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 September 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ____ Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of October 31, 2002. Title Outstanding Common stock, no par value 61,622,709
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Trustmark Corporation and Subsidiaries Consolidated Balance Sheets ($ in thousands) (Unaudited) September 30, December 31, 2002 2001 ----------- ----------- Assets Cash and due from banks (noninterest-bearing) $ 354,824 $ 328,779 Federal funds sold and securities purchased under reverse repurchase agreements 189,056 137,521 Securities available for sale (at fair value) 940,061 1,061,495 Securities held to maturity (fair value: $648,162 - 2002; $820,917 - 2001) 614,417 792,052 Loans 4,613,570 4,524,366 Less allowance for loan losses 75,538 75,534 ----------- ----------- Net loans 4,538,032 4,448,832 Premises and equipment 104,928 97,158 Intangible assets: Mortgage servicing rights 46,923 53,470 Goodwill 47,982 41,004 Other identifiable intangible assets 23,056 22,217 ----------- ----------- Total intangible assets 117,961 116,691 Other assets 200,030 197,811 ----------- ----------- Total Assets $ 7,059,309 $ 7,180,339 =========== =========== Liabilities Deposits: Noninterest-bearing $ 1,237,109 $ 1,167,437 Interest-bearing 3,585,085 3,445,928 ----------- ----------- Total deposits 4,822,194 4,613,365 Federal funds purchased 296,881 235,781 Securities sold under repurchase agreements 427,135 801,725 Short-term borrowings 429,760 558,687 Long-term FHLB advances 325,000 225,000 Other liabilities 65,705 60,337 ----------- ----------- Total Liabilities 6,366,675 6,494,895 Commitments and Contingencies Shareholders' Equity Common stock, no par value: Authorized: 250,000,000 shares Issued and outstanding: 61,660,409 shares - 2002; 63,705,671 shares - 2001 12,847 13,273 Capital surplus 14,370 66,083 Retained earnings 651,015 587,387 Accumulated other comprehensive income, net of tax 14,402 18,701 ----------- ----------- Total Shareholders' Equity 692,634 685,444 ----------- ----------- Total Liabilities and Shareholders' Equity $ 7,059,309 $ 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 Nine Months Ended September 30, September 30, ---------------------- ---------------------- 2002 2001 2002 2001 -------- -------- -------- -------- <S> <C> <C> <C> <C> Interest Income Interest and fees on loans $ 77,554 $ 86,501 $231,100 $259,579 Interest on securities: Taxable 21,519 29,979 70,197 97,154 Tax exempt 2,175 2,473 6,747 7,050 Interest on federal funds sold and securities purchased under reverse repurchase agreements 150 108 345 843 Other interest income 23 396 1,368 396 -------- -------- -------- -------- Total Interest Income 101,421 119,457 309,757 365,022 Interest Expense Interest on deposits 19,634 31,106 61,432 100,560 Interest on federal funds purchased and securities sold under repurchase agreements 3,058 8,624 9,946 36,963 Other interest expense 5,636 9,600 16,566 33,280 -------- -------- -------- -------- Total Interest Expense 28,328 49,330 87,944 170,803 -------- -------- -------- -------- Net Interest Income 73,093 70,127 221,813 194,219 Provision for loan losses 3,000 3,800 10,307 8,600 -------- -------- -------- -------- Net Interest Income After Provision for Loan Losses 70,093 66,327 211,506 185,619 Noninterest Income Service charges on deposit accounts 12,725 12,077 36,546 34,448 Other account charges, fees and commissions 14,189 10,469 34,866 30,775 Mortgage servicing fees 4,310 4,294 12,925 12,537 Trust service income 2,402 2,351 7,413 7,191 Gains on sales of loans 2,376 805 6,050 6,489 Securities gains 12,033 1,362 12,549 1,730 Other income (3,114) 2,854 (5,792) 4,059 -------- -------- -------- -------- Total Noninterest Income 44,921 34,212 104,557 97,229 Noninterest Expense Salaries and employee benefits 30,568 28,225 89,030 81,950 Net occupancy - premises 3,168 3,201 8,863 8,634 Equipment expense 3,598 3,942 11,357 11,684 Services and fees 8,093 7,638 23,720 21,725 Amortization of intangible assets 15,063 5,281 18,886 10,575 Loan expense 2,373 2,435 7,314 6,959 Other expense 5,618 5,475 15,015 15,175 -------- -------- -------- -------- Total Noninterest Expense 68,481 56,197 174,185 156,702 -------- -------- -------- -------- Income Before Income Taxes 46,533 44,342 141,878 126,146 Income taxes 16,471 15,633 50,084 44,274 -------- -------- -------- -------- Net Income $ 30,062 $ 28,709 $ 91,794 $ 81,872 ======== ======== ======== ======== Earnings Per Share Basic $ 0.49 $ 0.45 $ 1.47 $ 1.26 ======== ======== ======== ======== Diluted $ 0.49 $ 0.45 $ 1.46 $ 1.26 ======== ======== ======== ======== </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 91,794 81,872 Net change in unrealized gains/losses on securities available for sale, net of tax (1,198) 14,696 Net change in accumulated net losses on cash flow hedges, net of tax (3,101) (1,070) --------- --------- Comprehensive income 87,495 95,498 Cash dividends paid (28,166) (26,403) Common stock issued in business combination - 46,022 Common stock transactions, long-term incentive plan 20 - Repurchase and retirement of common stock (52,159) (64,900) --------- --------- Balance, September 30, $ 692,634 $ 679,858 ========= ========= See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Cash Flows ($ in thousands) (Unaudited) Nine Months Ended September 30, --------------------- 2002 2001 --------- --------- Operating Activities Net income $ 91,794 $ 81,872 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 10,307 