FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ___________ Commission file number: 0-3683 TRUSTMARK CORPORATION State or other jurisdiction of (I.R.S. Employer incorporation or organization Identification No.) Mississippi 64-0471500 Trustmark Corporation 248 East Capitol Street Jackson, MS 39201 (601) 354-5111 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of July 31, 2002. Title Outstanding Common stock, no par value 61,769,332
PART I. FINANCIAL INFORMATION INFORMATION WITH RESPECT TO FINANCIAL STATEMENTS The financial statements filed with Form 10-Q for the quarter ended March 31, 2002 included unaudited financial statements that had not been reviewed in accordance with Rule 10-01(d) of Regulation S-X promulgated by the Securities and Exchange Commission, because Trustmark Corporation (Trustmark) elected not to engage Arthur Andersen LLP to perform such a review. On April 29, 2002, the Board of Directors of Trustmark, based on the recommendation of its Audit Committee, engaged KPMG LLP (KPMG) as its independent public accountants. Subsequent to the initial filing on Form 10-Q, KPMG has reviewed the unaudited financial statements for the quarter ended March 31, 2002 in accordance with Rule 10-01(d) and determined that no material changes were required.
ITEM 1. FINANCIAL STATEMENTS Trustmark Corporation and Subsidiaries Consolidated Balance Sheets ($ in thousands) (Unaudited) June 30, December 31, 2002 2001 ----------- ----------- Assets Cash and due from banks (noninterest-bearing) $ 289,006 $ 328,779 Federal funds sold and securities purchased under reverse repurchase agreements 14,798 137,521 Securities available for sale (at fair value) 996,315 1,061,495 Securities held to maturity (fair value: $696,439 - 2002; $820,917 - 2001) 661,594 792,052 Loans 4,533,120 4,524,366 Less allowance for loan losses 75,900 75,534 ----------- ----------- Net loans 4,457,220 4,448,832 Premises and equipment 105,510 97,158 Intangible assets: Mortgage servicing rights 58,199 53,470 Goodwill 47,515 41,004 Other identifiable intangible assets 23,924 22,217 ----------- ----------- Total intangible assets 129,638 116,691 Other assets 192,269 197,811 ----------- ----------- Total Assets $ 6,846,350 $ 7,180,339 =========== =========== Liabilities Deposits: Noninterest-bearing $ 1,076,048 $ 1,167,437 Interest-bearing 3,523,041 3,445,928 ----------- ----------- Total deposits 4,599,089 4,613,365 Federal funds purchased 222,197 235,781 Securities sold under repurchase agreements 489,569 801,725 Short-term borrowings 454,503 558,687 Long-term FHLB advances 325,000 225,000 Other liabilities 64,059 60,337 ----------- ----------- Total Liabilities 6,154,417 6,494,895 Commitments and Contingencies Shareholders' Equity Common stock, no par value: Authorized: 250,000,000 shares Issued and outstanding: 62,204,272 shares - 2002; 63,705,671 shares - 2001 12,961 13,273 Capital surplus 27,750 66,083 Retained earnings 630,217 587,387 Accumulated other comprehensive income, net of tax 21,005 18,701 ----------- ----------- Total Shareholders' Equity 691,933 685,444 ----------- ----------- Total Liabilities and Shareholders' Equity $ 6,846,350 $ 7,180,339 =========== =========== See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Income ($ in thousands except per share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ---------------------- ---------------------- 2002 2001 2002 2001 -------- -------- -------- -------- <S> <C> <C> <C> <C> Interest Income Interest and fees on loans $ 76,083 $ 88,316 $153,546 $173,078 Interest on securities: Taxable 24,509 32,821 48,678 67,175 Tax exempt 2,236 2,496 4,572 4,577 Interest on federal funds sold and securities purchased under reverse repurchase agreements 96 358 195 735 Other interest income 575 - 1,345 - -------- -------- -------- -------- Total Interest Income 103,499 123,991 208,336 245,565 Interest Expense Interest on deposits 20,020 35,116 41,798 69,454 Interest on federal funds purchased and securities sold under repurchase agreements 3,229 12,964 6,888 28,339 Other interest expense 5,459 10,018 10,930 23,680 -------- -------- -------- -------- Total Interest Expense 28,708 58,098 59,616 121,473 -------- -------- -------- -------- Net Interest Income 74,791 65,893 148,720 124,092 Provision for loan losses 3,000 2,400 7,307 4,800 -------- -------- -------- -------- Net Interest Income After Provision for Loan Losses 71,791 63,493 141,413 119,292 Noninterest Income Service charges on deposit accounts 12,397 11,948 23,821 22,371 Other account charges, fees and commissions 11,016 10,312 20,677 20,306 Mortgage servicing fees 4,293 4,150 8,615 8,243 Trust service income 2,492 2,367 5,011 4,840 Gains on sales of loans 2,169 1,303 3,674 5,684 Securities gains 376 368 516 368 Other income (2,093) 236 (2,678) 1,205 -------- -------- -------- -------- Total Noninterest Income 30,650 30,684 59,636 63,017 Noninterest Expense Salaries and employee benefits 28,940 27,536 58,462 53,725 Net occupancy - premises 2,906 2,837 5,695 5,433 Equipment expense 3,864 3,951 7,759 7,742 Services and fees 7,822 7,332 15,627 14,087 Amortization of intangible assets 2,837 3,017 3,823 5,294 Loan expense 2,389 2,386 4,941 4,524 Other expense 4,956 5,202 9,397 9,700 -------- -------- -------- -------- Total Noninterest Expense 53,714 52,261 105,704 100,505 -------- -------- -------- -------- Income Before Income Taxes 48,727 41,916 95,345 81,804 Income taxes 17,324 14,637 33,613 28,641 -------- -------- -------- -------- Net Income $ 31,403 $ 27,279 $ 61,732 $ 53,163 ======== ======== ======== ======== Earnings Per Share Basic and Diluted $ 0.50 $ 0.41 $ 0.98 $ 0.81 ======== ======== ======== ======== </TABLE> See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity ($ in thousands) (Unaudited) 2002 2001 --------- --------- Balance, January 1, $ 685,444 $ 629,641 Comprehensive income: Net income per consolidated statements of income 61,732 53,163 Net change in unrealized gains/losses on securities available for sale, net of tax 3,636 4,618 Net change in accumulated net losses on cash flow hedges, net of tax (1,332) (77) --------- --------- Comprehensive income 64,036 57,704 Cash dividends paid (18,902) (17,685) Common stock issued in business combination - 46,022 Common stock transactions, long-term incentive plan (36) - Repurchase and retirement of common stock (38,609) (47,871) --------- --------- Balance, June 30, $ 691,933 $ 667,811 ========= ========= See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Cash Flows ($ in thousands) (Unaudited) Six Months Ended June 30, --------------------- 2002 2001 --------- --------- Operating Activities Net income $ 61,732 $ 53,163 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 7,307 4,800 Depreciation and amortization 10,274 11,450 Net (accretion) amortization of securities (412) 331 Securities gains (516) (368) Gains on sales of loans (3,674) (5,684) Deferred income tax provision 1,927 4,194 Proceeds from sales of loans 438,873 662,318 Purchases and originations of loans held for sale (387,550) (441,316) Proceeds from sales of trading securities - 990 Net increase in intangible assets (7,025) (10,235) Net increase in other assets (1,099) (4,080) Net decrease in other liabilities (773) (1,571) Other operating activities, net 56 1,058 --------- --------- Net cash provided by operating activities 119,120 275,050 Investing Activities Proceeds from calls and maturities of securities available for sale 159,985 90,478 Proceeds from calls and maturities of securities held to maturity 134,228 295,780 Proceeds from sales of securities available for sale 12,935 11,983 Purchases of securities available for sale (102,067) (353,667) Purchases of securities held to maturity (2,635) - Net decrease in federal funds sold and securities purchased under reverse repurchase agreements 122,723 93,261 Net increase in loans (63,344) (129,096) Purchases of premises and equipment (12,930) (6,850) Proceeds from sales of premises and equipment 19 114 Proceeds from sales of other real estate 1,739 1,055 Cash paid in business combination (7,799) (38,175) --------- --------- Net cash provided (used) by investing activities 242,854 (35,117) Financing Activities Net decrease in deposits (14,276) (121,539) Net decrease in federal funds purchased and securities sold under repurchase agreements (325,740) (23,808) Net decrease in other borrowings (104,184) (242,890) Proceeds from long-term FHLB advances 100,000 200,000 Cash dividends (18,902) (17,685) Common stock transactions, net (38,645) (47,871) --------- --------- Net cash used by financing activities (401,747) (253,793) --------- --------- Decrease in cash and cash equivalents (39,773) (13,860) Cash and cash equivalents at beginning of period 328,779 298,651 --------- --------- Cash and cash equivalents at end of period $ 289,006 $ 284,791 ========= ========= See notes to consolidated financial statements.
