustmark’s securities portfolio by amortized cost and estimated fair value and by credit rating, as determined by Moody’s, at September 30, 2014 ($ in thousands):
| | September 30, 2014 | |
| | Amortized Cost | | | Estimated Fair Value | |
| | Amount | | | % | | | Amount | | | % | |
Securities Available for Sale | | | | | | | | | | | | |
Aaa | | $ | 2,181,567 | | | | 92.8 | % | | $ | 2,189,410 | | | | 92.6 | % |
Aa1 to Aa3 | | | 93,481 | | | | 4.0 | % | | | 97,124 | | | | 4.1 | % |
A1 to A3 | | | 3,463 | | | | 0.2 | % | | | 3,565 | | | | 0.2 | % |
Not Rated (1) | | | 71,120 | | | | 3.0 | % | | | 73,796 | | | | 3.1 | % |
Total securities available for sale | | $ | 2,349,631 | | | | 100.0 | % | | $ | 2,363,895 | | | | 100.0 | % |
| | | | | | | | | | | | | | | | |
Securities Held to Maturity | | | | | | | | | | | | | | | | |
Aaa | | $ | 1,105,102 | | | | 94.5 | % | | $ | 1,102,188 | | | | 94.2 | % |
Aa1 to Aa3 | | | 43,139 | | | | 3.7 | % | | | 46,125 | | | | 3.9 | % |
A1 to A3 | | | 2,590 | | | | 0.2 | % | | | 2,643 | | | | 0.2 | % |
Not Rated (1) | | | 18,809 | | | | 1.6 | % | | | 19,257 | | | | 1.7 | % |
Total securities held to maturity | | $ | 1,169,640 | | | | 100.0 | % | | $ | 1,170,213 | | | | 100.0 | % |
(1) Not rated issues primarily consist of Mississippi municipal general obligations.
The table above presenting the credit rating of Trustmark’s securities is formatted to show the securities according to the credit rating category, and not by category of the underlying security. At September 30, 2014, approximately 92.6% of the available for sale securities and 94.5% of held to maturity securities were rated Aaa.
Loans Held for Sale (LHFS)
At September 30, 2014, LHFS totaled $135.6 million, consisting of $96.0 million of residential real estate mortgage loans in the process of being sold to third parties and $39.6 million of GNMA optional repurchase loans. At December 31, 2013, LHFS totaled $149.2 million, consisting of $111.1 million in residential real estate mortgage loans in the process of being sold to third parties and $38.0 million in GNMA optional repurchase loans. Please refer to the nonperforming assets table that follows for information on GNMA loans eligible for repurchase which are past due 90 days or more.
GNMA optional repurchase programs allow financial institutions to buy back individual delinquent mortgage loans that meet certain criteria from the securitized loan pool for which the institution provides servicing. At the servicer's option and without GNMA's prior authorization, the servicer may repurchase such a delinquent loan for an amount equal to 100 percent of the remaining principal balance of the loan. This buy-back option is considered a conditional option until the delinquency criteria are met, at which time the option becomes unconditional. When Trustmark is deemed to have regained effective control over these loans under the unconditional buy-back option, the loans can no longer be reported as sold and must be brought back onto the balance sheet as LHFS, regardless of whether Trustmark intends to exercise the buy-back option. These loans are reported as held for sale with the offsetting liability being reported as short-term borrowings.
Trustmark did not exercise its buy-back option on any delinquent loans serviced for GNMA during the first nine months of 2014. During the first quarter of 2013, Trustmark exercised its option to repurchase approximately $57.4 million delinquent loans serviced for GNMA. These loans were subsequently sold to a third party under different repurchase provisions. Trustmark retained the servicing for these loans, which are fully guaranteed by FHA/VA. As a result of this repurchase and sale, the loans were no longer carried as LHFS. The transaction resulted in a gain of $534 thousand, which was included in mortgage banking, net for the first nine months of 2013.
LHFI and Allowance for Loan Losses, LHFI
LHFI
The table below provides the carrying value of the LHFI portfolio by type for each of the periods presented ($ in thousands):
| | September 30, 2014 | | | December 31, 2013 | |
| | Amount | | | % | | | Amount | | | % | |
Loans secured by real estate: | | | | | | | | | | | | |
Construction, land development and other land | | $ | 580,794 | | | | 9.2 | % | | $ | 596,889 | | | | 10.3 | % |
Secured by 1-4 family residential properties | | | 1,625,480 | | | | 25.6 | % | | | 1,485,564 | | | | 25.6 | % |
Secured by nonfarm, nonresidential properties | | | 1,560,901 | | | | 24.6 | % | | | 1,415,139 | | | | 24.4 | % |
Other | | | 239,819 | | | | 3.8 | % | | | 189,362 | | | | 3.3 | % |
Commercial and industrial loans | | | 1,246,753 | | | | 19.7 | % | | | 1,157,614 | | | | 20.0 | % |
Consumer loans | | | 168,813 | | | | 2.7 | % | | | 165,308 | | | | 2.8 | % |
Other loans | | | 911,091 | | | | 14.4 | % | | | 789,005 | | | | 13.6 | % |
LHFI | | $ | 6,333,651 | | | | 100.0 | % | | $ | 5,798,881 | | | | 100.0 | % |
LHFI at September 30, 2014 totaled $6.334 billion compared to $5.799 billion at December 31, 2013, an increase of $534.8 million. Growth in LHFI was primarily attributable to growth in the real estate secured loans, other loans, and commercial and industrial loans portfolios. Growth in LHFI secured by real estate was attributable to growth in commercial real estate loans, 1-4 family mortgage loans and other real estate secured loans, offset by a decline in construction, land development and other land loans.
The commercial real estate loan portfolio increased $145.8 million during the nine months ended September 30, 2014. The growth in the commercial real estate loan portfolio was primarily attributable to increases in non-owner occupied loans in all of Trustmark’s market regions principally due to construction loans moved to permanent financing. Due to the rise in interest rates on the mortgage portfolio and the tightening of the secondary marketing spreads during the second half of 2013, Management elected to resume the practice of retaining certain 10-15 year mortgage loans in the portfolio. As a result of this decision, the 1-4 family mortgage loan portfolio increased $139.9 million during the nine months ended September 30, 2014, primarily in the Mississippi, Alabama and Florida market regions. Other real estate secured LHFI increased $50.5 million during the first nine months of 2014, primarily due to increases in multi-family residential loans in the Mississippi, Texas, Tennessee and Alabama market regions as construction loans were moved to permanent financing.
LHFI secured by construction, land development and other land decreased $16.1 million during the first nine months of 2014, primarily due to declines in land development and other construction loans partially offset by growth in 1-4 family construction. Land development loans declined $37.3 million during the first nine months of 2014, primarily in the Florida, Mississippi, Texas and Tennessee market regions. The 1-4 family construction loan portfolio increased $24.2 million during the nine months ended September 30, 2014, principally due to growth in the Alabama, Texas, Florida and Mississippi market regions. Other construction loans decreased $15.6 million during the first nine months of 2014, primarily due to $201.5 million in other construction loans that were moved to the appropriate permanent categories upon completion, including $103.3 million in non-owner occupied, $62.3 million in multi-family residential, $24.8 million in owner occupied and $10.9 million in obligations of states and political subdivisions. Excluding all reclasses between loan categories, growth in other construction loans was $190.8 million for the nine months ended September 30, 2014.
The other loan portfolio increase of $122.1 million represents growth in all of Trustmark’s market regions primarily in the obligations of states and political subdivisions loan segment and other loans, which includes lending to nonprofits and REITS. The commercial and industrial loan portfolio increase of $89.1 million was primarily attributable to growth in Trustmark’s Alabama, Mississippi and Tennessee market regions.
The following table provides information regarding Trustmark’s home equity loans and home equity lines of credit which are included in the LHFI secured by 1-4 family residential properties for the periods presented ($ in thousands):
| | September 30, 2014 | | | December 31, 2013 | |
Home equity loans | | $ | 61,633 | | | $ | 61,464 | |
Home equity lines of credit | | $ | 350,657 | | | $ | 327,482 | |
Percentage of loans and lines for which Trustmark holds first lien | | | 56.5 | % | | | 54.7 | % |
Percentage of loans and lines for which Trustmark does not hold first lien | | | 43.5 | % | | | 45.3 | % |
Due to the increased risk associated with second liens, loan terms and underwriting guidelines differ from those used for products secured by first liens. Loan amounts and loan-to-value ratios are limited and are lower for second liens than first liens. Also, interest rates and maximum amortization periods are adjusted accordingly. In addition, regardless of lien position, the passing credit score for approval of all home equity lines of credit is higher than that of term loans. The allowance for loan losses, LHFI is also reflective of the increased risk related to second liens through application of a greater loss factor to this portion of the portfolio.