8,600 Depreciation and amortization 28,414 20,046 Net (accretion) amortization of securities (750) 570 Securities gains (12,549) (1,730) Gains on sales of loans (6,050) (6,489) Deferred income tax provision (5,036) 1,807 Proceeds from sales of loans 673,698 936,759 Purchases and originations of loans held for sale (715,427) (750,493) Proceeds from sales of trading securities - 990 Net increase in intangible assets (10,385) (15,663) Net increase in other assets (257) (7,501) Net (decrease) increase in other liabilities (1,992) 534 Other operating activities, net 547 1,859 --------- --------- Net cash provided by operating activities 52,314 271,161 Investing Activities Proceeds from calls and maturities of securities available for sale 263,676 465,121 Proceeds from calls and maturities of securities held to maturity 198,991 156,868 Proceeds from sales of securities available for sale 229,442 12,076 Purchases of securities available for sale (361,982) (400,401) Purchases of securities held to maturity (19,708) - Net (increase) decrease in federal funds sold and securities purchased under reverse repurchase agreements (51,535) 96,313 Net increase in loans (51,728) (98,737) Purchases of premises and equipment (14,901) (9,330) Proceeds from sales of premises and equipment 19 123 Proceeds from sales of other real estate 3,149 2,474 Cash paid in business combination (7,799) (38,175) --------- --------- Net cash provided by investing activities 187,624 186,332 Financing Activities Net increase (decrease) in deposits 208,829 (97,887) Net decrease in federal funds purchased and securities sold under repurchase agreements (313,490) (321,937) Net decrease in other borrowings (128,927) (169,412) Proceeds from long-term FHLB advances 100,000 225,000 Cash dividends (28,166) (26,403) Common stock transactions, net (52,139) (64,900) --------- --------- Net cash used by financing activities (213,893) (455,539) --------- --------- Increase in cash and cash equivalents 26,045 1,954 Cash and cash equivalents at beginning of period 328,779 298,651 --------- --------- Cash and cash equivalents at end of period $ 354,824 $ 300,605 ========= ========= 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 $163 million in total assets. Both business combinations were accounted for under the purchase method of accounting and their results of operations, which are not material, have been included in the financial statements from the merger dates. NOTE 3 - ALLOWANCE FOR LOAN LOSSES The following table summarizes the activity in the allowance for loan losses for the nine month periods ended September 30 ($ in thousands): 2002 2001 -------- -------- Balance at beginning of year $ 75,534 $ 65,850 Provision charged to expense 10,307 8,600 Loans charged off (17,281) (16,426) Recoveries 6,978 5,797 -------- -------- Net charge-offs (10,303) (10,629) Allowance applicable to loans of acquired bank - 8,708 -------- -------- Balance at end of period $ 75,538 $ 72,529 ======== ======== At September 30, 2002 and 2001, the carrying amounts of nonaccrual loans were $31.0 million and $31.1 million, respectively. Included in these nonaccrual loans at September 30, 2002 and 2001, are loans that are considered to be impaired, which totaled $23.7 million and $24.5 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 third quarter of 2002 and 2001 were $28.7 million and $22.5 million, respectively. No material amounts of interest income were recognized on impaired loans or nonaccrual loans for the third 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 September 30, 2002, the carrying amounts, net of accumulated amortization, for other identifiable intangible assets and goodwill were $23.1 million and $48.0 million, respectively. The increases from adoption date are from the addition of $3.2 million of other intangible assets and $6.6 million of goodwill resulting from the acquisition of CSI, along with $386 thousand in subsequent purchase accounting goodwill adjustments related to previously completed business combinations. Trustmark recorded $2.3 million of amortization of other identifiable intangible assets for the first nine months of 2002. The following table sets forth the reconcilement of net income and earnings per share excluding goodwill amortization for the nine months ended September 30, 2002 and 2001 ($ in thousands, except per share data): Nine Months Ended September 30, ---------------------- 2002 2001 -------- -------- Reported net income $ 91,794 $ 81,872 Add back goodwill amortization, net of tax - 626 -------- -------- Adjusted net income $ 91,794 $ 82,498 ======== ======== Basic earnings per share: Reported net income $ 1.47 $ 1.26 Goodwill amortization, net of tax - .01 -------- -------- Adjusted net income $ 1.47 $ 1.27 ======== ======== Diluted earnings per share: Reported net income $ 1.46 $ 1.26 Goodwill amortization, net of tax - .01 -------- -------- Adjusted net income $ 1.46 $ 1.27 ======== ======== 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: Nine Months Ended September 30, ------------------------- 2002 2001 ---------- ---------- Basic 62,608,357 65,033,889 Dilutive shares (due to stock options) 192,152 107,060 ---------- ---------- Diluted 62,800,509 65,140,949 ========== ========== NOTE 7 - STATEMENTS OF CASH FLOWS Trustmark made cash payments for income taxes approximating $47.2 million and $36.3 million during the nine months ended September 30, 2002 and 2001, respectively. Interest paid on deposit liabilities and other borrowings approximated $92.6 million in the first nine months of 