TRUSTMARK CORPORATION & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF FINANCIAL STATEMENT PRESENTATION AND PRINCIPLES OF CONSOLIDATION The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of Management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair presentation of these consolidated financial statements have been included. The notes included herein should be read in conjunction with the notes to the consolidated financial statements included in Trustmark Corporation's (Trustmark) 2001 annual report on Form 10-K. The consolidated financial statements include Trustmark and its wholly-owned bank subsidiaries, Trustmark National Bank (TNB) and Somerville Bank & Trust Company (Somerville). All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior period amounts to conform with the current year presentation. NOTE 2 - BUSINESS COMBINATIONS On June 28, 2002, Trustmark announced that Bottrell Insurance Agency, Inc., a wholly owned subsidiary of TNB, had acquired Chandler-Sampson Insurance, Inc. (CSI) in Jackson, Mississippi. CSI was a regional leader in school, medical malpractice and mid-market business insurance. This business combination, which is not material to Trustmark, was accounted for under the purchase method of accounting and the results of operations have been included in the financial statements from the merger date. During 2001, Trustmark completed two business combinations in the greater Memphis, Tennessee area: Barret Bancorp, Inc. (Barret) in Barretville, Tennessee, and Nashoba Bancshares, Inc. (Nashoba) in Germantown, Tennessee. On April 6, 2001, Trustmark acquired Barret, the holding company for Peoples Bank in Barretville, Tennessee, and Somerville Bank & Trust Company in Somerville, Tennessee, which collectively had 13 offices and $508 million in total assets. The shareholders of Barret received approximately 2.4 million shares of Trustmark's common stock as well as $51 million in cash. On December 14, 2001, Trustmark completed its acquisition of Nashoba, paying Nashoba's shareholders $28 million in cash. Nashoba was the holding company for Nashoba Bank and at the merger date had three offices and $163 million in total assets. Both business combinations were accounted for under the purchase method of accounting and their results of operations, which are not material, have been included in the financial statements from the merger dates. NOTE 3 - LOANS The following table summarizes the activity in the allowance for loan losses for the six month periods ended June 30 ($ in thousands): 2002 2001 -------- -------- Balance at beginning of year $ 75,534 $ 65,850 Provision charged to expense 7,307 4,800 Loans charged off (11,501) (9,233) Recoveries 4,560 3,814 -------- -------- Net charge-offs (6,941) (5,419) Allowance applicable to loans of acquired bank - 8,708 -------- -------- Balance at end of period $ 75,900 $ 73,939 ======== ======== At June 30, 2002 and 2001, the carrying amounts of nonaccrual loans were $41.1 million and $25.5 million, respectively. Included in these nonaccrual loans at June 30, 2002 and 2001, are loans that are considered to be impaired, which totaled $33.1 million and $19.8 million, respectively. As a result of direct write-downs, the specific allowance related to these impaired loans was not material. The average carrying amounts of impaired loans during the second quarter of 2002 and 2001 were $33.6 million and $19.3 million, respectively. No material amounts of interest income were recognized on impaired loans or nonaccrual loans for the second quarter of 2002 or 2001.
NOTE 4 - GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS Effective January 1, 2002, Trustmark adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." As of the adoption date, Trustmark had unamortized goodwill in the amount of $41.0 million and unamortized other identifiable intangible assets, consisting of core deposit intangible assets, in the amount of $22.2 million. These assets are subject to the provisions of SFAS No. 142. Trustmark has performed a transitional impairment test on its goodwill assets, using three separate reporting units. Two reporting units were determined by separating Trustmark's Retail Banking Group into its two components, Somerville and the retail portion of TNB. The third reporting unit, Bottrell Insurance Agency, is a subset of Financial Services. This test indicated that no impairment charge was required. Additionally, no material reclassifications of finite-lived intangible assets were made as a result of adoption. As of June 30, 2002, the carrying amounts, net of accumulated amortization, for other identifiable intangible assets and goodwill were $23.9 million and $47.5 million, respectively. The increases from adoption date are from the addition of $3.2 million of other intangible assets and $6.5 million of goodwill resulting from the acquisition of CSI. Trustmark recorded $1.5 million of amortization of other identifiable intangible assets for the first six months of 2002. The following table sets forth the reconcilement of net income and earnings per share excluding goodwill amortization for the six months ended June 30, 2002 and 2001 ($ in thousands, except per share data): Six Months Ended June 30, ---------------------- 2002 2001 -------- -------- Reported net income $ 61,732 $ 53,163 Add back goodwill amortization, net of tax - 386 -------- -------- Adjusted net income $ 61,732 $ 53,549 ======== ======== Basic and diluted earnings per share: Reported net income $ 0.98 $ 0.81 Goodwill amortization, net of tax - .01 -------- -------- Adjusted net income $ 0.98 $ 0.82 ======== ======== NOTE 5 - CONTINGENCIES Trustmark and its subsidiaries are parties to lawsuits and other claims that arise in the ordinary course of business. Some of the lawsuits assert claims related to the lending, collection, servicing, investment, trust and other business activities; and some of the lawsuits allege substantial claims for damages. The cases are being vigorously contested. In the regular course of business, Management evaluates estimated losses or costs related to litigation, and provision is made for anticipated losses whenever Management believes that such losses are probable and can be reasonably estimated. At the present time, Management believes, based on the advice of legal counsel, that the final resolution of pending legal proceedings will not have a material impact on Trustmark's consolidated financial position or results of operations. NOTE 6 - EARNINGS PER SHARE Basic earnings per share (EPS) are computed by dividing net income by the weighted average shares of common stock outstanding. Diluted EPS are computed by dividing net income by the weighted average shares of common stock outstanding, adjusted for the effect of stock options outstanding during the period. The following table reflects weighted average shares used to calculate basic and diluted EPS for the periods presented: Six Months Ended June 30, ------------------------- 2002 2001 ---------- ---------- Basic 63,026,007 65,271,791 Dilutive shares (due to stock options) 201,590 96,124 ---------- ---------- Diluted 63,227,597 65,367,915 ========== ==========