In the following tables, LHFI reported by region (along with related nonperforming assets and net charge-offs) are associated with location of origination except for loans secured by 1-4 family residential properties (representing traditional mortgages), credit cards and indirect consumer auto loans. These loans are included in the Mississippi Region because they are centrally analyzed and approved as part of a specific line of business located at Trustmark’s headquarters in Jackson, Mississippi.
The following table presents the LHFI composition by region at September 30, 2014 and reflects a diversified mix of loans by region ($ in thousands):
| | September 30, 2014 | |
LHFI Composition by Region | | Total | | | Alabama | | | Florida | | | Mississippi (Central and Southern Regions) | | | Tennessee (Memphis, TN and Northern MS Regions) | | | Texas | |
Loans secured by real estate: | | | | | | | | | | | | | | | | | | |
Construction, land development and other land | | $ | 580,794 | | | $ | 56,496 | | | $ | 59,822 | | | $ | 251,931 | | | $ | 36,868 | | | $ | 175,677 | |
Secured by 1-4 family residential properties | | | 1,625,480 | | | | 34,915 | | | | 50,888 | | | | 1,392,033 | | | | 128,966 | | | | 18,678 | |
Secured by nonfarm, nonresidential properties | | | 1,560,901 | | | | 81,220 | | | | 169,716 | | | | 796,158 | | | | 145,197 | | | | 368,610 | |
Other | | | 239,819 | | | | 7,236 | | | | 4,527 | | | | 155,652 | | | | 27,064 | | | | 45,340 | |
Commercial and industrial loans | | | 1,246,753 | | | | 78,335 | | | | 10,269 | | | | 797,307 | | | | 96,445 | | | | 264,397 | |
Consumer loans | | | 168,813 | | | | 16,028 | | | | 2,804 | | | | 130,710 | | | | 16,512 | | | | 2,759 | |
Other loans | | | 911,091 | | | | 51,840 | | | | 46,230 | | | | 665,139 | | | | 58,723 | | | | 89,159 | |
LHFI | | $ | 6,333,651 | | | $ | 326,070 | | | $ | 344,256 | | | $ | 4,188,930 | | | $ | 509,775 | | | $ | 964,620 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Construction, Land Development and Other Land Loans by Region | | | | | | | | | | | | | | | | | | | | | | | | |
Lots | | $ | 51,089 | | | $ | 4,319 | | | $ | 26,551 | | | $ | 14,983 | | | $ | 1,154 | | | $ | 4,082 | |
Development | | | 58,350 | | | | 836 | | | | 6,924 | | | | 31,889 | | | | 956 | | | | 17,745 | |
Unimproved land | | | 121,841 | | | | 6,529 | | | | 21,474 | | | | 60,039 | | | | 23,518 | | | | 10,281 | |
1-4 family construction | | | 120,747 | | | | 21,721 | | | | 4,724 | | | | 59,896 | | | | 2,836 | | | | 31,570 | |
Other construction | | | 228,767 | | | | 23,091 | | | | 149 | | | | 85,124 | | | | 8,404 | | | | 111,999 | |
Construction, land development and other land loans | | $ | 580,794 | | | $ | 56,496 | | | $ | 59,822 | | | $ | 251,931 | | | $ | 36,868 | | | $ | 175,677 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Loans Secured by Nonfarm, Nonresidential Properties by Region | | | | | | | | | | | | | | | | | | | | | |
Income producing: | | | | | | | | | | | | | | | | | | | | | | | | |
Retail | | $ | 186,564 | | | $ | 18,070 | | | $ | 38,968 | | | $ | 63,805 | | | $ | 16,490 | | | $ | 49,231 | |
Office | | | 205,957 | | | | 9,897 | | | | 44,271 | | | | 83,556 | | | | 8,010 | | | | 60,223 | |
Nursing homes/assisted living | | | 111,338 | | | | - | | | | - | | | | 92,345 | | | | 5,848 | | | | 13,145 | |
Hotel/motel | | | 107,720 | | | | 11,853 | | | | 16,067 | | | | 46,106 | | | | 23,744 | | | | 9,950 | |
Industrial | | | 68,183 | | | | 4,262 | | | | 6,086 | | | | 32,871 | | | | 141 | | | | 24,823 | |
Health care | | | 29,204 | | | | 5,147 | | | | - | | | | 24,014 | | | | 43 | | | | - | |
Convenience stores | | | 9,225 | | | | 248 | | | | - | | | | 5,782 | | | | 1,266 | | | | 1,929 | |
Other | | | 144,033 | | | | 4,677 | | | | 20,756 | | | | 68,070 | | | | 4,327 | | | | 46,203 | |
Total income producing loans | | | 862,224 | | | | 54,154 | | | | 126,148 | | | | 416,549 | | | | 59,869 | | | | 205,504 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Owner-occupied: | | | | | | | | | | | | | | | | | | | | | | | | |
Office | | | 116,451 | | | | 5,965 | | | | 15,652 | | | | 54,700 | | | | 8,285 | | | | 31,849 | |
Churches | | | 90,977 | | | | 2,895 | | | | 3,345 | | | | 41,791 | | | | 32,092 | | | | 10,854 | |
Industrial warehouses | | | 115,273 | | | | 332 | | | | 4,115 | | | | 61,568 | | | | 7,830 | | | | 41,428 | |
Health care | | | 120,906 | | | | 11,122 | | | | 8,666 | | | | 66,029 | | | | 16,469 | | | | 18,620 | |
Convenience stores | | | 53,291 | | | | 522 | | | | 1,572 | | | | 32,919 | | | | 2,818 | | | | 15,460 | |
Retail | | | 30,268 | | | | 1,333 | | | | 3,906 | | | | 18,532 | | | | 3,080 | | | | 3,417 | |
Restaurants | | | 35,077 | | | | 241 | | | | 2,062 | | | | 27,657 | | | | 4,076 | | | | 1,041 | |
Auto dealerships | | | 8,123 | | | | - | | | | 160 | | | | 6,367 | | | | 1,569 | | | | 27 | |
Other | | | 128,311 | | | | 4,656 | | | | 4,090 | | | | 70,046 | | | | 9,109 | | | | 40,410 | |
Total owner-occupied loans | | | 698,677 | | | | 27,066 | | | | 43,568 | | | | 379,609 | | | | 85,328 | | | | 163,106 | |
Loans secured by nonfarm, nonresidential properties | | $ | 1,560,901 | | | $ | 81,220 | | | $ | 169,716 | | | $ | 796,158 | | | $ | 145,197 | | | $ | 368,610 | |
Trustmark makes loans in the normal course of business to certain directors, 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.
There is no industry standard definition of “subprime loans.” Trustmark categorizes certain loans as subprime for its purposes using a set of factors, which Management believes are consistent with industry practice. Trustmark has not originated or purchased subprime mortgages. At September 30, 2014, Trustmark held “alt A” mortgages with an aggregate principal balance of $2.0 million (0.05% of total LHFI secured by real estate at that date). These “alt A” loans have been originated by Trustmark as an accommodation to certain Trustmark customers for whom Trustmark determined that such loans were suitable under the purposes of the Fannie Mae “alt A” program and under Trustmark’s loan origination standards. Trustmark does not have any no-interest loans, other than a small number of loans made to customers that are charitable organizations, the aggregate amount of which is not material to Trustmark’s financial condition or results of operations.