2002 and $177.2 million in the first nine months of 2001. For the nine months ended September 30, 2002 and 2001, noncash transfers from loans to foreclosed properties were $5.5 million and $4.1 million, respectively. NOTE 8 - RECENT PRONOUNCEMENTS In October 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 147, "Acquisitions of Certain Financial Institutions." As of October 1, 2002, this statement requires financial services companies to subject all of their goodwill to annual impairment tests instead of amortizing any goodwill previously subject to SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions." This statement applies to all new and past financial institution acquisitions, including "branch acquisitions" that qualify as acquisitions of a business, but excluding acquisitions between mutual institutions. All acquisitions within the scope of the SFAS No. 147 will now be governed by the requirements of SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." Additionally, this statement amends SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," to include long-term customer-relationship intangible assets in its scope. As of October 1, 2002, these intangibles must be evaluated for impairment just like other long-lived assets. The impact of this statement on Trustmark's consolidated financial position and results of operations is not expected to be material. 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 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 risk management 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 credit 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 10 and 11 disclose financial information by segment for the periods ended September 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 September 30, 2002 - ---------------------------------- <S> <C> <C> <C> <C> <C> Net interest income from external customers $ 14,004 $ 25,844 $ 17,689 $ 15,556 $ 73,093 Internal funding 23,992 (13,837) (6,422) (3,733) - ---------- ---------- ---------- ---------- ---------- Net interest income 37,996 12,007 11,267 11,823 73,093 Provision for loan losses 1,312 1,357 465 (134) 3,000 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 36,684 10,650 10,802 11,957 70,093 Noninterest income 14,261 158 20,642 9,860 44,921 Noninterest expense 32,064 4,128 28,849 3,440 68,481 ---------- ---------- ---------- ---------- ---------- Income before income taxes 18,881 6,680 2,595 18,377 46,533 Income taxes 6,509 2,305 1,060 6,597 16,471 ---------- ---------- ---------- ---------- ---------- Segment net income $ 12,372 $ 4,375 $ 1,535 $ 11,780 $ 30,062 ========== ========== ========== ========== ========== Selected Financial Information Average assets $2,349,441 $1,597,099 $1,154,323 $1,719,486 $6,820,349 Depreciation and amortization $ 1,352 $ 46 $ 14,526 $ 2,216 $ 18,140 For the three months ended September 30, 2001 - ---------------------------------- Net interest income from external customers $ 7,195 $ 31,122 $ 13,768 $ 18,042 $ 70,127 Internal funding 31,890 (19,795) (4,843) (7,252) - ---------- ---------- ---------- ---------- ---------- Net interest income 39,085 11,327 8,925 10,790 70,127 Provision for loan losses 3,677 910 505 (1,292) 3,800 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 35,408 10,417 8,420 12,082 66,327 Noninterest income 13,835 120 15,368 4,889 34,212 Noninterest expense 32,571 3,981 16,208 3,437 56,197 ---------- ---------- ---------- ---------- ---------- Income before income taxes 16,672 6,556 7,580 13,534 44,342 Income taxes 5,748 2,263 2,701 4,921 15,633 ---------- ---------- ---------- ---------- ---------- Segment net income $ 10,924 $ 4,293 $ 4,879 $ 8,613 $ 28,709 ========== ========== ========== ========== ========== Selected Financial Information Average assets $2,336,247 $1,593,915 $ 881,954 $2,203,673 $7,015,789 Depreciation and amortization $ 1,276 $ 55 $ 4,405 $ 2,859 $ 8,595 </TABLE>
Trustmark Corporation Segment Information ($ in thousands) <TABLE> <CAPTION> Retail Commercial Financial Treasury & Banking Banking Services Other Total ---------- ---------- ---------- ---------- ---------- For the nine months ended September 30, 2002 - ---------------------------------- <S> <C> <C> <C> <C> <C> Net interest income from external customers $ 38,505 $ 77,881 $ 50,745 $ 54,682 $ 221,813 Internal funding 73,168 (43,033) (19,520) (10,615) - ---------- ---------- ---------- ---------- ---------- Net interest income 111,673 34,848 31,225 44,067 221,813 Provision for loan losses 3,785 4,468 1,413 641 10,307 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 107,888 30,380 29,812 43,426 211,506 Noninterest income 41,185 470 53,313 9,589 104,557 Noninterest expense 95,817 11,890 56,290 10,188 174,185 ---------- ---------- ---------- ---------- ---------- Income before income taxes 53,256 18,960 26,835 42,827 141,878 Income taxes 18,409 6,544 9,591 15,540 50,084 ---------- ---------- ---------- ---------- ---------- Segment net income $ 34,847 $ 12,416 $ 17,244 $ 27,287 $ 91,794 ========== ========== ========== ========== ========== Selected Financial Information Average assets $2,346,616 $1,581,155 $1,094,327 $1,807,926 $6,830,024 Depreciation and amortization $ 3,938 $ 141 $ 17,289 $ 7,046 $ 28,414 For the nine months ended September 30, 2001 - ---------------------------------- Net interest income from external customers $ 15,317 $ 95,812 $ 34,899 $ 48,191 $ 194,219 Internal funding 91,545 (63,096) (10,068) (18,381) - ---------- ---------- ---------- ---------- ---------- Net interest income 106,862 32,716 24,831 29,810 