NOTE 7 - STATEMENTS OF CASH FLOWS Trustmark made cash payments for income taxes approximating $15.0 million and $21.1 million during the six months ended June 30, 2002 and 2001, respectively. Interest paid on deposit liabilities and other borrowings approximated $62.8 million in the first six months of 2002 and $123.9 million in the first six months of 2001. For the six months ended June 30, 2002 and 2001, noncash transfers from loans to foreclosed properties were $3.4 million and $2.9 million, respectively. NOTE 8 - RECENT PRONOUNCEMENTS In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The impact of this statement on Trustmark's consolidated financial position and results of operations is not expected to be material. NOTE 9 - SEGMENT INFORMATION Trustmark has three reportable segments: Retail Banking Group, Commercial Banking Group and Financial Services. The Retail Banking Group delivers a full range of banking, investment and insurance products and services to individuals and small businesses through Trustmark's extensive branch network. The Commercial Banking Group provides various financial products and services to corporate and middle market clients. Included among these products and services are specialized services for commercial and residential real estate development lending, indirect automobile financing and other specialized lending services. Financial Services includes trust and fiduciary services, discount brokerage services, insurance services, as well as credit card and mortgage services. Also included in this segment is a selection of investment management services including Trustmark's proprietary mutual fund family. Treasury & Other consists of asset/liability management activities that include the investment portfolio and the related gains/losses on sales of securities, as well as risk management, bank operations, human resources, marketing and the controller's division. Treasury & Other also includes expenses such as corporate overhead and amortization of intangible assets. The tables on pages 11 and 12 disclose financial information by segment for the periods ended June 30, 2002 and 2001:
Trustmark Corporation Segment Information ($ in thousands) <TABLE> <CAPTION> Retail Commercial Financial Treasury & Banking Banking Services Other Total ---------- ---------- ---------- ---------- ---------- For the three months ended June 30, 2002 - ---------------------------------- <S> <C> <C> <C> <C> <C> Net interest income from external customers $ 12,681 $ 26,114 $ 16,505 $ 19,491 $ 74,791 Internal funding 24,703 (14,329) (6,789) (3,585) - ---------- ---------- ---------- ---------- ---------- Net interest income 37,384 11,785 9,716 15,906 74,791 Provision for loan losses 1,281 342 454 923 3,000 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 36,103 11,443 9,262 14,983 71,791 Noninterest income 13,921 154 17,276 (701) 30,650 Noninterest expense 31,814 3,905 14,497 3,498 53,714 ---------- ---------- ---------- ---------- ---------- Income before income taxes 18,210 7,692 12,041 10,784 48,727 Income taxes 6,290 2,655 4,263 4,116 17,324 ---------- ---------- ---------- ---------- ---------- Segment net income $ 11,920 $ 5,037 $ 7,778 $ 6,668 $ 31,403 ========== ========== ========== ========== ========== Selected Financial Information Average assets $2,319,319 $1,573,258 $1,084,881 $1,809,754 $6,787,212 Depreciation and amortization $ 1,319 $ 49 $ 2,303 $ 2,427 $ 6,098 For the three months ended June 30, 2001 - ---------------------------------- Net interest income from external customers $ 5,629 $ 32,029 $ 10,984 $ 17,251 $ 65,893 Internal funding 30,756 (20,626) (2,401) (7,729) - ---------- ---------- ---------- ---------- ---------- Net interest income 36,385 11,403 8,583 9,522 65,893 Provision for loan losses 1,459 872 504 (435) 2,400 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 34,926 10,531 8,079 9,957 63,493 Noninterest income 13,799 127 15,541 1,217 30,684 Noninterest expense 31,740 3,772 13,395 3,354 52,261 ---------- ---------- ---------- ---------- ---------- Income before income taxes 16,985 6,886 10,225 7,820 41,916 Income taxes 5,865 2,378 3,604 2,790 14,637 ---------- ---------- ---------- ---------- ---------- Segment net income $ 11,120 $ 4,508 $ 6,621 $ 5,030 $ 27,279 ========== ========== ========== ========== ========== Selected Financial Information Average assets $2,391,651 $1,593,980 $ 852,496 $2,329,845 $7,167,972 Depreciation and amortization $ 1,256 $ 55 $ 2,132 $ 2,789 $ 6,232 </TABLE>
Trustmark Corporation Segment Information ($ in thousands) <TABLE> <CAPTION> Retail Commercial Financial Treasury & Banking Banking Services Other Total ---------- ---------- ---------- ---------- ---------- For the six months ended June 30, 2002 - ---------------------------------- <S> <C> <C> <C> <C> <C> Net interest income from external customers $ 24,501 $ 52,037 $ 33,056 $ 39,126 $ 148,720 Internal funding 49,176 (29,196) (13,098) (6,882) - ---------- ---------- ---------- ---------- ---------- Net interest income 73,677 22,841 19,958 32,244 148,720 Provision for loan losses 2,473 3,111 948 775 7,307 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 71,204 19,730 19,010 31,469 141,413 Noninterest income 26,924 312 32,671 (271) 59,636 Noninterest expense 63,753 7,762 27,441 6,748 105,704 ---------- ---------- ---------- ---------- ---------- Income before income taxes 34,375 12,280 24,240 24,450 95,345 Income taxes 11,900 4,239 8,531 8,943 33,613 ---------- ---------- ---------- ---------- ---------- Segment net income $ 22,475 $ 8,041 $ 15,709 $ 15,507 $ 61,732 ========== ========== ========== ========== ========== Selected Financial Information Average assets $2,345,179 $1,573,051 $1,063,832 $1,852,879 $6,834,941 Depreciation and amortization $ 2,586 $ 95 $ 2,763 $ 4,830 $ 10,274 For the six months ended June 30, 2001 - ---------------------------------- Net interest income from external customers $ 8,122 $ 64,690 $ 21,131 $ 30,149 $ 124,092 Internal funding 59,655 (43,301) (5,225) (11,129) - ---------- ---------- ---------- ---------- ---------- Net interest income 67,777 21,389 15,906 19,020 124,092 Provision for loan losses 2,587 1,641 1,147 (575) 4,800 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 65,190 19,748 14,759 19,595 119,292 Noninterest income 26,282 259 33,691 2,785 63,017 Noninterest expense 60,885 7,518 26,212 5,890 100,505 ---------- ---------- ---------- ---------- ---------- Income before income taxes 30,587 12,489 22,238 16,490 81,804 Income taxes 10,558 4,313 7,786 5,984 28,641 ---------- ---------- ---------- ---------- ---------- Segment net income $ 20,029 $ 8,176 $ 14,452 $ 10,506 $ 53,163 ========== ========== ========== ========== ========== Selected Financial Information Average assets $2,225,059 $1,580,790 $ 845,737 $2,359,034 $7,010,620 Depreciation and amortization $ 2,313 $ 106 $ 3,841 $ 5,190 $ 11,450 </TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following provides a narrative discussion and analysis of significant changes in Trustmark's financial condition and results of operations. This discussion should be read in conjunction with the consolidated financial statements and the supplemental financial data included elsewhere in this report. FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act evidences Congress' determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by Management. Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements with respect to the adequacy of the allowance for loan losses; the effect of legal proceedings on Trustmark's financial condition, results of operations and liquidity; and market risk disclosures. Although Management believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Such forward-looking statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks materialize, or should any such underlying assumptions prove to be significantly different, actual results may vary significantly from those anticipated, estimated, projected or expected. Factors that could cause actual results to differ materially from current expectations by Management include, but are not limited to: o Legislative or regulatory changes, including changes in accounting standards; o General economic conditions, either nationally or regionally; o Changes in interest rates, yield curves and interest rate spread relationships; o Deposit attrition, customer loss or revenue loss in the ordinary course of business; o Increases in competitive pressure in the financial services industry; o Changes in the rate of inflation; o Changes in securities markets; o Changes in technology. Forward-looking statements speak only as of the date they are made. Trustmark does not undertake any obligation to update any forward-looking statement to reflect subsequent circumstances or events. FINANCIAL HIGHLIGHTS Trustmark announced basic and diluted earnings per share of $0.50 for the second quarter of 2002, which represents a 22.0% increase compared to $0.41 for the second quarter of 2001. Net income for the second quarter totaled $31.4 million, resulting in a return on average assets of 1.86% and a return on average equity of 18.70%. For the six months ended June 30, 2002, net income totaled $61.7 million, with a return on average assets of 1.82% and a return on average equity of 18.46%. At June 30, 2002, Trustmark reported total loans of $4.5 billion, total assets of $6.8 billion, total deposits of $4.6 billion and shareholders' equity of $691.9 million. BUSINESS COMBINATIONS On June 28, 2002, Trustmark announced that Bottrell Insurance Agency, Inc., a wholly owned subsidiary of TNB, had acquired Chandler-Sampson Insurance, Inc. (CSI) in Jackson, Mississippi. CSI was a regional leader in school, medical malpractice and mid-market business insurance. This business combination, which is not material to Trustmark, was accounted for under the purchase method of accounting and the results of operations have been included in the financial statements from the merger date. During 2001, Trustmark completed two business combinations in the greater Memphis, Tennessee area: Barret Bancorp, Inc. (Barret) in Barretville, Tennessee, and Nashoba Bancshares, Inc. (Nashoba) in Germantown, Tennessee. On April 6, 2001, Trustmark acquired Barret, the holding company for Peoples Bank in Barretville, Tennessee, and Somerville Bank & Trust Company in Somerville, Tennessee, which collectively had 13 offices and $508 million in total assets. The shareholders of Barret received approximately 2.4 million shares of Trustmark's common stock as well as $51 million in cash. On December 14, 2001, Trustmark completed its acquisition of Nashoba, paying Nashoba's shareholders $28 million in cash. Nashoba was the holding company for Nashoba Bank and at the merger date had three offices and $163 million in total assets. Both business combinations were accounted for under the purchase method of accounting and their results of operations, which are not material, have been included in the financial statements from the merger dates.
RESULTS OF OPERATIONS Net Interest Income Net interest income is the principal component of Trustmark's income stream and represents the difference or spread between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates as well as volume and mix changes in earning assets and interest-bearing liabilities can materially impact net interest income. The net interest margin (NIM) is computed by dividing fully taxable equivalent net interest income by average interest-earning assets and measures how effectively Trustmark utilizes its interest-earning assets in relationship to the interest cost of funding them. The Yield/Rate Analysis Tables on pages 15 and 16 show the average balances for all assets and liabilities of Trustmark and the interest income or expense associated with those assets and liabilities. The yields and rates have been computed based upon interest income and expense adjusted to a fully taxable equivalent (FTE) basis using a 35% federal marginal tax rate for all periods shown. Net interest income for the three-month and six-month periods ended June 30, 2002, increased $8.6 million, or 12.5%, and $24.3 million, or 18.8%, respectively, when compared with the same periods in 2001. Interest rates fell dramatically during 2001, a situation that proved to be beneficial for Trustmark because of its liability sensitive position. While earning asset yields were affected, a greater impact was felt in the cost of interest-bearing liabilities, resulting in an overall positive impact to the NIM of 96 basis points, when comparing the first six months of 2002 to the same period in 2001. Additionally, during the first six months of 2002, Trustmark's use of interest rate caps and floors provided $1.3 million of additional interest income as the floor reached its strike price during a volatile interest rate environment. Average interest-earning assets for the first six months of 2002 were $6.213 billion, compared with $6.467 billion in the same period for 2001, a decrease of $254.0 million, or 3.9%. Growth realized in average loans was offset by decreases in average securities. This change in earning assets mix also proved beneficial to the increase in net interest income. The yield on average earning assets dropped from 7.81% in the first six months of 2001 to 6.91% in the same period in 2002, a decrease of 90 basis points. The combination of a decrease in the earning asset base and declining yields resulted in a decrease in interest income during the first six months of 2002 of $37.5 million, or 15.0%, when compared with the first six months of 2001. Average interest-bearing liabilities for the first six months of 2002 totaled $5.048 billion, compared with $5.363 billion for the first six months of 2001, a decrease of $315.0 million, or 5.9%. Average interest-bearing deposits increased while fed funds purchased, repurchase agreements and borrowings decreased. This change in mix proved beneficial in reducing interest expense through the growth of lower cost core deposits versus borrowings. The average rates on interest-bearing liabilities for the six months ended June 30, 2002 and 2001, were 2.38% and 4.57%, respectively, a decrease of 219 basis points. As a result of these factors, total interest expense for the first and second quarters of 2002 decreased $61.9 million, or 50.9%, when compared with the first half of 2001. Anticipating interest rates to rise in the future, Management has strategically reduced Trustmark's exposure by restructuring the balance sheet and through the use of interest rate contracts. Liquidity provided by maturing investments was utilized to reduce Trustmark's wholesale funding reliance. Also, Trustmark was able to benefit during this falling interest rate environment by locking into liabilities at lower, long-term fixed rates. Trustmark will continue to utilize interest rate contracts to limit the overall risk exposure present during significant movements in interest rates and reduce the impact on net interest income. For additional discussion, see Market/Interest Rate Risk Management on page 23.