The following table provides information regarding the interest rate terms of Trustmark’s LHFI for the periods presented ($ in thousands). Trustmark’s variable rate LHFI are based primarily on various prime and LIBOR interest rate bases.
| | September 30, 2014 | |
| | Fixed | | | Variable | | | Total | |
Loans secured by real estate: | | | | | | | | | |
Construction, land development and other land | | $ | 154,519 | | | $ | 426,275 | | | $ | 580,794 | |
Secured by 1- 4 family residential properties | | | 1,511,914 | | | | 113,566 | | | | 1,625,480 | |
Secured by nonfarm, nonresidential properties | | | 1,002,511 | | | | 558,390 | | | | 1,560,901 | |
Other | | | 139,756 | | | | 100,063 | | | | 239,819 | |
Commercial and industrial loans | | | 420,570 | | | | 826,183 | | | | 1,246,753 | |
Consumer loans | | | 150,368 | | | | 18,445 | | | | 168,813 | |
Other loans | | | 612,841 | | | | 298,250 | | | | 911,091 | |
LHFI | | $ | 3,992,479 | | | $ | 2,341,172 | | | $ | 6,333,651 | |
| | | | | | | | | | | | |
| | December 31, 2013 | |
| | Fixed | | | Variable | | | Total | |
Loans secured by real estate: | | | | | | | | | | | | |
Construction, land development and other land | | $ | 203,607 | | | $ | 393,282 | | | $ | 596,889 | |
Secured by 1- 4 family residential properties | | | 1,298,295 | | | | 187,269 | | | | 1,485,564 | |
Secured by nonfarm, nonresidential properties | | | 882,724 | | | | 532,415 | | | | 1,415,139 | |
Other | | | 115,315 | | | | 74,047 | | | | 189,362 | |
Commercial and industrial loans | | | 478,842 | | | | 678,772 | | | | 1,157,614 | |
Consumer loans | | | 147,119 | | | | 18,189 | | | | 165,308 | |
Other loans | | | 522,276 | | | | 266,729 | | | | 789,005 | |
LHFI | | $ | 3,648,178 | | | $ | 2,150,703 | | | $ | 5,798,881 | |
Allowance for Loan Losses, LHFI
The allowance for loan losses, LHFI is established through provisions for estimated loan losses charged against net income. The allowance reflects Management’s best estimate of the probable loan losses related to specifically identified LHFI as well as probable incurred loan losses in the remaining loan portfolio and requires considerable judgment. The allowance is based upon Management’s current judgments and the credit quality of the loan portfolio, including all internal and external factors that impact loan collectibility. Accordingly, the allowance is based upon both past events and current economic conditions.
Trustmark’s allowance has been developed using different factors to estimate losses based upon specific evaluation of identified individual LHFI considered impaired, estimated identified losses on various pools of LHFI and/or groups of risk rated LHFI with common risk characteristics and other external and internal factors of estimated probable losses based on other facts and circumstances.
Trustmark’s allowance for loan loss methodology is based on guidance provided in Staff Accounting Bulletin (SAB) No. 102 as well as other regulatory guidance. The level of Trustmark’s allowance reflects Management’s continuing evaluation of specific credit risks, loan loss experience, current loan portfolio growth, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. This evaluation takes into account other qualitative factors including recent acquisitions; national, regional and local economic trends and conditions; changes in industry and credit concentration; changes in levels and trends of delinquencies and nonperforming LHFI; changes in levels and trends of net charge-offs; changes in interest rates and collateral, financial and underwriting exceptions; and loan facility risk. For a complete description of Trustmark’s allowance for loan loss methodology and the quantitative and qualitative factors included in the valuation allowance, please see Note 4 – Loans Held for Investment (LHFI) and Allowance for Loan Losses, LHFI located elsewhere in this report.
At September 30, 2014, the allowance for loan losses, LHFI, was $70.1 million, an increase of $3.7 million, or 5.5%, when compared with December 31, 2013. Total allowance coverage of nonperforming LHFI, excluding impaired LHFI, at September 30, 2014, was 178.81%, compared to 190.70% at December 31, 2013. Allocation of Trustmark’s $70.1 million allowance for loan losses, LHFI, represented 1.26% of commercial LHFI and 0.69% of consumer and home mortgage LHFI, resulting in an allowance to total LHFI of 1.11% as of September 30, 2014. This compares with an allowance to total LHFI of 1.15% at December 31, 2013, which was allocated to commercial LHFI at 1.30% and to consumer and mortgage LHFI at 0.75%.
Recoveries exceeded charge-offs of LHFI for the first nine months of 2014 resulting in a net recovery of $1.1 million, or -0.02% of average LHFI, compared to a net recovery of $1.3 million, or -0.03% of average LHFI, during the same time period in 2013. Florida had the highest recoveries, which totaled $3.1 million for the first nine months of 2014. The decrease in net recoveries can be primarily attributed to a decline in recoveries resulting from impaired LHFI paid off in excess of the book value, net of previous charge-downs, partially offset by an increase in charge-offs of LHFI for the first nine months of 2014 principally in the Mississippi market region. Management continues to monitor the impact of real estate values on borrowers and is proactively managing these situations.
The following table presents the net (recoveries) charge-offs for LHFI by geographic market region for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | 2014 | | | 2013 | |
Alabama | | $ | 172 | | | $ | 132 | | | $ | 311 | | | $ | 210 | |
Florida | | | (89 | ) | | | (138 | ) | | | (3,138 | ) | | | (2,413 | ) |
Mississippi (2) | | | 462 | | | | 375 | | | | 2,656 | | | | 376 | |
Tennessee (3) | | | 48 | | | | (153 | ) | | | 134 | | | | 199 | |
Texas | | | (1,021 | ) | | | 353 | | | | (1,045 | ) | | | 296 | |
Total net (recoveries) charge-offs | | $ | (428 | ) | | $ | 569 | | | $ | (1,082 | ) | | $ | (1,332 | ) |
(1) Mississippi includes Central and Southern Mississippi Regions
(2) Tennessee includes Memphis, Tennessee and Northern Mississippi Regions
Trustmark’s loan policy dictates the guidelines to be followed in determining when a loan is charged off. Commercial purpose loans are charged off when a determination is made that the loan is uncollectible and continuance as a bankable asset is not warranted or an impairment evaluation indicates that a value adjustment is necessary. Consumer loans secured by 1-4 family residential real estate are generally charged off or written down when the credit becomes severely delinquent and the balance exceeds the fair value of the property less costs to sell. Non-real estate consumer purpose loans, both secured and unsecured, are generally charged off in full during the month in which the loan becomes 120 days past due. Credit card loans are generally charged off in full when the loan becomes 180 days past due.
Nonperforming Assets, excluding Acquired Loans and Covered Other Real Estate
The table below provides the components of the nonperforming assets, excluding acquired loans and covered other real estate, by geographic market regions for the periods presented ($ in thousands):
| | September 30, 2014 | | | December 31, 2013 | |
Nonaccrual LHFI | | | | | | |
Alabama | | $ | 852 | | | $ | 14 | |
Florida | | | 10,986 | | | | 12,278 | |
Mississippi (1) | | | 65,751 | | | | 42,307 | |
Tennessee (2) | | | 5,901 | | | | 4,390 | |
Texas | | | 4,824 | | | | 6,249 | |
Total nonaccrual LHFI | | | 88,314 | | | | 65,238 | |
Other real estate | | | | | | | | |
Alabama | | | 24,256 | | | | 25,912 | |
Florida | | | 36,608 | | | | 34,480 | |
Mississippi (1) | | | 16,419 | | | | 22,766 | |
Tennessee (2) | | | 11,347 | | | | 12,892 | |
Texas | | | 8,407 | | | | 10,489 | |
Total other real estate, excluding covered other real estate | | | 97,037 | | | | 106,539 | |
Total nonperforming assets | | $ | 185,351 | | | $ | 171,777 | |
| | | | | | | | |
Nonperforming assets/total loans (LHFI and LHFS) and ORE | | | 2.82 | % | | | 2.84 | % |
| | | | | | | | |
Loans past due 90 days or more | | | | | | | | |
LHFI | | $ | 3,839 | | | $ | 3,298 | |
| | | | | | | | |
LHFS - Guaranteed GNMA serviced loans (3) | | $ | 24,979 | | | $ | 21,540 | |
(1) Mississippi includes Central and Southern Mississippi Regions
(2) Tennessee includes Memphis, Tennessee and Northern Mississippi Regions
(3) No obligation to repurchase
See the previous discussion of LHFS for more information on Trustmark’s serviced GNMA loans eligible for repurchase and the impact of Trustmark’s repurchases of delinquent mortgage loans under the GNMA optional repurchase program.