194,219 Provision for loan losses 6,264 2,551 1,652 (1,867) 8,600 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 100,598 30,165 23,179 31,677 185,619 Noninterest income 40,117 379 49,059 7,674 97,229 Noninterest expense 93,456 11,499 42,420 9,327 156,702 ---------- ---------- ---------- ---------- ---------- Income before income taxes 47,259 19,045 29,818 30,024 126,146 Income taxes 16,306 6,576 10,487 10,905 44,274 ---------- ---------- ---------- ---------- ---------- Segment net income $ 30,953 $ 12,469 $ 19,331 $ 19,119 $ 81,872 ========== ========== ========== ========== ========== Selected Financial Information Average assets $2,262,529 $1,585,213 $ 857,942 $2,306,678 $7,012,362 Depreciation and amortization $ 3,589 $ 161 $ 8,246 $ 8,050 $ 20,046 </TABLE> During 2002, noninterest income for Financial Services and Treasury & Other was affected by gains of sales of loans and securities gains, respectively. Noninterest expense for Financial Services was affected by impairment of mortgage servicing rights during 2002 and 2001. See discussion of these items in Management's Discussion and Analysis on pages 17 and 18.
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; o Changes in credit quality. 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 $0.49 for the third quarter of 2002, which represents an 8.9% increase compared to $0.45 for the third quarter of 2001. Net income for the third quarter totaled $30.1 million, resulting in a return on average assets of 1.75% and a return on average equity of 17.70%. For the nine months ended September 30, 2002, net income totaled $91.8 million, with a return on average assets of 1.80% and a return on average equity of 18.20%. At September 30, 2002, Trustmark reported total loans of $4.6 billion, total assets of $7.1 billion, total deposits of $4.8 billion and shareholders' equity of $692.6 million. The decline in interest rates to the lowest levels in over 40 years has provided Trustmark both challenges and opportunities during 2002. The effect of continued reductions in long-term mortgage rates reduced the value of the mortgage servicing portfolio. During the third quarter, Trustmark recorded a non-cash charge of $6.6 million, or $0.11 per share, net of taxes, to recognize this reduction in value of the mortgage servicing portfolio. This non-cash charge against income may be reversed, in whole or in part, as refinancing slows or the expected life of the mortgage lengthens. Trustmark also recognized a non-cash mark-to-market charge on its interest rate hedging position of $1.9 million, net of taxes, or $0.03 per share. This non-cash charge against income may also be reversed, in whole or in part, if interest rates increase. The current interest rate environment also provided a number of opportunities. During the third quarter, Trustmark realized an after-tax net gain of $7.4 million, or $0.12 per share, resulting from gains on security transactions. This net gain on sale of securities is the result of recent significant price changes, which provided Trustmark an opportunity to restructure a portion of its investment portfolio and reduce exposure to volatile interest rates. The collective result of these nonrecurring items reduced Trustmark's net income by $1.1 million, or $0.02 per share in the third quarter.
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 14 and 15 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-FTE for the three-month and nine-month periods ended September 30, 2002, increased $2.7 million, or 3.7%, and $27.0 million, or 13.4%, respectively, when compared with the same periods in 2001. The continuing decline in interest rates has impacted both assets and liabilities. 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 75 basis points, when comparing the first nine months of 2002 to the same period in 2001. Additionally, during the first nine 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 falling interest rate environment, compared to $396 thousand during the same period in 2001. Average interest-earning assets for the first nine months of 2002 were $6.202 billion, compared with $6.457 billion in the same period for 2001, a decrease of $254.3 million, or 3.9%. While an overall decrease did occur, the change in mix of interest earning assets proved favorable as Trustmark effectively replaced lower yielding securities with loans with relatively higher yields, which has contributed to the increase in net interest income. This change in mix is illustrated by loans as a percent of total earning assets increasing to 72.6% at September 30, 2002, from 68.2% at September 30, 2001. The yield on average earning assets dropped from 7.71% in the first nine months of 2001 to 6.83% in the same period in 2002, a decrease of 88 basis points. The combination of a decrease in the earning asset base and declining yields resulted in a decrease in interest income-FTE during the first nine months of 2002 of $55.9 million, or 15.0%, when compared with the first nine months of 2001. Average interest-bearing liabilities for the first nine months of 2002 totaled $5.026 billion, compared with $5.345 billion for the first nine months of 2001, a decrease of $319.0 million, or 6.0%. 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 nine months ended September 30, 2002 and 2001, were 2.34% and 4.27%, respectively, a decrease of 193 basis points. As a result of these factors, total interest expense for the first three quarters of 2002 decreased $82.9 million, or 48.5%, when compared with the first three quarters of 2001.