Trustmark Corporation Yield/Rate Analysis Table ($ in thousands) <TABLE> <CAPTION> For the Three Months Ended June 30, --------------------------------------------------------------- 2002 2001 ------------------------------ ------------------------------ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ---------- -------- ------ ---------- -------- ------ <S> <C> <C> <C> <C> <C> <C> Assets Interest-earning assets: Federal funds sold and securities purchased under reverse repurchase agreements $ 22,224 $ 96 1.73% $ 35,558 $ 358 4.04% Securities - taxable 1,485,367 24,509 6.62% 2,011,563 32,821 6.54% Securities - nontaxable 173,109 3,440 7.97% 194,502 3,840 7.92% Loans, net of unearned income 4,488,719 77,749 6.95% 4,368,285 89,575 8.22% ---------- -------- ---------- -------- Total interest-earning assets 6,169,419 105,794 6.88% 6,609,908 126,594 7.68% Cash and due from banks 274,572 256,013 Other assets 418,600 376,123 Allowance for loan losses (75,379) (74,072) ---------- ---------- Total Assets $6,787,212 $7,167,972 ========== ========== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing deposits $3,538,272 $ 20,020 2.27% $3,440,085 $ 35,116 4.09% Federal funds purchased and securities sold under repurchase agreements 768,239 3,229 1.69% 1,248,324 12,964 4.17% Borrowings 691,069 5,459 3.17% 775,491 10,018 5.18% ---------- -------- ---------- -------- Total interest-bearing liabilities 4,997,580 28,708 2.30% 5,463,900 58,098 4.26% -------- -------- Noninterest-bearing demand deposits 1,059,806 954,942 Other liabilities 56,167 77,486 Shareholders' equity 673,659 671,644 ---------- ---------- Total Liabilities and Shareholders' Equity $6,787,212 $7,167,972 ========== ========== Net Interest Margin 77,086 5.01% 68,496 4.16% Less tax equivalent adjustment 2,295 2,603 -------- -------- Net Interest Margin per Consolidated Statements of Income $ 74,791 $ 65,893 ======== ======== </TABLE>
Trustmark Corporation Yield/Rate Analysis Table ($ in thousands) <TABLE> <CAPTION> For the Six Months Ended June 30, -------------------------------------------------------------- 2002 2001 ----------------------------- ------------------------------ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ---------- -------- ------ ---------- -------- ------ <S> <C> <C> <C> <C> <C> <C> Assets Interest-earning assets: Federal funds sold and securities purchased under reverse repurchase agreements $ 23,415 $ 195 1.68% $ 30,633 $ 735 4.84% Securities - taxable 1,532,684 48,678 6.40% 2,036,501 67,175 6.65% Securities - nontaxable 176,631 7,034 8.03% 176,009 7,042 8.07% Loans, net of unearned income 4,479,874 157,107 7.07% 4,223,478 175,594 8.38% ---------- -------- ---------- -------- Total interest-earning assets 6,212,604 213,014 6.91% 6,466,621 250,546 7.81% Cash and due from banks 280,164 253,620 Other assets 417,544 360,344 Allowance for loan losses (75,371) (69,965) ---------- ---------- Total Assets $6,834,941 $7,010,620 ========== ========== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing deposits $3,529,165 $ 41,798 2.39% $3,311,522 $ 69,454 4.23% Federal funds purchased and securities sold under repurchase agreements 829,617 6,888 1.67% 1,207,758 28,339 4.73% Borrowings 689,358 10,930 3.20% 843,862 23,680 5.66% ---------- -------- ---------- -------- Total interest-bearing liabilities 5,048,140 59,616 2.38% 5,363,142 121,473 4.57% -------- -------- Noninterest-bearing demand deposits 1,049,627 927,409 Other liabilities 62,795 71,592 Shareholders' equity 674,379 648,477 ---------- ---------- Total Liabilities and Shareholders' Equity $6,834,941 $7,010,620 ========== ========== Net Interest Margin 153,398 4.98% 129,073 4.02% Less tax equivalent adjustment 4,678 4,981 -------- -------- Net Interest Margin per Consolidated Statements of Income $148,720 $124,092 ======== ======== </TABLE> Provision for Loan Losses Trustmark's provision for loan losses totaled $3.0 million and $7.3 million, respectively, for the three month and six month periods ended June 30, 2002, compared with $2.4 million and $4.8 million, respectively, for the same periods in 2001. The provision to average loans was 0.33% for the first six months of 2002, compared with 0.23% for the same period in 2001. For the quarters ended June 30, 2002 and 2001, the provision to average loans was 0.27% and 0.22%, respectively. The provision for loan losses reflects Management's assessment of the adequacy of the allowance for loan losses to absorb probable losses inherent in the loan portfolio. The amount of provision for each period is dependent upon many factors including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, Management's assessment of loan portfolio quality, the value of collateral and general economic factors. See further discussion of Loans beginning on page 21. Noninterest Income Noninterest income consists of revenues generated from a broad range of banking, insurance and investment products and services. For the six months ended June 30, 2002, noninterest income totaled $59.6 million, decreasing $3.4 million, or 5.4%, from the prior-year period. The major categories contributing to the decline were gains on sales of loans and other income. Noninterest income represented 22.3% of total gross revenues in the first six months of 2002 versus 20.4% in the same period in 2001.
For the quarters ended June 30, 2002 and 2001, noninterest income maintained a consistent level at $30.7 million. Losses recognized in other income were offset by increases in other account charges, fees and commissions as well as gains on sales of loans. The single largest component of noninterest income continues to be service charges for deposit products and services, which increased 6.5% in the first six months of 2002 from the same period during 2001. In addition to increases in service charges for demand deposit accounts, $1.0 million of the $1.5 million increase is attributable to business combinations completed during the second and fourth quarters of 2001. Other account charges, fees and commissions increased $371 thousand, or 1.8%, during the first six months of 2002, when compared to the levels maintained for the prior year. Net insurance commissions increased $1.2 million, or 23.5%, from expanded product lines and distribution channels for commercial and retail insurance services. Bank card fees increased 12.1% in 2002, due to increases in debit card usage by individuals and businesses. These increases were offset by declines in products with market-driven fees, such as brokerage and cash management activities. Mortgage servicing fees increased by $372 thousand, or 4.5%, when comparing the first six months of 2002 to the same period in 2001. This growth continued the upward trend seen over the last three years. Reductions in interest rates have resulted in an increase in mortgages originated, refinanced and purchased, leading to growth in mortgages serviced. Trustmark serviced $4.4 billion in mortgage loans at June 30, 2002, up from $4.0 billion at June 30, 2001. Trust service income and securities gains and losses both had minor increases of $171 thousand and $148 thousand, respectively, in the first half of 2002, compared with the same period in 2001. At June 30, 2002, Trustmark, which continues to be one of the largest providers of asset management services in Mississippi, held assets under administration of $7.3 billion. Gains on sales of loans were $3.7 million and $5.7 million for the six months ended June 30, 2002 and 2001, respectively. Trustmark recorded a $507 thousand gain on the sale of $18.2 million of GNMA loans during the second quarter of 2002, compared to a $3.9 million gain during the first quarter of 2001 from the sale of $192 million in mortgage loans with significant prepayment risk. Excluding the impacts of these transactions, gains on sales of loans experienced volume-driven growth of $1.4 million during the first half of 2002, compared with the same period in 2001. Other income during the first six months of 2002 was a loss of $2.7 million compared with a gain of $1.2 million in the prior-year period, with the largest portion of this change from the second quarter of 2002 versus the same period in 2001. This variance is primarily due to valuation adjustments on Trustmark's interest rate caps and floors. Caps and floors are classified as derivative financial instruments and carried at their current fair value with changes in value recognized currently in earnings as other income. Noninterest Expense Trustmark's noninterest expense increased $5.2 million, or 5.2%, in the first six months of 2002 to $105.7 million, compared with $100.5 million in the first six months of 2001. Included in this amount is $2.9 million from business combinations completed during the second and fourth quarters of 2001. Offsetting this increase is the 2002 reversal of a $2.0 million impairment allowance for mortgage servicing rights. Excluding these items, total noninterest expense increased $4.3 million, or 4.3%, during the first six months of 2002 compared with the same period in 2001. Noninterest expense was $53.7 million for the three months ended June 30, 2002, a 2.8% increase from the $52.3 million recognized in the second quarter of 2001. This change was primarily related to salaries and employee benefits. Control of expenses remains a management priority. Improvement in expense control is evidenced in Trustmark's efficiency ratio, which decreased to 50.11% during the first six months of 2002 from 53.51% during the first six months of 2001. The efficiency ratio is calculated by dividing total noninterest expense by tax-equivalent net interest income plus noninterest income, excluding nonrecurring items. Salaries and employee benefits, the largest category of noninterest expense, were $58.5 million and $53.7 million for the first six months of 2002 and 2001, respectively, increasing 8.8%. Excluding business combinations, the increase was $2.9 million, or 5.6%. This change represents normal annual merit increases along with increases in benefit costs.