During the first nine months of 2014, nonaccrual LHFI increased $23.1 million, or 35.4%, relative to December 31, 2013 to total $88.3 million, or 1.37% of total LHFI and LHFS. The increase in nonaccrual LHFI was principally the result of one substandard credit migrating to nonaccrual status during the second quarter of 2014 and two substandard credits migrating to nonaccrual status during the third quarter of 2014. These three credit relationships totaled $24.8 million at September 30, 2014 and were included in Trustmark’s Mississippi market region. Excluding these three credit relationships, nonaccrual LHFI totaled $63.5 million at September 30, 2014, a decrease of $1.7 million, or 2.6%, relative to December 31, 2013 as Trustmark continues to work through its problem assets. The following table illustrates nonaccrual LHFI by loan type for the periods presented ($ in thousands):
| | September 30, 2014 | | | December 31, 2013 | |
Loans secured by real estate: | | | | | | |
Construction, land development and other land | | $ | 20,286 | | | $ | 13,327 | |
Secured by 1-4 family residential properties | | | 27,017 | | | | 21,603 | |
Secured by nonfarm, nonresidential properties | | | 23,885 | | | | 21,809 | |
Other | | | 1,203 | | | | 1,327 | |
Commercial and industrial | | | 15,178 | | | | 6,286 | |
Consumer loans | | | 160 | | | | 151 | |
Other loans | | | 585 | | | | 735 | |
Total nonaccrual LHFI | | $ | 88,314 | | | $ | 65,238 | |
At September 30, 2014, other real estate, excluding covered other real estate, totaled $97.0 million, a decrease of $9.5 million, or 8.9%, when compared with December 31, 2013. The decrease in other real estate, excluding covered other real estate, was attributable to decreases in the Mississippi, Texas, Alabama and Tennessee market regions, which were partially offset by an increase in the Florida market region.
The following table illustrates changes in other real estate, excluding covered other real estate, by geographic market region for the periods presented ($ in thousands):
| | Nine Months Ended September 30, 2013 | |
| | Total | | | Alabama | | | Florida | | | Mississippi (1) | | | Tennessee (2) | | | Texas | |
Balance at beginning of period | | $ | 106,539 | | | $ | 25,912 | | | $ | 34,480 | | | $ | 22,766 | | | $ | 12,892 | | | $ | 10,489 | |
Additions | | | 29,972 | | | | 8,147 | | | | 15,386 | | | | 6,023 | | | | 416 | | | | - | |
Disposals | | | (34,641 | ) | | | (8,853 | ) | | | (12,424 | ) | | | (10,557 | ) | | | (725 | ) | | | (2,082 | ) |
Write-downs | | | (4,833 | ) | | | (1,015 | ) | | | (834 | ) | | | (1,748 | ) | | | (1,236 | ) | | | - | |
Adjustments | | | - | | | | 65 | | | | - | | | | (65 | ) | | | - | | | | - | |
Balance at end of period | | $ | 97,037 | | | $ | 24,256 | | | $ | 36,608 | | | $ | 16,419 | | | $ | 11,347 | | | $ | 8,407 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, 2013 | |
| | Total | | | Alabama | | | Florida | | | Mississippi (1) | | | Tennessee (2) | | | Texas | |
Balance at beginning of period | | $ | 78,189 | | | $ | - | | | $ | 18,569 | | | $ | 27,771 | | | $ | 17,589 | | | $ | 14,260 | |
Additions (3) | | | 73,890 | | | | 31,473 | | | | 31,554 | | | | 5,741 | | | | 3,550 | | | | 1,572 | |
Disposals | | | (29,605 | ) | | | (5,476 | ) | | | (10,251 | ) | | | (8,209 | ) | | | (3,326 | ) | | | (2,343 | ) |
Write-downs | | | (6,145 | ) | | | (689 | ) | | | (674 | ) | | | 136 | | | | (3,198 | ) | | | (1,720 | ) |
Balance at end of period | | $ | 116,329 | | | $ | 25,308 | | | $ | 39,198 | | | $ | 25,439 | | | $ | 14,615 | | | $ | 11,769 | |
(1) Mississippi includes Central and Southern Mississippi Regions
(2) Tennessee includes Memphis, Tennessee and Northern Mississippi Regions
(3) Additions at September 30, 2013 included $40.1 million of other real estate acquired from BancTrust
Other real estate, excluding covered other real estate, in Trustmark’s Florida market region included $11.8 million of BancTrust properties foreclosed during the first nine months of 2014, and $9.1 million of BancTrust other real estate in Florida was sold during the first nine months of 2014. Excluding other real estate resulting from the BancTrust acquisition, other real estate, excluding covered other real estate, decreased $10.4 million during the first nine months of 2014.
The following table illustrates other real estate, excluding covered other real estate, by type of property for the periods presented ($ in thousands):
| | September 30, 2014 | | | December 31, 2013 | |
Construction, land development and other land properties | | $ | 63,127 | | | $ | 65,273 | |
1-4 family residential properties | | | 9,998 | | | | 14,696 | |
Nonfarm, nonresidential properties | | | 22,251 | | | | 26,433 | |
Other real estate properties | | | 1,661 | | | | 137 | |
Total other real estate, excluding covered other real estate | | $ | 97,037 | | | $ | 106,539 | |
Other real estate is revalued on an annual basis or more often if market conditions necessitate. Subsequent to foreclosure, losses on the periodic revaluation of the property are charged against the reserve for other real estate write-downs or net income in ORE/Foreclosure expense, if a reserve does not exist. Write-downs of other real estate, excluding covered other real estate, decreased $1.3 million during the first nine months of 2014 compared to the same time period in 2013. The decrease in write-downs on other real estate, excluding covered other real estate, was primarily the result of the write-down on an individual property in the Tennessee market region during the second quarter of 2013 as well as stabilizing property values and adequate reserves established in prior periods, which were partially offset by the increase in write-downs in the Mississippi market region and write-downs on BancTrust related other real estate that was revalued during the second quarter of 2014. The increase in write-downs on other real estate, excluding covered other real estate, in the Mississippi market region during the first nine months of 2014 was principally due to reserves released during the second quarter of 2013.
The following table illustrates write-downs of other real estate, excluding covered other real estate, by region for the periods presented ($ in thousands):
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | | | 2014 | | | 2013 | |
Alabama | | $ | 93 | | | $ | 627 | | | $ | 1,015 | | | $ | 689 | |
Florida | | | 582 | | | | 343 | | | | 834 | | | | 674 | |
Mississippi (1) | | | 288 | | | | 16 | | | | 1,748 | | | | (136 | ) |
Tennessee (2) | | | 528 | | | | (15 | ) | | | 1,236 | | | | 3,198 | |
Texas | | | - | | | | 750 | | | | - | | | | 1,720 | |
Total write-downs of other real estate | | $ | 1,491 | | | $ | 1,721 | | | $ | 4,833 | | | $ | 6,145 | |
(1) Mississippi includes Central and Southern Mississippi Regions
(2) Tennessee includes Memphis, Tennessee and Northern Mississippi Regions
Acquired Loans
For the periods presented, acquired loans consisted of the following ($ in thousands):
| | September 30, 2014 | | | December 31, 2013 | |
| | Noncovered | | | Covered | | | Noncovered | | | Covered | |
Loans secured by real estate: | | | | | | | | | | | | |
Construction, land development and other land | | $ | 64,808 | | | $ | 1,721 | | | $ | 98,928 | | | $ | 2,363 | |
Secured by 1-4 family residential properties | | | 120,366 | | | | 14,114 | | | | 157,914 | | | | 16,416 | |
Secured by nonfarm, nonresidential properties | | | 214,806 | | | | 8,270 | | | | 287,136 | | | | 10,945 | |
Other | | | 28,036 | | | | 2,949 | | | | 33,948 | | | | 2,644 | |
Commercial and industrial loans | | | 103,185 | | | | 327 | | | | 149,495 | | | | 394 | |
Consumer loans | | | 11,236 | | | | - | | | | 18,428 | | | | 119 | |
Other loans | | | 22,105 | | | | 226 | | | | 24,141 | | | | 1,335 | |
Acquired loans | | | 564,542 | | | | 27,607 | | | | 769,990 | | | | 34,216 | |
Less allowance for loan losses, acquired loans | | | 11,136 | | | | 813 | | | | 7,249 | | | | 2,387 | |
Net acquired loans | | $ | 553,406 | | | $ | 26,794 | | | $ | 762,741 | | | $ | 31,829 | |
Loans acquired through business combinations were evaluated for evidence of credit deterioration since origination and collectability of contractually required payments. Trustmark elected to account for all loans acquired in business combinations as acquired impaired loans under FASB ASC Topic 310-30, except for acquired loans with revolving privileges and acquired commercial leases, which are outside the scope of this guidance. While not all loans acquired in business combinations exhibited evidence of significant credit deterioration, accounting for these acquired loans under FASB ASC Topic 310-30 would have materially the same result as the alternative accounting treatment. Acquired loans with revolving privileges and acquired commercial leases were accounted for in accordance with accounting requirements for acquired nonimpaired loans.