Management has strategically reduced Trustmark's exposure to future increases in interest rates by restructuring the balance sheet and utilizing interest rate contracts. Balance sheet restructuring has occurred by reducing Trustmark's wholesale funding reliance with liquidity provided by maturing investments. Also, Trustmark was able to benefit during this falling interest rate environment by locking into liabilities at lower, long-term fixed rates. Trustmark will continue to manage the overall risk exposure present during significant movements in interest rates and reduce the impact on net interest income. For additional discussion, see Market/Interest Rate Risk Management on page 23. Trustmark Corporation Yield/Rate Analysis Table ($ in thousands) <TABLE> <CAPTION> For the Three Months Ended September 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 $ 35,001 $ 150 1.70% $ 22,114 $ 108 1.94% Securities - taxable 1,391,978 21,519 6.13% 1,866,497 29,979 6.37% Securities - nontaxable 168,603 3,346 7.87% 191,658 3,804 7.87% Loans, net of unearned income 4,587,012 78,594 6.80% 4,357,251 88,040 8.02% ---------- -------- ---------- -------- Total interest-earning assets 6,182,594 103,609 6.65% 6,437,520 121,931 7.51% Cash and due from banks 282,665 263,284 Other assets 431,083 388,791 Allowance for loan losses (75,993) (73,807) ---------- ---------- Total Assets $6,820,349 $7,015,788 ========== ========== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing deposits $3,519,645 19,634 2.21% $3,360,334 31,106 3.67% Federal funds purchased and securities sold under repurchase agreements 729,862 3,058 1.66% 1,055,348 8,624 3.24% Borrowings 733,051 5,636 3.05% 893,891 9,600 4.26% ---------- -------- ---------- -------- Total interest-bearing liabilities 4,982,558 28,328 2.26% 5,309,573 49,330 3.69% -------- -------- Noninterest-bearing demand deposits 1,089,755 960,984 Other liabilities 74,127 85,830 Shareholders' equity 673,909 659,401 ---------- ---------- Total Liabilities and Shareholders' Equity $6,820,349 $7,015,788 ========== ========== Net Interest Margin 75,281 4.83% 72,601 4.47% Less tax equivalent adjustment 2,188 2,474 -------- -------- Net Interest Margin per Consolidated Statements of Income $ 73,093 $ 70,127 ======== ======== </TABLE>
Trustmark Corporation Yield/Rate Analysis Table ($ in thousands) <TABLE> <CAPTION> For the Nine Months Ended September 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 $ 27,319 $ 345 1.69% $ 27,762 $ 843 4.06% Securities - taxable 1,485,267 70,197 6.32% 1,979,210 97,154 6.56% Securities - nontaxable 173,925 10,380 7.98% 181,283 10,846 8.00% Loans, net of unearned income 4,515,979 235,701 6.98% 4,268,559 263,634 8.26% ---------- -------- ---------- -------- Total interest-earning assets 6,202,490 316,623 6.83% 6,456,814 372,477 7.71% Cash and due from banks 281,007 256,877 Other assets 422,107 369,931 Allowance for loan losses (75,580) (71,260) ---------- ---------- Total Assets $6,830,024 $7,012,362 ========== ========== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing deposits $3,525,957 61,432 2.33% $3,327,971 100,560 4.04% Federal funds purchased and securities sold under repurchase agreements 796,000 9,946 1.67% 1,156,396 36,963 4.27% Borrowings 704,082 16,566 3.15% 860,721 33,280 5.17% ---------- -------- ---------- -------- Total interest-bearing liabilities 5,026,039 87,944 2.34% 5,345,088 170,803 4.27% -------- -------- Noninterest-bearing demand deposits 1,063,149 938,723 Other liabilities 66,615 76,393 Shareholders' equity 674,221 652,158 ---------- ---------- Total Liabilities and Shareholders' Equity $6,830,024 $7,012,362 ========== ========== Net Interest Margin 228,679 4.93% 201,674 4.18% Less tax equivalent adjustment 6,866 7,455 -------- -------- Net Interest Margin per Consolidated Statements of Income $221,813 $194,219 ======== ======== </TABLE> Provision for Loan Losses Trustmark's provision for loan losses totaled $3.0 million and $10.3 million, respectively, for the three-month and nine-month periods ended September 30, 2002, compared with $3.8 million and $8.6 million, respectively, for the same periods in 2001. The provision to average loans was 0.31% for the first nine months of 2002, compared with 0.27% for the same period in 2001. For the quarters ended September 30, 2002 and 2001, the provision to average loans was 0.26% and 0.35%, 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, risk management and investment products and services. For the nine months ended September 30, 2002, noninterest income totaled $104.6 million, increasing $7.3 million, or 7.5%, from the prior-year period. For the quarter ended September 30, 2002, noninterest income totaled $44.9 million, an increase of $10.7 million over the same period in 2001. Decreases recorded in the fair value of interest rate contracts were offset by security gains and increases in other account charges, fees and commissions. Noninterest income represented 25.2% of total gross revenues in the first nine months of 2002 versus 21.0% in the same period in 2001. The single largest component of noninterest income continues to be service charges for deposit products and services, which increased 6.1% in the first nine months of 2002 from the same period during 2001. In addition to increases in service charges for demand deposit accounts, $1.1 million of the $2.1 million increase is attributable to business combinations completed during 2001. Other account charges, fees and commissions increased $4.1 million, or 13.3%, during the first nine months of 2002, when compared to the levels maintained for the prior year. Net insurance commissions increased $5.1 million, or 60.0%. This increase includes $3.5 million from the CSI merger as well as increases resulting from expanded product lines and distribution channels for commercial and retail insurance services. Bank card fees increased 14.1% 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 $388 thousand, or 3.1%, when comparing the first nine 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 $4.3 billion in mortgage loans at September 30, 2002, up from $4.2 billion at September 30, 2001. Trust service income increased $222 thousand in the first nine months of 2002, compared with the same period in 2001, as continued weakness in the capital markets slowed growth in this area. At September 30, 2002, Trustmark, which continues to be one of the largest providers