During the first six months of 2002, net occupancy-premises expense and equipment expense experienced minor increases of $262 thousand and $17 thousand, respectively, from the same period in 2001. Services and fees for the first half of 2002 totaled $15.6 million, compared to $14.1 million for the same period a year ago. This variance is attributable to expenditures for software services and additional advertising as well as professional fees associated with Trustmark's credit process redesign. For the six months ended June 30, 2002, amortization expense associated with intangible assets totaled $3.8 million, decreasing $1.5 million from the same period in 2001. During the first quarter of 2002, the valuation of mortgage servicing rights indicated that Trustmark's mortgage servicing rights were no longer impaired; therefore, Management reversed the $2.0 million valuation allowance that had been established during the third quarter of 2001. The prior period included amortization of goodwill in the amount of $557 thousand, whereas the current period did not include amortization of goodwill due to Trustmark's adoption of SFAS No. 142 effective January 1, 2002. These reductions were partially offset by increases in amortization of core deposit intangibles from business combinations as well as amortization of mortgage servicing rights from increased volume. Loan expense increased $417 thousand during the first six months of 2002 from the same period in 2001, primarily from increased mortgage activity in a lower interest rate environment. During the first half of 2002, other expense decreased $303 thousand from the same period in 2001. Decreases were recognized in the areas of contributions, deferred compensation, travel and entertainment, which were partially offset by increases in stationery and supplies and expenses related to business combinations. SHAREHOLDERS' EQUITY As of June 30, 2002, Trustmark's shareholders' equity was $691.9 million, an increase of $6.5 million, or 0.9%, from its level at December 31, 2001. The increase from net income was partially offset by common shares repurchased and dividends paid. Trustmark continues to improve shareholder value by utilizing strategic capital management plans designed to improve earnings per share and return on equity while maintaining sufficient regulatory capital levels. As a result of these activities, Trustmark's return on average equity increased to 18.46% for the first six months of 2002 from 16.53% for the first six months of 2001, while earnings per share have risen from $0.81 to $0.98 for these same periods, an increase of 21.0%. Common Stock Repurchase Program During 2001, the Board of Directors of Trustmark authorized the repurchase of an additional 5% of common stock, or approximately 3.2 million shares, subject to market conditions and management discretion. As of June 30, 2002, 1.6 million shares had been purchased under this authorization. Collectively, the capital management plans adopted by Trustmark since 1998 have authorized the repurchase of 15.4 million shares of common stock. Pursuant to these plans, Trustmark has repurchased approximately 13.8 million shares at a cost of $285.5 million, including 1.5 million shares during 2002 at a cost of $38.6 million. The current remaining authorization is approximately 1.6 million shares. Authorization of Preferred Shares On April 9, 2002, the shareholders approved a proposal by the Board of Directors to amend the Articles of Incorporation to authorize the issuance of up to 20 million preferred shares. Although Trustmark has no current intention to issue any preferred shares, the Board of Directors believes that authorizing preferred shares for potential issuance is advisable and in the best interests of Trustmark. The ability to issue preferred shares in the future will provide Trustmark with additional financial and management flexibility for general corporate and acquisition purposes. Dividends Another strategy designed to enhance shareholder value has been to maintain a consistent dividend payout ratio. Trustmark's dividend payout ratio was 30.6% for the first six months of 2002, compared with 33.3% for the same period in 2001. Dividends for the first half of 2002 were $0.30 per share, an increase of 11.1% when compared with dividends of $0.27 per share for the prior-year period. Regulatory Capital Trustmark and TNB are subject to minimum capital requirements, which are administered by various Federal regulatory agencies. These capital requirements, as defined by Federal guidelines, involve quantitative and qualitative measures of assets, liabilities and certain off-balance sheet instruments. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the financial statements of both Trustmark and TNB.
Management believes that Trustmark and TNB have met or exceeded all of the minimum capital standards for the parent company and its primary banking subsidiary as established by regulatory requirements as of June 30, 2002. At June 30, 2002, the most recent notification from the Office of the Comptroller of the Currency (OCC) categorized TNB as well capitalized. To be categorized in this manner, TNB must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios (defined in applicable regulations) as set forth in the accompanying table. There are no significant conditions or events that have occurred since the OCC's notification that Management believes have affected TNB's present classification. Regulatory Capital Table ($ in thousands) <TABLE> <CAPTION> June 30, 2002 -------------------------------------------------------------- Minimum Regulatory Actual Regulatory Minimum Regulatory Provision to be Capital Capital Required Well Capitalized ------------------ ------------------ ------------------ Amount Ratio Amount Ratio Amount Ratio -------- ------ -------- ------ -------- ------ <S> <C> <C> <C> <C> Total Capital (to Risk Weighted Assets) Trustmark Corporation $652,563 14.44% $361,414 8.00% - - Trustmark National Bank 629,802 14.25% 353,457 8.00% $441,821 10.00% Tier 1 Capital (to Risk Weighted Assets) Trustmark Corporation $595,852 13.19% $180,707 4.00% - - Trustmark National Bank 574,368 13.00% 176,728 4.00% $265,093 6.00% Tier 1 Capital (to Average Assets) Trustmark Corporation $595,852 8.88% $201,364 3.00% - - Trustmark National Bank 574,368 8.75% 196,903 3.00% $328,172 5.00% </TABLE> EARNING ASSETS Earning assets are comprised of securities, loans, federal funds sold and securities purchased under resale agreements, which are the primary revenue streams for Trustmark. At June 30, 2002, earning assets were $6.206 billion, or 90.64% of total assets, compared with $6.515 billion, or 90.74% of total assets at December 31, 2001, a decrease of $309.6 million, or 4.8%. This decrease is part of Management's overall strategy to reduce reliance on wholesale funding and neutralize the balance sheet during a volatile interest rate environment. Securities The securities portfolio consists primarily of debt securities, which are utilized to provide Trustmark with a quality investment alternative, a stable source of interest income, as well as collateral for pledges on public deposits and repurchase agreements. Additionally, the securities portfolio is used as a tool to manage risk from movements in interest rates. At June 30, 2002, Trustmark's securities portfolio totaled $1.658 billion, compared to $1.854 billion at December 31, 2001, a reduction of $195.6 million, or 10.6%. Management is continuing to utilize the liquidity provided by maturing securities to reduce Trustmark's reliance on wholesale funding. This strategy has reduced exposure to market sensitive assets and allowed the duration of the portfolio to shorten. Available-for-sale (AFS) securities are carried at their estimated fair value with unrealized gains or losses recognized, net of taxes, in accumulated other comprehensive income, a separate component of shareholders' equity. At June 30, 2002, AFS securities totaled $996.3 million, which represented 60.1% of the securities portfolio, compared to $1.061 billion or 57.3% at December 31, 2001. Held-to-maturity (HTM) securities are carried at amortized cost and represent those securities that Trustmark both positively intends and has the ability to hold to maturity. At June 30, 2002, HTM securities totaled $661.6 million and represented 39.9% of the total portfolio, compared with $792.1 million or 42.7% at the end of 2001. Management continues to focus on asset quality as one of the strategic goals of the securities portfolio, which is evidenced by the investment of 80% of the portfolio in U.S. Treasury and U.S. Government agencies obligations. In order to avoid excessive yield volatility from unexpected prepayments, Trustmark's normal practice is to purchase investment securities at or near par value, which also reduces the risk of premium write-offs.