On February 15, 2013, Trustmark completed its merger with BancTrust. Trustmark acquired $944.2 million of noncovered loans, including $153.9 million of revolving credit agreements and commercial leases, at fair value, in the BancTrust acquisition. During the second quarter of 2013, Trustmark recorded a fair value adjustment based on the estimated fair value of certain acquired loans which resulted in a net decrease in acquired noncovered loans of $524 thousand. During the third quarter of 2013, Trustmark recorded a fair value adjustment based on the estimated fair value of certain acquired loans which resulted in a net decrease in acquired noncovered loans of $6.3 million. The purchase price allocation for these loans was considered final as of December 31, 2013.
The following table illustrates changes in the net carrying value of the acquired loans for the periods presented ($ in thousands):
| | Noncovered | | | Covered | |
| | | | | Acquired Not ASC 310-30 (1) | | | | | | Acquired Not ASC 310-30 (1) | |
Carrying value, net at January 1, 2013 | | $ | 72,942 | | | $ | 6,696 | | | $ | 45,391 | | | $ | 2,460 | |
Loans acquired (2) | | | 790,335 | | | | 153,900 | | | | - | | | | - | |
Accretion to interest income | | | 35,538 | | | | 2,628 | | | | 5,150 | | | | 159 | |
Payments received, net | | | (229,618 | ) | | | (39,281 | ) | | | (18,976 | ) | | | (819 | ) |
Other | | | (24,177 | ) | | | (858 | ) | | | (3,202 | ) | | | (137 | ) |
Less change in allowance for loan losses, acquired loans | | | (5,364 | ) | | | - | | | | 1,803 | | | | - | |
Carrying value, net at December 31, 2013 | | | 639,656 | | | | 123,085 | | | | 30,166 | | | | 1,663 | |
Accretion to interest income | | | 35,423 | | | | 1,442 | | | | 3,010 | | | | (1 | ) |
Payments received, net | | | (185,880 | ) | | | (37,437 | ) | | | (7,831 | ) | | | 126 | |
Other | | | (26,284 | ) | | | (486 | ) | | | (1,429 | ) | | | (484 | ) |
Less change in allowance for loan losses, acquired loans | | | 4,400 | | | | (513 | ) | | | 1,129 | | | | 445 | |
Carrying value, net at September 30, 2014 | | $ | 467,315 | | | $ | 86,091 | | | $ | 25,045 | | | $ | 1,749 | |
(1) "Acquired Not ASC 310-30" loans consist of revolving credit agreements and commercial leases that are not in scope for FASB ASC Topic 310-30.
(2) Adjusted fair value of loans acquired from BancTrust on February 15, 2013.
Covered Other Real Estate
The following table illustrates covered other real estate by type of property for the periods presented ($ in thousands):
| | September 30, 2014 | | | December 31, 2013 | |
Construction, land development and other land properties | | $ | 713 | | | $ | 733 | |
1-4 family residential properties | | | 1,267 | | | | 1,981 | |
Nonfarm, nonresidential properties | | | 2,166 | | | | 2,394 | |
Total covered other real estate | | $ | 4,146 | | | $ | 5,108 | |
The following table illustrates changes and (losses) gains, net on covered other real estate for the nine months ended September 30, 2014 and 2013 ($ in thousands):
| | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | |
Balance at beginning of period | | $ | 5,108 | | | $ | 5,741 | |
Transfers from covered loans | | | 690 | | | | 1,380 | |
FASB ASC 310-30 adjustment for the residual recorded investment | | | 9 | | | | (541 | ) |
Net transfers from covered loans | | | 699 | | | | 839 | |
Disposals | | | (870 | ) | | | (848 | ) |
Write-downs | | | (791 | ) | | | (640 | ) |
Balance at end of period | | $ | 4,146 | | | $ | 5,092 | |
| | | | | | | | |
(Loss) Gain, net on the sale of covered other real estate included in ORE/Foreclosure expense | | $ | (132 | ) | | $ | 47 | |
FDIC Indemnification Asset
Trustmark periodically re-estimates the expected cash flows on the acquired covered loans as required by FASB ASC Topic 310-30. For the first nine months of 2014 and 2013, this analysis resulted in improvements in the estimated future cash flows of the acquired covered loans that remain outstanding as well as lower expected remaining losses on those loans, primarily due to pay-offs of acquired covered loans. The pay-offs and improvements in the estimated expected cash flows of the acquired covered loans resulted in a reduction of the expected loss-share receivable from the FDIC. Reductions of the FDIC indemnification asset resulting from improvements in expected cash flows and covered losses based on the re-estimation of acquired covered loans are amortized over the lesser of the remaining life or contractual period of the acquired covered loan as a yield adjustment consistent with the associated acquired covered loan. Other noninterest income for the first nine months of 2014 and 2013 included $1.6 million and $141 thousand, respectively, of amortization of the FDIC indemnification asset, as a result of improvements in the expected cash flows and lower loss expectations. During the first nine months of 2014 and 2013, other noninterest income also included a reduction of the FDIC indemnification asset of $507 thousand and $3.3 million, respectively, primarily resulting from loan pay-offs partially offset by loan pools of acquired covered loans with increased loss expectations.
The following table illustrates changes in the FDIC indemnification asset for the periods presented ($ in thousands):
| | Nine Months Ended September 30, | |
| | 2014 | | | 2013 | |
Balance at beginning of period | | $ | 14,347 | | | $ | 21,774 | |
(Amortization) Accretion | | | (1,633 | ) | | | (141 | ) |
Transfers to FDIC claims | | | (4,021 | ) | | | (1,097 | ) |
Change in expected cash flows | | | (373 | ) | | | (3,251 | ) |
Change in FDIC true-up provision | | | (166 | ) | | | (200 | ) |
Balance at end of period | | $ | 8,154 | | | $ | 17,085 | |
Pursuant to the provisions of the loss-share agreement with the FDIC, TNB may be required to make a true-up payment to the FDIC at the termination of the loss-share agreement should actual losses be less than certain thresholds established in the agreement. TNB calculates the projected true-up payable to the FDIC quarterly and records a FDIC true-up provision for the present value of the projected true-up payable to the FDIC at the termination of the loss-share agreement. TNB’s FDIC true-up provision totaled $1.9 million at September 30, 2014 compared to $1.7 million at December 31, 2013.
Other Earning Assets
Average federal funds sold and securities purchased under reverse repurchase agreements were $4.4 million for the nine months ended September 30, 2014, a decrease of $3.0 million, or 40.7%, when compared with the same time period in 2013. Trustmark utilizes these products as offerings for its correspondent banking customers as well as a short-term investment alternative whenever it has excess liquidity.
Average other earning assets totaled $38.3 million for the nine months ended September 30, 2014, compared with $35.9 million for the nine months ended September 30, 2013, an increase of $2.4 million, or 6.8%.
Deposits and Other Interest-Bearing Liabilities
Trustmark’s deposits are its primary source of funding and consist of core deposits from the communities Trustmark serves. Deposits include interest-bearing and noninterest-bearing demand accounts, savings, money market, certificates of deposit and individual retirement accounts. Total deposits were $9.513 billion at September 30, 2014, compared to $9.860 billion at December 31, 2013. Growth in noninterest-bearing deposits totaled $60.0 million and was more than offset by a decline in interest-bearing deposits of $406.7 million during the first nine months of 2014. The increase in noninterest-bearing deposits was primarily due to growth in commercial and public demand deposit accounts, partially offset by a decline in personal demand deposit accounts. The decrease in interest-bearing deposits resulted primarily from decreases in interest checking accounts, time deposits and money market deposit accounts. Time deposit account balances declined by $248.3 million as a result of Trustmark’s continued efforts to reduce high-cost deposit balances and the $50.0 million term fixed-rate brokered CD which matured on February 25, 2014. For additional information regarding Trustmark’s brokered deposits, please see the section captioned “Liquidity” included elsewhere in this report.