of asset management services in Mississippi, held assets under administration of $8.5 billion. Gains on sales of loans totaled $6.1 million and $6.5 million for the nine months ended September 30, 2002 and 2001, respectively. Trustmark recorded gains of $1.1 million on the sale of $42 million of GNMA loans during the first nine months of 2002, which allowed Trustmark to eliminate costly servicing of delinquent loans. This is compared to a $3.9 million gain during the first quarter of 2001 from the sale of $191 million in mortgage loans with significant prepayment risk. Excluding the impacts of these nonrecurring transactions, gains on sales of loans from secondary marketing activity experienced volume-driven growth of $2.4 million during the first nine months of 2002, compared with the same period in 2001. Securities gains for the nine months ended September 30, 2002 and 2001, were $12.5 million and $1.7 million, respectively, resulting in an increase of $10.8 million, or 625.4%. This increase is primarily from sales of $216.5 million in available-for-sale securities during the third quarter of 2002. These securities were sold as recent significant price increases provided the opportunity to restructure a portion of the portfolio to reduce price volatility in an extremely low interest rate cycle. In addition, securities sold had performed exceedingly well during a recent bond rally, but also had features that would have exposed Trustmark to excessive downside price risk during a period of rising interest rates. Management has always regarded the investment portfolio as an integral tool in the management of interest rate risk. Other income during the first nine months of 2002 was a loss of $5.8 million compared with a gain of $4.1 million in the prior-year period. This variance is primarily due to valuation adjustments on Trustmark's interest rate caps and floors. This non-cash charge against income may be reversed, in whole or in part, if interest rates increase. Interest rate caps and floors are used to mitigate the risks of excessive rate moves which may be detrimental to Trustmark's earnings. Although the intent is to provide protection against large rate moves over a period of years, current fair value accounting must be used to carry derivative financial instruments, with changes in value recognized currently in earnings as other income. The fair value of these interest rate contracts was $683 thousand and $8.0 million at September 30, 2002 and 2001, respectively.
Noninterest Expense Trustmark's noninterest expense increased $17.5 million, or 11.2%, in the first nine months of 2002 to $174.2 million, compared with $156.7 million in the first nine months of 2001. Included in this amount are $1.6 million from the CSI business combination and $4.3 million from business combinations completed during 2001. This increase in noninterest expense is also attributable to Trustmark's recognition of $8.8 million in impairment allowance for mortgage servicing rights in the first nine months of 2002 compared with $2.0 million for the prior-year period. Excluding these items, total noninterest expense increased $4.7 million, or 3.0%, during the first nine months of 2002 compared with the same period in 2001. Noninterest expense was $68.5 million for the three months ended September 30, 2002, a 21.9% increase from the $56.2 million recognized in the third quarter of 2001. This change was primarily related to amortization and impairment of intangible assets in addition to the CSI business combination completed on June 28, 2002. Control of expenses remains a management priority. Improvement in expense control is evidenced in Trustmark's efficiency ratio, which decreased to 50.79% during the first nine months of 2002 from 53.19% during the first nine months of 2001. The efficiency ratio is calculated by dividing total noninterest expense by tax-equivalent net interest income plus noninterest income, excluding specific nonrecurring items. Salaries and employee benefits were $89.0 million and $82.0 million for the first nine months of 2002 and 2001, respectively, increasing 8.6%. Excluding business combinations, the increase was $3.7 million, or 4.6%. This change represents normal annual merit increases along with increases in medical benefit and pension costs. When comparing the first nine months of 2002 with the same period in 2001, net occupancy-premises expense increased $229 thousand, while equipment expense decreased $327 thousand, both of which were minor changes. Services and fees for the first three quarters of 2002 totaled $23.7 million, compared to $21.7 million for the same period a year ago. The increase of $2.0 million, or 9.2%, is attributable to expenditures for software services and communications as well as professional fees. For the nine months ended September 30, 2002, amortization expense associated with intangible assets totaled $18.9 million, increasing $8.3 million from the same period in 2001. The current period included $8.8 million impairment of mortgage servicing rights compared with $2.0 million for the prior period. This non-cash charge against income may be reversed, in whole or in part, as refinancing slows or the expected life of the mortgage lengthens. Amortization of mortgage servicing rights increased by $2.1 million from increased volume, and customer-relationship intangibles, such as core deposit intangibles and insurance intangibles, increased from business combinations. These increases were partially offset by the $889 thousand reduction in goodwill amortization as the result of Trustmark's adoption of SFAS No. 142, which required Trustmark to discontinue amortization of goodwill, effective January 1, 2002. Loan expense increased $355 thousand during the first nine months of 2002 from the same period in 2001, primarily from increased mortgage activity in a lower interest rate environment. During the first nine months of 2002, other expense decreased $160 thousand from the same period in 2001, which was considered a minor change. SHAREHOLDERS' EQUITY As of September 30, 2002, Trustmark's shareholders' equity was $692.6 million, an increase of $7.2 million, or 1.0%, 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 18.20% for the first nine months of 2002 from 16.78% for the first nine months of 2001, while basic earnings per share have risen from $1.26 to $1.47 for these same periods, an increase of 16.7%.