Loans Loans, the largest group of earning assets, represented 73.0% of earning assets at June 30, 2002, compared with 69.4% at year-end 2001. At June 30, 2002, loans totaled $4.533 billion, increasing slightly from its level of $4.524 billion at December 31, 2001. During the first quarter of 2002, Trustmark launched its home equity line of credit (HELOC) program, approving approximately $240 million in credit lines to date, which added $70 million of new loans to the balance sheet. This program continues to provide potential for future loan growth with minimal operational expense. Growth in HELOC's and mortgage lending was offset by declines in consumer and commercial lending resulting primarily from recession-based factors. Trustmark's lending policies have resulted in consistently sound asset quality. One measure of asset quality in the financial services industry is the level of nonperforming assets. The details of Trustmark's nonperforming assets at June 30, 2002 and December 31, 2001, are shown in the following table: Nonperforming Assets ($ in thousands) June 30, December 31, 2002 2001 ------------ ------------ Nonaccrual and restructured loans $ 41,144 $ 36,901 Other real estate (ORE) 5,749 5,110 ------------ ------------ Total nonperforming assets $ 46,893 $ 42,011 ============ ============ Accruing loans past due 90 days or more $ 2,910 $ 2,740 ============ ============ Nonperforming assets/total loans and ORE 1.03% 0.93% ============ ============ Total nonperforming assets increased $4.9 million during the first six months of 2002. Three commercial customer relationships in unrelated industries accounted for the majority of the change and were previously identified as potential problems. Although nonperforming loans increased 11.6% when compared with December 31, 2001, the coverage by the allowance for loan losses remains strong at 184.5%. At June 30, 2002 and December 31, 2001, the allowance for loan losses was $75.9 million and $75.5 million, respectively, representing 1.67% of total loans outstanding at both dates. The allowance for loan losses is maintained at a level that Management and the Board of Directors believe is adequate to absorb estimated probable losses within the loan portfolio, including losses associated with off-balance sheet credit instruments such as letters of credit and unfunded lines of credit. A formal analysis is prepared monthly to assess the risk in the loan portfolio and to determine the adequacy of the allowance for loan losses. The analysis for loan losses considers any identified impairment and estimates determined by applying specific allowance factors to the commercial and consumer loan portfolios. Commercial loans as well as commercial real estate loans carry an internally assigned risk grade based on a scale of one to ten. An allowance factor is assigned to each loan grade based on historical loan losses in addition to other factors such as the level and trend of delinquencies, classified and criticized loans and nonperforming loans. Other factors are also taken into consideration such as local, regional and national economic trends, industry and other types of concentrations and loan loss trends that run counter to historical averages. All classified loans greater than $500 thousand are reviewed quarterly by the Asset Review Department to determine if a higher allowance factor should be applied to the loan based on a greater level of risk and probability of loss. Consumer loans carry allowance factors applied to pools of homogeneous loans such as direct and indirect loans, credit cards, home equity loans, other types of revolving consumer lines of credit and residential mortgage loans. The allowance factor applied to each pool is based on historical loan loss trends as well as current and projected trends in loan losses. Also taken into consideration are trends in consumer delinquencies, consumer bankruptcies, the effectiveness of the bank's collection function as well as economic conditions and trends referred to above. Net charge-offs were $6.9 million, or 0.31% of average loans, for the six months ended June 30, 2002, compared with $5.4 million, or 0.26% of average loans, for the six months ended June 30, 2001. Charge-offs for the first half of 2002 were affected by five larger commercial loan losses totaling $2.6 million. Net charge-offs were $2.3 million, or 0.21% of average loans, for the second quarter of 2002, comparing favorably with $2.9 million, or 0.26% of average loans, for the same period in 2001.
Other Earning Assets Federal funds sold and securities purchased under reverse repurchase agreements were $14.8 million at June 30, 2002, a decrease of $122.7 million, when compared with year-end 2001. At December 31, 2001, Trustmark had one reverse repurchase agreement for $125 million that was used as collateral for pledging to public deposits. Trustmark utilizes these products as a short-term investment alternative whenever it has excess liquidity. DEPOSITS AND OTHER INTEREST-BEARING LIABILITIES Trustmark's deposit base is its primary source of funding and consists of core deposits from the communities served by Trustmark. Total deposits were $4.599 billion at June 30, 2002, compared with $4.613 billion at December 31, 2001, a decrease of $14.3 million, or 0.3%. Interest-bearing deposits increased $77.1 million, or 2.2%, during the first half of 2002. For this same period, noninterest-bearing deposits decreased $91.4 million, a decline of 7.8%, partially due to payment of property taxes from customers' mortgage escrow accounts during the first quarter. Trustmark's deposit mix remains favorable with non-interest deposits representing 23.4% of total deposits. Trustmark will continue to seek deposits by expanding its presence in higher growth markets and evaluating additional wholesale deposit funding sources. Short-term borrowings consist of federal funds purchased, securities sold under repurchase agreements, FHLB borrowings and the treasury tax and loan note option account. Short-term borrowings totaled $1.166 billion at June 30, 2002, a decrease of $429.9 million, compared with $1.596 billion at year-end 2001. The liquidity created by maturing securities was utilized to reduce Trustmark's reliance on wholesale funding. Long-term FHLB advances totaled $325 million at June 30, 2002, an increase of $100 million from December 31, 2001. These are primarily fixed rate, long-term FHLB advances maturing from 2003 until 2006. Trustmark's use of these advances is significant in that it reduces the volatility of Trustmark's wholesale funding base by using long-term fixed rate products. CONTINGENCIES Trustmark and its subsidiaries are parties to lawsuits and other claims that arise in the ordinary course of business. Some of the lawsuits assert claims related to the lending, collection, servicing, investment, trust and other business activities; and some of the lawsuits allege substantial claims for damages. The cases are being vigorously contested. In the regular course of business, Management evaluates estimated losses or costs related to litigation, and provision is made for anticipated losses whenever Management believes that such losses are probable and can be reasonably estimated. At the present time, Management believes, based on the advice of legal counsel, that the final resolution of pending legal proceedings will not have a material impact on Trustmark's consolidated financial position or results of operations. ASSET/LIABILITY MANAGEMENT Overview Market risk is the risk of loss arising from adverse changes in market prices and rates. Trustmark has risk management policies to monitor and limit exposure to market risk. Trustmark's market risk is comprised primarily of interest rate risk created by core banking activities. Interest rate risk is the risk to net interest income represented by the impact of higher or lower interest rates. Management continually develops and applies cost-effective strategies to manage these risks. The Asset/Liability Committee sets the day-to-day operating guidelines, approves strategies affecting net interest income and coordinates activities within policy limits established by the Board of Directors. A key objective of the asset/liability management program is to quantify, monitor and manage interest rate risk and to assist Management in maintaining stability in the net interest margin under varying interest rate environments. Market/Interest Rate Risk Management The primary purpose in managing interest rate risk is to effectively invest capital 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.