Trustmark uses short-term borrowings to fund growth of earning assets in excess of deposit growth. Short-term borrowings consist primarily of federal funds purchased, securities sold under repurchase agreements, short-term FHLB advances and GNMA optional repurchase loans. Short-term borrowings totaled $924.5 million at September 30, 2014, an increase of $606.5 million when compared with $318.0 million at December 31, 2013. Of these amounts, $607.9 million and $251.6 million, respectively, were customer related transactions, such as commercial sweep repo balances. The increase in short-term borrowings resulted from increases in federal funds purchased of $341.9 million, short-term FHLB advances provided by the FHLB of Dallas of $250.0 million, securities sold under repurchase agreements of $14.4 million and GNMA optional repurchase loans of $1.5 million. For additional information regarding Trustmark’s short-term FHLB advances, please see the section captioned “Liquidity” included elsewhere in this report.
Legal Environment
For a complete overview of Trustmark’s legal environment and related contingencies, please see Note 12 – Contingencies: Legal Proceedings included in Part I. Item 1. – Financial Statements – of this report.
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, and thus are not expected to have a significant impact on Trustmark’s liquidity or capital resources. 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, 2014 and 2013, Trustmark had unused commitments to extend credit of $2.443 billion and $2.064 billion, respectively.
Standby and commercial letters of credit are conditional commitments issued by Trustmark to ensure 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 that are followed in the lending process. At September 30, 2014 and 2013, Trustmark’s maximum exposure to credit loss in the event of nonperformance by the other party for letters of credit was $137.1 million and $148.5 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.
Contractual Obligations
Payments due from Trustmark under specified long-term and certain other binding contractual obligations were scheduled in our Annual Report on Form 10-K for the year ended December 31, 2013. The most significant obligations, other than obligations under deposit contracts and short-term borrowings, were for operating leases for banking facilities. There have been no material changes in Trustmark’s contractual obligations since year-end.
Capital Resources
At September 30, 2014, Trustmark’s total shareholders’ equity was $1.415 billion, an increase of $60.1 million, or 4.4%, from its level at December 31, 2013. During the first nine months of 2014, shareholders’ equity increased primarily as a result of net income of $95.5 million and was partially offset by common stock dividends of $46.9 million. Trustmark utilizes a capital model in order to provide Management with a monthly tool for analyzing changes in its strategic capital ratios. This allows Management to hold sufficient capital to provide for growth opportunities and protect the balance sheet against sudden adverse market conditions, while maintaining an attractive return on equity to shareholders.
Regulatory Capital
Trustmark and TNB are subject to minimum capital requirements, which are administered by the federal bank regulatory agencies. These capital requirements, as defined by federal regulations, involve quantitative and qualitative measures of assets, liabilities and certain off-balance sheet instruments. Failure to meet minimum capital requirements can result in 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. TNB aims to exceed the well-capitalized guidelines for regulatory capital. As of September 30, 2014, Trustmark and TNB exceeded all of the minimum capital standards for the parent company and its primary banking subsidiary as established by regulatory requirements. In addition, TNB met applicable regulatory guidelines to be considered well-capitalized at September 30, 2014. To be categorized in this manner, TNB must maintain minimum total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage ratios as set forth in the accompanying table. There are no significant conditions or events that have occurred since September 30, 2014, which Management believes have affected Trustmark’s or TNB's present classification.
During 2006, Trustmark enhanced its capital structure with the issuance of trust preferred securities and Subordinated Notes. For regulatory capital purposes, the trust preferred securities currently qualify as Tier 1 capital while the Subordinated Notes qualify as Tier 2 capital. The addition of these capital instruments provided Trustmark a cost effective manner in which to manage shareholders’ equity and enhance financial flexibility. Trustmark will continue to utilize $60.0 million in trust preferred securities issued by the Trust as Tier 1 capital up to the regulatory limit, as permitted by the grandfather provision in the Dodd-Frank Act and the Basel III Final Rule.
The following table illustrates Trustmark's and TNB's actual regulatory capital amounts and ratios for the periods presented ($ in thousands):
| | | | | Minimum Regulatory Capital Required | | | Minimum Regulatory Provision to be Well-Capitalized | |
| | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
At September 30, 2014: | | | | | | | | | | | | | | | | | | |
Total Capital (to Risk Weighted Assets) | | | | | | | | | | | | | | | | | | |
Trustmark Corporation | | $ | 1,218,220 | | | | 14.70 | % | | $ | 663,009 | | | | 8.00 | % | | | n/ | a | | | n/ | a |
Trustmark National Bank | | | 1,194,589 | | | | 14.44 | % | | | 661,737 | | | | 8.00 | % | | $ | 827,171 | | | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Capital (to Risk Weighted Assets) | | | | | | | | | | | | | | | | | | | | | | | | |
Trustmark Corporation | | $ | 1,116,166 | | | | 13.47 | % | | $ | 331,504 | | | | 4.00 | % | | | n/ | a | | | n/ | a |
Trustmark National Bank | | | 1,094,124 | | | | 13.23 | % | | | 330,868 | | | | 4.00 | % | | $ | 496,302 | | | | 6.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Capital (to Average Assets) | | | | | | | | | | | | | | | | | | | | | | | | |
Trustmark Corporation | | $ | 1,116,166 | | | | 9.54 | % | | $ | 467,917 | | | | 4.00 | % | | | n/ | a | | | n/ | a |
Trustmark National Bank | | | 1,094,124 | | | | 9.37 | % | | | 467,135 | | | | 4.00 | % | | $ | 583,919 | | | | 5.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
At December 31, 2013: | | | | | | | | | | | | | | | | | | | | | | | | |
Total Capital (to Risk Weighted Assets) | | | | | | | | | | | | | | | | | | | | | | | | |
Trustmark Corporation | | $ | 1,122,904 | | | | 14.18 | % | | $ | 633,310 | | | | 8.00 | % | | | n/ | a | | | n/ | a |
Trustmark National Bank | | | 1,076,391 | | | | 13.74 | % | | | 626,672 | | | | 8.00 | % | | $ | 783,340 | | | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Capital (to Risk Weighted Assets) | | | | | | | | | | | | | | | | | | | | | | | | |
Trustmark Corporation | | $ | 1,026,858 | | | | 12.97 | % | | $ | 316,655 | | | | 4.00 | % | | | n/ | a | | | n/ | a |
Trustmark National Bank | | | 982,925 | | | | 12.55 | % | | | 313,336 | | | | 4.00 | % | | $ | 470,004 | | | | 6.00 | % |
| | | | | | | | | | | | | | | | | | | | �� | | | | |
Tier 1 Capital (to Average Assets) | | | | | | | | | | | | | | | | | | | | | | | | |
Trustmark Corporation | | $ | 1,026,858 | | | | 9.06 | % | | $ | 453,487 | | | | 4.00 | % | | | n/ | a | | | n/ | a |
Trustmark National Bank | | | 982,925 | | | | 8.76 | % | | | 448,665 | | | | 4.00 | % | | $ | 560,831 | | | | 5.00 | % |
Dividends on Common Stock
Dividends per common share for the nine months ended September 30, 2014 and 2013 were $0.69. Trustmark’s indicated dividend for 2014 is $0.92 per common share, which is the same as dividends per common share in 2013.
Liquidity
Liquidity is the ability to ensure that sufficient cash flow and liquid assets are available to satisfy current and future financial obligations, including demand for loans and deposit withdrawals, funding operating costs and other corporate purposes. 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 asset side of the balance sheet provides liquidity primarily through maturities and cash flows from loans and securities as well as the ability to sell certain loans and securities while the liability portion of the balance sheet provides liquidity primarily through noninterest and interest-bearing deposits. Trustmark utilizes federal funds purchased, FHLB advances, securities sold under repurchase agreements as well as the Federal Reserve Discount Window (Discount Window) and, on a limited basis as discussed below, brokered deposits to provide additional liquidity. Access to these additional sources represents Trustmark’s incremental borrowing capacity.
Deposit accounts represent Trustmark’s largest funding source. Average deposits totaled to $9.849 billion for the first nine months of 2014 and represented approximately 82.1% of average liabilities and shareholders’ equity, compared to average deposits of $9.435 billion, which represented 82.4% of average liabilities and shareholders’ equity for the same time period in 2013.