Common Stock Repurchase Program On October 15, 2002, the Board of Directors of Trustmark authorized the newest plan to repurchase up to 5% of common stock, or approximately 3.1 million shares, subject to market conditions and management discretion. Collectively, the capital management plans adopted by Trustmark since 1998 have authorized the repurchase of 18.5 million shares of common stock. Pursuant to these plans, Trustmark has repurchased approximately 14.4 million shares at a cost of $299.0 million, including 2.1 million shares during 2002 at a cost of $52.1 million. The current remaining authorization is approximately 4.1 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. 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 nine months of 2002, compared with 32.1% for the same period in 2001. Dividends for the first nine months of 2002 were $0.45 per share, an increase of 11.1% when compared with dividends of $0.405 per share for the prior-year period. On October 15, 2002, the Board of Directors announced a 10.0% increase in its regular quarterly dividend to $0.165 per share from $0.15 per share. This action raises the indicated annual dividend rate to $0.66 per share from $0.60 per share. Regulatory Capital Trustmark and TNB are subject to minimum capital requirements, which are administered by various Federal regulatory agencies. These capital requirements, as defined by Federal guidelines, involve quantitative and qualitative measures of assets, liabilities and certain off-balance sheet instruments. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the financial statements of both Trustmark and TNB. Management believes that Trustmark and TNB have met or exceeded all of the minimum capital standards for the parent company and its primary banking subsidiary as established by regulatory requirements as of September 30, 2002. At September 30, 2002, the most recent notification from the Office of the Comptroller of the Currency (OCC) categorized TNB as well capitalized. To be categorized in this manner, TNB must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios (defined in applicable regulations) as set forth in the accompanying table. There are no significant conditions or events that have occurred since the OCC's notification that Management believes have affected TNB's present classification. Regulatory Capital Table ($ in thousands) <TABLE> <CAPTION> September 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> <C> <C> Total Capital (to Risk Weighted Assets) Trustmark Corporation $660,944 14.31% $369,561 8.00% - - Trustmark National Bank 640,952 14.17% 361,753 8.00% $452,191 10.00% Tier 1 Capital (to Risk Weighted Assets) Trustmark Corporation $602,980 13.05% $184,780 4.00% - - Trustmark National Bank 584,240 12.92% 180,876 4.00% $271,314 6.00% Tier 1 Capital (to Average Assets) Trustmark Corporation $602,980 8.94% $202,353 3.00% - - Trustmark National Bank 584,240 8.86% 197,932 3.00% $329,887 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 September 30, 2002, earning assets were $6.357 billion, or 90.05% of total assets, compared with $6.515 billion, or 90.74% of total assets at December 31, 2001, a decrease of $158.3 million, or 2.4%. This decrease is part of Management's overall strategy to neutralize the effects of substantial interest rate changes on the balance sheet as well as the income statement 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, to support profitability and to offset risks incurred by business units. At September 30, 2002, Trustmark's securities portfolio totaled $1.554 billion, compared to $1.854 billion at December 31, 2001, a reduction of $299.1 million, or 16.1%. During the third quarter of 2002, significant price changes in the portfolio enabled Trustmark to sell securities with a total market value of $216.5 million. This enabled Trustmark to restructure a portion of its investment portfolio by investing the proceeds in short duration mortgage related securities, which reduced exposure to volatile interest rates. 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 September 30, 2002, AFS securities totaled $940.1 million, which represented 60.5% 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 September 30, 2002, HTM securities totaled $614.4 million and represented 39.5% 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 practice is to purchase investment securities at or near par value, which also reduces the risk of premium write-offs. Loans Loans represented 72.6% of earning assets at September 30, 2002, compared with 69.4% at year-end 2001. At September 30, 2002, loans totaled $4.614 billion, increasing $89.2 million, or 2.0%, from its level of $4.524 billion at December 31, 2001. This increase is primarily the result of Trustmark's home equity line of credit (HELOC) program, which was launched during the first quarter of 2002, as well as from increased mortgage activity during a period of low interest rates. The HELOC program continues to provide potential for future loan growth with minimal operational expense. Growth in HELOC's and mortgage lending was offset by declines in consumer and commercial lending, which reflected the impact of a slowing economy. Trustmark's lending policies have resulted in consistently sound asset quality. One measure of asset quality in the financial services industry is the level of nonperforming assets. The details of Trustmark's nonperforming assets at September 30, 2002 and December 31, 2001, are shown in the following table: Nonperforming Assets ($ in thousands) September 30, December 31, 2002 2001 ------------- ------------- Nonaccrual and restructured loans $ 30,998 $ 36,901 Other real estate (ORE) 5,983 5,110 ------------- ------------- Total nonperforming assets $ 36,981 $ 42,011 ============= ============= Accruing loans past due 90 days or more $ 3,145 $ 2,740 ============= ============= Nonperforming assets/total loans and ORE 0.80% 0.93% ============= =============