Management has continued its concerted effort to decrease interest rate sensitivity through changes to the balance sheet mix and risk characteristics of assets and liabilities as well as through purchases of interest rate hedging instruments. Asset sensitivity has been reduced in commercial lending by increasing holdings of floating rate loans. Also, both the overall size of the securities portfolio and the maturity structure of securities have been lowered. Liability sensitivity has been reduced with growth in core deposits, declines in short-term wholesale funding and in the use of longer term borrowings. Trustmark continues utilizing hedging activities to lessen the adverse effects of large swings in interest rates, adding $300 million in notional amounts of long-term interest rate caps during the past year. As a result of these changes, Trustmark has improved its interest rate sensitivity position while experiencing a lower growth in net interest income. At June 30, 2002, the balance sheet is in a more neutral position than at year-end 2001, and it is estimated that net interest income may drop less than 2% in a one-year, shocked, up 200 basis point rate shift scenario, assuming no balance sheet growth. This represents a substantial decline in rate sensitivity at June 30, 2002, when compared to June 30, 2001. Management will continue to monitor the balance sheet to manage risk. The primary tool utilized by the Asset/Liability Committee is a modeling system that provides information used to evaluate exposure to interest rate risk, project earnings and manage balance sheet growth. This modeling system utilizes the following scenarios in order to give Management a method of evaluating Trustmark's interest rate, basis and prepayment risk under different conditions: o Rate shocked scenarios of up-and-down 100, 200 and 300 basis points. o Yield curve twist of +/- 2 standard deviations of the change in spread of the three-month Treasury bill and the 10-year Treasury note yields. o Basis risk scenarios where federal funds/LIBOR spread widens and tightens to the high and low spread determined by using 2 standard deviations. o Prepayment risk scenarios where projected prepayment speeds in up-and- down 200 basis point rate scenarios are compared to current projected prepayment speeds. A static gap analysis is a tool used mainly for interest rate risk measurement, which highlights significant short-term repricing volume mismatches. Management's assumptions related to the prepayment of certain loans and securities, as well as the maturity for rate sensitive assets and liabilities, are utilized for sensitivity static gap analysis. Three-month gap analysis projected at June 30, 2002, reflected a liability gap of $257 million, dramatically down from $1.063 billion on June 30, 2001. One-year gap analysis projected at June 30, 2002, reflected a liability gap of $73 million, down from $963 million on June 30, 2001. This new static gap analysis indicates that, though somewhat liability sensitive to interest rate movements, Trustmark is more favorably positioned for a rising interest rate environment, when compared to the prior year period. Trustmark uses derivatives to hedge interest rate exposures by mitigating the interest rate risk of mortgage loans held for sale and mortgage loans in process. Trustmark regularly enters into derivative financial instruments in the form of forward contracts, as part of its normal asset/liability management strategies. Forward contracts, a type of derivative financial instrument, are agreements to purchase or sell securities or other money market instruments at a future specified date at a specified price or yield. Trustmark's obligations under forward contracts consist of commitments to deliver mortgage loans, originated and/or purchased, in the secondary market at a future date. Trustmark continued a risk controlling strategy that utilizes caps and floors, which will be further implemented over time. During the second quarter of 2002, Trustmark sold its 5-year floor contract and purchased an additional 5-year cap contract with a notional amount of $100 million. As of June 30, 2002, Trustmark had interest rate cap contracts with notional amounts totaling $300 million, which mature in 2006. The intent of utilizing these financial instruments is to reduce the risk associated with the effects of significant movements in interest rates. Caps and floors, which are not designated as hedging instruments, are options linked to a notional principal amount and an underlying indexed interest rate. Exposure to loss on these options will increase or decrease as interest rates fluctuate. Liquidity The liquidity position of Trustmark is monitored on a daily basis by Trustmark's Treasury division. In addition, the Asset/Liability Committee reviews liquidity on a regular basis and approves any changes in strategy that are necessary as a result of balance sheet or anticipated cash flow changes. Also, on a monthly basis, Management compares Trustmark's liquidity position to established corporate policies. At June 30, 2002, Trustmark was within all established guidelines. Trustmark was able to improve overall liquidity capacity over the last year, as indicated by the reduction in the loan to deposit ratio and reliance on wholesale funding. The ability to maintain consistent cash flows from operations as well as adequate capital also enhances Trustmark's liquidity.
The primary source of liquidity on the asset side of the balance sheet are maturities and cash flows from both loans and securities as well as the ability to sell certain loans and securities. Liquidity on the liability side is generated primarily through growth in core deposits and the ability to obtain economical wholesale funding in national and regional markets through a variety of sources. Sources of wholesale funding are federal funds, repurchase agreements, brokered CD's and FHLB advances which allow Trustmark to meet necessary funding requirements as well as provide excess capacity for contingency funding needs. RECENT PRONOUNCEMENTS In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The impact of this statement on Trustmark's consolidated financial position and results of operations is not expected to be material.
PART II. OTHER INFORMATION Item 1. Legal Proceedings There were no material developments for the quarter ended June 30, 2002, other than those disclosed in the Notes to Consolidated Financial Statements and Management's Discussion and Analysis of this Form 10-Q. Item 4. Submission of Matters to a Vote of Security Holders The annual meeting of Trustmark's shareholders was held on April 9, 2002. At this meeting the following matters were voted on by Trustmark's shareholders: A. Election of Directors The following individuals were elected to serve as Directors of Trustmark until the annual meeting of shareholders in 2003 or until their respective successors are elected and qualified. The vote was cast as follows: Votes Cast Votes Cast in Favor Against/Withheld --------------------- ------------------- Number % Number % ---------- ------ --------- ----- J. Kelly Allgood 52,645,442 99.70% 156,941 0.30% Reuben V. Anderson 52,635,900 99.68% 166,483 0.32% John L. Black, Jr. 52,623,550 99.66% 178,833 0.34% William C. Deviney, Jr. 52,623,062 99.66% 179,321 0.34% C. Gerald Garnett 52,660,242 99.73% 142,141 0.27% Richard G. Hickson 51,144,317 96.86% 1,658,066 3.14% Matthew L. Holleman III 52,658,142 99.73% 144,241 0.27% William Neville III 52,642,182 99.70% 160,201 0.30% Richard H. Puckett 52,661,763 99.73% 140,620 0.27% Carolyn C. Shanks 52,654,727 99.72% 147,656 0.28% Kenneth W. Williams 52,640,982 99.69% 161,401 0.31% William G. Yates, Jr. 52,623,550 99.66% 178,833 0.34% B. Amend Articles of Incorporation A proposal was made to amend Trustmark's Articles of Incorporation in order to authorize 20 million shares of preferred stock having such designations, powers, terms, preferences, rights and limitations as may be determined, from time to time, by the Board of Directors. The vote was cast as follows: Votes Cast Votes Cast in Favor Against ---------- ---------- Authorization of preferred stock 35,094,604 8,257,431 Item 6. Exhibits and Reports on Form 8-K A. Exhibits The exhibits listed in the Exhibit Index are filed herewith or are incorporated herein by reference. B. Reports on Form 8-K 1. On April 9, 2002, Trustmark filed a report on Form 8-K announcing that the Board of Directors of Trustmark, based on the recommendation of its Audit Committee, had decided not to renew the engagement of its independent public accountants, Arthur Andersen LLP. 2. On April 10, 2002, Trustmark filed a report on Form 8-K announcing the retirement of T.H. Kendall, III, Chairman of the Board, and the election of Richard G. Hickson, Trustmark's Chief Executive Officer, as the new Chairman of the Board. 3. On April 29, 2002, Trustmark filed a report on Form 8-K announcing that the Board of Directors of Trustmark, based on the recommendation of its Audit Committee, had engaged KPMG LLP as its independent public accountants. 4. On May 1, 2002, Trustmark filed a report on Form 8-K announcing that Moody's Investors Service and Standard & Poor's had assigned investment grade ratings to Trustmark and its lead bank subsidiary, TNB.
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. TRUSTMARK CORPORATION BY: /s/ Richard G. Hickson BY: /s/ Zach L. Wasson ---------------------- ------------------ Richard G. Hickson Zach L. Wasson Chairman of the Board, President Treasurer (Principal & Chief Executive Officer Financial Officer) DATE: August 12, 2002 DATE: August 12, 2002
EXHIBIT INDEX 99 Certification by Chief Executive Officer and Chief Financial Officer.