Trustmark utilizes a limited amount of brokered deposits to supplement other wholesale funding sources. At September 30, 2014, brokered sweep Money Market Deposit Account (MMDA) deposits totaled $22.3 million compared to $42.9 million at December 31, 2013. At December 31, 2013, Trustmark had $50.0 million in term fixed-rate brokered CDs outstanding. The addition of brokered CDs during 2011 was part of an interest rate risk management strategy and represented the lowest cost alternative for term fixed-rate funding. Trustmark’s brokered CDs matured on February 25, 2014. Based on its funding position at the time, Trustmark did not renew the brokered CDs.
At September 30, 2014, Trustmark had $9.7 million of reciprocal Certificate of Deposit Account Registry Service (CDARS) time deposits, which were acquired in the BancTrust merger, compared to $18.3 million at December 31, 2013. CDARS is a product offered by a third-party through which a customer’s deposits in excess of FDIC insurance limits is distributed to multiple participating banks, with Trustmark remaining as the relationship bank. When a customer’s excess deposits are distributed through the CDARS system, Trustmark receives reciprocal excess deposits from other participating banks. Trustmark has no customer relationship or contact with the customers whose excess deposits it receives. The funds are entitled to 100% FDIC insurance coverage as none of the deposits received exceed the FDIC insurance limit at the individual customer level.
At September 30, 2014, Trustmark had $386.0 million upstream federal funds purchased, compared to $20.0 million at December 31, 2013. Trustmark maintains adequate federal funds lines to provide sufficient short-term liquidity. Trustmark also maintains a relationship with the FHLB of Dallas, which provided $250.0 million of advances at September 30, 2014 compared to no advances at December 31, 2013. Trustmark chose to utilize the short-term FHLB advances as a funding source during the third quarter of 2014 due to the favorable interest rates afforded by that source as compared to other sources in the market at that time. Under the existing borrowing agreement, Trustmark had sufficient qualifying collateral to increase FHLB advances with the FHLB of Dallas by $1.677 billion at September 30, 2014. In addition, at September 30, 2014, Trustmark had $8.1 million in FHLB advances outstanding with the FHLB of Atlanta, which were acquired in the BancTrust merger, compared to $10.5 million at December 31, 2013. Trustmark has a non-member status and no additional borrowing capacity with the FHLB of Atlanta.
Additionally, Trustmark has the ability to enter into wholesale funding repurchase agreements as a source of borrowing by utilizing its unencumbered investment securities as collateral. At September 30, 2014, Trustmark had approximately $884.0 million available in repurchase agreement capacity compared to $670.0 million at December 31, 2013. The increase in repurchase agreement capacity at September 30, 2014, was primarily due to the increase in Trustmark’s investment portfolio and a seasonal decrease in public deposits during the third quarter of 2014.
Another borrowing source is the Discount Window. At September 30, 2014, Trustmark had approximately $912.4 million available in collateral capacity at the Discount Window from pledges of loans and securities, compared with $931.6 million at December 31, 2013.
TNB has outstanding $50.0 million in aggregate principal amount of Subordinated Notes (the Notes) due December 15, 2016. At September 30, 2014, the carrying amount of the Notes was $49.9 million. The Notes were sold pursuant to the terms of regulations issued by the OCC and in reliance upon an exemption provided by the Securities Act of 1933. The Notes are unsecured and subordinate and junior in right of payment to TNB’s obligations to its depositors, its obligations under bankers’ acceptances and letters of credit, its obligations to any Federal Reserve Bank or the FDIC and its obligations to its other creditors, and to any rights acquired by the FDIC as a result of loans made by the FDIC to TNB.
During 2006, Trustmark completed a private placement of $60.0 million of trust preferred securities through the Trust. The trust preferred securities mature September 30, 2036 and are redeemable at Trustmark’s option. The proceeds from the sale of the trust preferred securities were used by the Trust to purchase $61.9 million in aggregate principal amount of Trustmark’s junior subordinated debentures.
The Board of Directors currently has the authority to issue up to 20.0 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, 2014, Trustmark had no shares of preferred stock 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.
Asset/Liability Management
Overview
Market risk reflects the potential risk of loss arising from adverse changes in interest rates and market prices. Trustmark has risk management policies to monitor and limit exposure to market risk. Trustmark’s primary market risk is interest rate risk created by core banking activities. Interest rate risk is the potential variability of the income generated by Trustmark’s financial products or services, which results from changes in various market interest rates. Market rate changes may take the form of absolute shifts, variances in the relationships between different rates and changes in the shape or slope of the interest rate term structure.
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.
Derivatives
Trustmark uses financial derivatives for management of interest rate risk. The Asset/Liability Committee, in its oversight role for the management of interest rate risk, approves the use of derivatives in balance sheet hedging strategies. The most common derivatives employed by Trustmark are interest rate lock commitments, forward contracts (both futures contracts and options on futures contracts), interest rate swaps, interest rate caps and interest rate floors. In addition, Trustmark has entered into derivative contracts as counterparty to one or more customers in connection with loans extended to those customers. These transactions are designed to hedge interest rate, currency or other exposures of the customers and are not entered into by Trustmark for speculative purposes. Increased federal regulation of the derivative markets may increase the cost to Trustmark to administer derivative programs.
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. Rate lock commitments are residential mortgage loan commitments with customers, which guarantee a specified interest rate for a specified period of time. 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. The forward sales contracts are derivative instruments designated as fair value hedges under FASB ASC Topic 815. The gross, notional amount of Trustmark’s off-balance sheet obligations under these derivative instruments totaled $282.6 million at September 30, 2014, with a positive valuation adjustment of $717 thousand, compared to $214.3 million, with a positive valuation adjustment of $2.0 million as of December 31, 2013.
On April 4, 2013, Trustmark entered into a forward interest rate swap contract on junior subordinated debentures with a total notional amount of $60.0 million. The interest rate swap contract was designated as a derivative instrument in a cash flow hedge under FASB ASC Topic 815, with the objective of protecting the quarterly interest payments on Trustmark’s $60.0 million of junior subordinated debentures issued to Trustmark Preferred Capital Trust I throughout the five-year period beginning December 31, 2014 and ending December 31, 2019 from the risk of variability of those payments resulting from changes in the three-month LIBOR interest rate. Under the swap, commencing on December 31, 2014, Trustmark will pay a fixed interest rate of 1.66% and receive a variable interest rate based on three-month LIBOR on a total notional amount of $60.0 million, with quarterly net settlements.
No ineffectiveness related to the interest rate swap designated as a cash flow hedge was recognized in the consolidated statements of income during the nine months ended September 30, 2014. The accumulated net after-tax gain related to effective cash flow hedges included in AOCI totaled $717 thousand at September 30, 2014 compared to $1.5 million at December 31, 2013. Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments are made on the Trustmark’s variable rate junior subordinated debentures. During the next twelve months, Trustmark estimates that $575 thousand will be reclassified as an increase to interest expense.
Trustmark utilizes a portfolio of exchange-traded derivative instruments, such as Treasury note futures contracts and option contracts, to achieve a fair value return that economically hedges changes in fair value of MSR attributable to interest rates. These transactions are considered freestanding derivatives that do not otherwise qualify for hedge accounting. These exchange-traded derivative instruments are accounted for at fair value with changes in the fair value recorded in noninterest income in mortgage banking, net and are offset by the changes in the fair value of MSR. The MSR fair value represents the present value of future cash flows, which among other things includes decay and the effect of changes in interest rates. Ineffectiveness of hedging the MSR fair value is measured by comparing the change in value of hedge instruments to the change in the fair value of the MSR asset attributable to changes in interest rates and other market driven changes in valuation inputs and assumptions. The impact of this strategy resulted in a net positive ineffectiveness of $583 thousand and $1.3 million for the three months ended September 30, 2014 and 2013, respectively. For the nine months ended September 30, 2014 and 2013, the impact was a net positive ineffectiveness of $3.0 million and $2.7 million, respectively.
Trustmark offers certain derivatives products directly to qualified commercial lending clients seeking to manage their interest rate risk. Trustmark economically hedges interest rate swap transactions executed with commercial lending clients by entering into offsetting interest rate swap transactions with institutional derivatives market participants. Derivative transactions executed as part of this program are not designated as qualifying hedging relationships and are, therefore, carried at fair value with the change in fair value recorded in noninterest income in bank card and other fees. Because these derivatives have mirror-image contractual terms, in addition to collateral provisions which mitigate the impact of non-performance risk, the changes in fair value are expected to substantially offset. As of September 30, 2014, Trustmark had interest rate swaps with an aggregate notional amount of $337.9 million related to this program, compared to $355.9 million as of December 31, 2013.