Total nonperforming assets decreased $5.0 million during the first nine months of 2002. A significant improvement has been seen in nonperforming loans, where Management has made an intensified effort to return these assets to a performing status. The improvement in nonperforming loans is also evident in the coverage by the allowance for loan losses, which remains strong at 243.7%. At September 30, 2002 and December 31, 2001, the allowance for loan losses maintained a level at $75.5 million, representing 1.64% and 1.67%, respectively, of total loans outstanding. 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. 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 $10.3 million, or 0.31% of average loans, for the nine months ended September 30, 2002, compared with $10.6 million, or 0.33% of average loans, for the same period in 2001. Net charge-offs were $3.4 million, or 0.29% of average loans, for the third quarter of 2002, comparing favorably with $5.2 million, or 0.47% of average loans, for the same period in 2001. Other Earning Assets Federal funds sold and securities purchased under reverse repurchase agreements were $189.1 million at September 30, 2002, an increase of $51.5 million, when compared with year-end 2001. 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 $4.822 billion at September 30, 2002, compared with $4.613 billion at December 31, 2001, an increase of $208.8 million, or 4.5%. This growth was fueled by increased demand for the safety and liquidity of deposit products during a period of volatile market conditions. Interest-bearing deposits increased $139.2 million, or 4.0%, during the first nine months of 2002. For this same period, noninterest-bearing deposits increased $69.7 million, or 6.0%. Trustmark's deposit mix remains favorable with noninterest-bearing deposits representing 25.7% 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 $1.154 billion at September 30, 2002, a decrease of $442.4 million, compared with $1.596 billion at year-end 2001. Trustmark has used the liquidity created by maturing securities as well as increased core deposits to reduce reliance on wholesale funding. Long-term FHLB advances totaled $325 million at September 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 in third quarter 2001 and second quarter 2002. As a result of these changes, Trustmark has improved its interest rate sensitivity position while experiencing a lower growth in net interest income. During the third quarter 2002, the balance sheet shifted to an asset sensitive position, and it is estimated that net interest income may increase 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 September 30, 2002, when compared to September 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 September 30, 2002, reflected an asset gap of $325 million, a dramatic shift from a liability gap of $812 million at September 30, 2001. One-year gap analysis projected at September 30, 2002, reflected an asset gap of $674 million, an improvement from a liability gap of $488 million at September 30, 2001. This new static gap analysis indicates that Trustmark is better positioned for the possibility of a rising interest rate environment. 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 September 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. 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 October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions." As of October 1, 2002, this statement requires financial services companies to subject all of their goodwill to annual impairment tests instead of amortizing any goodwill previously subject to SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions." This statement applies to all new and past financial institution acquisitions, including "branch acquisitions" that qualify as acquisitions of a business, but excluding acquisitions between mutual institutions. All acquisitions within the scope of the SFAS No. 147 will now be governed by the requirements of SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." Additionally, this statement amends SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," to include long-term customer-relationship intangible assets in its scope. As of October 1, 2002, these intangibles must be evaluated for impairment just like other long-lived assets. The impact of this statement on Trustmark's consolidated financial position and results of operations is not expected to be material.
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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is included on pages 23 through 24 of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 4. CONTROLS AND PROCEDURES For the period ending September 30, 2002, Trustmark evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended (Exchange Act) , under the supervision and with the participation of its management, including the Chief Executive Officer and the Treasurer (the principal finance officer). Based upon this evaluation, the Chief Executive Officer and the Treasurer concluded that, as of September 30, 2002, Trustmark's disclosure controls and procedures were adequate to ensure that information required to be disclosed by Trustmark in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS There were no material developments for the quarter ended September 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 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 There were no reports on Form 8-K filed during the third quarter of 2002.
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: November 13, 2002 DATE: November 13, 2002
EXHIBIT INDEX 99.1 Certification by Chief Executive Officer pursuant to 18 U.S.C. ss. 1350. 99.2 Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 99.3 Certification by Chief Financial Officer pursuant to 18 U.S.C. ss. 1350. 99.4 Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.