Trustmark has agreements with its financial institution counterparties that contain provisions where if Trustmark defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Trustmark could also be declared in default on its derivative obligations.
As of September 30, 2014, the termination value of interest rate swaps in a liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $631 thousand compared to $508 thousand as of December 31, 2013. As of September 30, 2014, Trustmark had posted collateral with a market value of $1.0 million against its obligations because of negotiated thresholds and minimum transfer amounts under these agreements. If Trustmark had breached any of these triggering provisions at September 30, 2014, it could have been required to settle its obligations under the agreements at the termination value.
Credit risk participation agreements arise when Trustmark contracts with other financial institutions, as a guarantor or beneficiary, to share credit risk associated with certain interest rate swaps. These agreements provide for reimbursement of losses resulting from a third party default on the underlying swap. As of September 30, 2014 and December 31, 2013, Trustmark had entered into three risk participation agreements as a beneficiary with an aggregate notional amount of $19.3 million and $19.7 million, respectively. As of September 30, 2014, Trustmark had entered into one risk participation agreement as a guarantor with an aggregate notional amount of $6.3 million, compared to none at December 31, 2013. The fair values of these risk participation agreements were immaterial at September 30, 2014 and December 31, 2013.
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.
Financial simulation models are the primary tools used by Trustmark’s Asset/Liability Committee to measure interest rate exposure. Using a wide range of scenarios, Management is provided with extensive information on the potential impact to net interest income caused by changes in interest rates. Models are structured to simulate cash flows and accrual characteristics of Trustmark’s balance sheet. Assumptions are made about the direction and volatility of interest rates, the slope of the yield curve and the changing composition of Trustmark’s balance sheet, resulting from both strategic plans and customer behavior. In addition, the model incorporates Management’s assumptions and expectations regarding such factors as loan and deposit growth, pricing, prepayment speeds and spreads between interest rates.
Based on the results of the simulation models using static balances, it is estimated that net interest income may increase 2.9% and 0.8% in a one-year, shocked, up 200 basis point rate shift scenario, compared to a base case, flat rate scenario at August 31, 2014 (the latest available information) and September 30, 2013, respectively. In the event of a 100 basis point decrease in interest rates using static balances at August 31, 2014, it is estimated that net interest income may decrease by 4.9% compared to a 2.6% decrease at September 30, 2013. At August 31, 2014 and September 30, 2013, the impact of a 200 basis point drop scenario was not calculated due to the low interest rate environment.
The table below summarizes the effect various rate shift scenarios would have on net interest income at August 31, 2014 and September 30, 2013:
| | Estimated Annual % Change in Net Interest Income | |
| | August 31, 2014 | | | September 30, 2013 | |
Change in Interest Rates | | | | | | |
+200 basis points | | | 2.9 | % | | | 0.8 | % |
+100 basis points | | | 1.5 | % | | | 0.2 | % |
-100 basis points | | | -4.9 | % | | | -2.6 | % |
As shown in the table above, the interest rate shocks for the first eight months of 2014 illustrate little to no change in net interest income in rising rate scenarios while displaying modest exposure to a falling rate environment. The exposure to falling rates is primarily due to a downward repricing of various earning assets with minimal contribution from liabilities given the already low cost of deposits in the base scenario. 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 2014 or additional actions Trustmark could undertake in response to changes in interest rates. Management will continue to prudently manage the balance sheet in an effort to control interest rate risk and maintain profitability over the long term.
Another component of interest rate risk management is measuring the economic value-at-risk for a given change in market interest rates. The economic value-at-risk may indicate risks associated with longer-term balance sheet items that may not affect net interest income at risk over shorter time periods. Trustmark also uses computer-modeling techniques to determine the present value of all asset and liability cash flows (both on- and off-balance sheet), adjusted for prepayment expectations, using a market discount rate. The economic value of equity (EVE), also known as net portfolio value, is defined as the difference between the present value of asset cash flows and the present value of liability cash flows. The resulting change in EVE in different market rate environments, from the base case scenario, is the amount of EVE at risk from those rate environments. As of August 31, 2014 (the latest available information), the EVE at risk for an instantaneous up 200 basis point shift in rates produced an increase in net portfolio value of 6.4%, compared to a net portfolio value increase of 4.6% at September 30, 2013. An instantaneous 100 basis point decrease in interest rates produced a decline in net portfolio value of 6.4% at August 31, 2014, compared to a decline of 3.3% at September 30, 2013. At August 31, 2014 and September 30, 2013, the impact of a 200 basis point drop scenario was not calculated due to the low interest rate environment. The following table summarizes the effect that various rate shifts would have on net portfolio value at August 31, 2014 and September 30, 2013:
| | Estimated % Change in Net Portfolio Value | |
| | August 31, 2014 | | | September 30, 2013 | |
Change in Interest Rates | | | | | | |
+200 basis points | | | 6.4 | % | | | 4.6 | % |
+100 basis points | | | 4.2 | % | | | 2.7 | % |
-100 basis points | | | -6.4 | % | | | -3.3 | % |
Trustmark determines the fair value of MSR using a valuation model administered by a third party that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service (including delinquency and foreclosure costs), escrow account earnings, contractual servicing fee income and other ancillary income such as late fees. Management reviews all significant assumptions quarterly. Mortgage loan prepayment speeds, a key assumption in the model, is the annual rate at which borrowers are forecasted to repay their mortgage loan principal. The discount rate used to determine the present value of estimated future net servicing income, another key assumption in the model, is an estimate of the required rate of return investors in the market would require for an asset with similar risk. Both assumptions can, and generally will, change as market conditions and interest rates change.
By way of example, an increase in either the prepayment speed or discount rate assumption will result in a decrease in the fair value of the MSR, while a decrease in either assumption will result in an increase in the fair value of the MSR. In recent years, there have been significant market-driven fluctuations in loan prepayment speeds and discount rates. These fluctuations can be rapid and may continue to be significant. Therefore, estimating prepayment speed and/or discount rates within ranges that market participants would use in determining the fair value of MSR requires significant management judgment.
At September 30, 2014, the MSR fair value was approximately $67.1 million, compared to $62.9 million at September 30, 2013. The impact on the MSR fair value of a 10% adverse change in prepayment speed or a 100 basis point increase in discount rate at September 30, 2014, would be a decline in fair value of approximately $2.6 million and $2.4 million, respectively. Changes of equal magnitude in the opposite direction would produce similar increases in fair value in the respective amounts.
Accounting Policies Recently Adopted and Pending Accounting Pronouncements
For a complete list of recently adopted and pending accounting policies and the impact to Trustmark, see Note 19 – Accounting Policies Recently Adopted and Pending Accounting Pronouncements located elsewhere in this report.
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
As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by Trustmark’s Management, with the participation of its Chief Executive Officer and Treasurer and Principal Financial Officer (Principal Financial Officer), of the effectiveness of Trustmark’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer and the Principal Financial Officer concluded that Trustmark’s disclosure controls and procedures were effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting
There has been no change in Trustmark’s internal control over financial reporting during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, Trustmark’s internal control over financial reporting.
PART II. OTHER INFORMATION
Information required by this item is set forth in under the heading “Note 12 – Contingencies: Legal Proceedings” in Part I. Item 1. – Financial Statements – of this report, which is incorporated herein by reference.
There has been no material change in the risk factors previously disclosed in Trustmark’s Annual Report on Form 10-K for its fiscal year ended December 31, 2013.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
Trustmark did not engage in any unregistered sales of equity securities during the third quarter of 2014.
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None
ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable
None
The exhibits listed in the Exhibit Index are filed herewith or are incorporated herein by reference.
EXHIBIT INDEX
| Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| Certification by Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| Certification by Chief Executive Officer pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| Certification by Principal Financial Officer pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
All other exhibits are omitted, as they are inapplicable or not required by the related instructions.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TRUSTMARK CORPORATION
BY: | /s/ Gerard R. Host | BY: | /s/ Louis E. Greer |
| Gerard R. Host | | Louis E. Greer |
| President and Chief Executive Officer | | Treasurer, Principal Financial Officer and |
| | | Principal Accounting Officer |
| | | |
DATE: | November 6, 2014 | DATE: | November 6, 2014 |