UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (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, 2004 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 (Exact name of Registrant as specified in its charter) Mississippi 64-0471500 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 248 East Capitol Street, Jackson, Mississippi 39201 (Address of principal executive offices) (Zip Code) (601) 208-5111 (Registrant's telephone number, including area code) 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 20, 2004. Title Outstanding Common stock, no par value 57,822,833
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Trustmark Corporation and Subsidiaries Consolidated Balance Sheets ($ in thousands) (Unaudited) September 30, December 31, 2004 2003 ------------ ------------ Assets Cash and due from banks (noninterest-bearing) $ 273,385 $ 333,096 Federal funds sold and securities purchased under reverse repurchase agreements 16,290 37,712 Securities available for sale (at fair value) 1,916,093 1,933,993 Securities held to maturity (fair value: $157,490 - 2004; $191,146 - 2003) 147,214 178,450 Loans held for sale 104,389 112,560 Loans 5,283,953 4,920,052 Less allowance for loan losses 74,179 74,276 ------------ ------------ Net loans 5,209,774 4,845,776 Premises and equipment 113,511 108,374 Mortgage servicing rights 51,199 49,707 Identifiable intangible assets 21,173 21,921 Goodwill 110,271 95,877 Other assets 187,328 196,855 ------------ ------------ Total Assets $ 8,150,627 $ 7,914,321 ============ ============ Liabilities Deposits: Noninterest-bearing $ 1,242,612 $ 1,329,444 Interest-bearing 4,044,919 3,760,015 ------------ ------------ Total deposits 5,287,531 5,089,459 Federal funds purchased 294,232 253,419 Securities sold under repurchase agreements 560,254 674,716 Short-term borrowings 855,214 621,532 Long-term FHLB advances 355,926 531,035 Other liabilities 63,236 54,587 ------------ ------------ Total Liabilities 7,416,393 7,224,748 Commitments and Contingencies Shareholders' Equity Common stock, no par value: Authorized: 250,000,000 shares Issued and outstanding: 57,822,833 shares - 2004; 58,246,733 shares - 2003 12,048 12,136 Capital surplus 121,282 132,383 Retained earnings 603,316 548,521 Accumulated other comprehensive loss, net of tax (2,412) (3,467) ------------ ------------ Total Shareholders' Equity 734,234 689,573 ------------ ------------ Total Liabilities and Shareholders' Equity $ 8,150,627 $ 7,914,321 ============ ============ 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, ------------------ ------------------ 2004 2003 2004 2003 -------- -------- -------- -------- <S> <C> <C> <C> <C> Interest Income Interest and fees on loans $ 74,669 $ 71,093 $217,921 $212,960 Interest on securities: Taxable 16,162 12,065 47,183 50,610 Tax exempt 1,925 1,953 5,888 6,033 Interest on federal funds sold and securities purchased under reverse repurchase agreements 120 60 226 236 Other interest income 16 14 37 37 -------- -------- -------- -------- Total Interest Income 92,892 85,185 271,255 269,876 Interest Expense Interest on deposits 13,547 14,167 40,259 45,882 Interest on federal funds purchased and securities sold under repurchase agreements 3,243 2,269 7,503 8,096 Other interest expense 6,179 4,918 15,663 14,681 -------- -------- -------- -------- Total Interest Expense 22,969 21,354 63,425 68,659 -------- -------- -------- -------- Net Interest Income 69,923 63,831 207,830 201,217 Provision for loan losses 1,161 1,771 3,916 7,420 -------- -------- -------- -------- Net Interest Income After Provision for Loan Losses 68,762 62,060 203,914 193,797 Noninterest Income Service charges on deposit accounts 15,010 14,304 42,295 40,054 Wealth management 5,080 5,118 15,054 14,616 Retail banking - other 4,678 4,721 13,495 13,826 Insurance commissions 5,197 6,942 12,728 14,050 Mortgage banking (931) 8,428 6,267 3,599 Securities gains 6 57 21 12,226 Other income 1,935 1,298 5,387 4,727 -------- -------- -------- -------- Total Noninterest Income 30,975 40,868 95,247 103,098 Noninterest Expense Salaries and employee benefits 32,602 31,434 95,475 96,855 Services and fees 9,190 7,806 26,415 23,696 Equipment expense 3,799 3,721 11,122 11,104 Net occupancy - premises 4,043 3,395 10,773 9,541 Other expense 7,288 7,325 21,273 21,119 -------- -------- -------- -------- Total Noninterest Expense 56,922 53,681 165,058 162,315 -------- -------- -------- -------- Income Before Income Taxes 42,815 49,247 134,103 134,580 Income taxes 14,728 16,829 46,242 46,514 -------- -------- -------- -------- Net Income $ 28,087 $ 32,418 $ 87,861 $ 88,066 ======== ======== ======== ======== Earnings Per Share Basic $ 0.49 $ 0.55 $ 1.51 $ 1.49 ======== ======== ======== ======== Diluted $ 0.48 $ 0.55 $ 1.51 $ 1.48 ======== ======== ======== ======== Dividends Per Share $ 0.1900 $ 0.1650 $ 0.5700 $ 0.4950 ======== ======== ======== ======== </TABLE> See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity ($ in thousands) (Unaudited) 2004 2003 -------- -------- Balance, January 1, $689,573 $679,534 Comprehensive income: Net income per consolidated statements of income 87,861 88,066 Net change in fair value of securities available for sale, net of tax 1,055 (10,325) Net change in fair value of cash flow hedges, net of tax - 2,966 -------- -------- Comprehensive income 88,916 80,707 Cash dividends paid (33,066) (29,229) Common stock issued, long-term incentive plan 1,602 1,995 Compensation expense, long-term incentive plan 748 266 Repurchase and retirement of common stock (13,539) (51,175) -------- -------- Balance, September 30, $734,234 $682,098 ======== ======== See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Cash Flows ($ in thousands) (Unaudited) Nine Months Ended September 30, ---------------------- 2004 2003 ---------- ---------- Operating Activities Net income $ 87,861 $ 88,066 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 3,916 7,420 Depreciation and amortization/impairment 18,633 28,032 Net amortization of securities 15,955 13,886 Securities gains (21) (12,226) Gains on sales of loans (5,152) (14,715) Deferred income tax provision 5,040 977 Proceeds from sales of loans 640,000 1,217,389 Purchases and originations of loans held for sale (631,829) (1,176,419) Net increase in intangible assets (8,652) (17,586) Net decrease (increase) in other assets 1,516 (6,876) Net increase in other liabilities 8,132 689 Other operating activities, net 20 (54) ---------- ---------- Net cash provided by operating activities 135,419 128,583 Investing Activities Proceeds from calls and maturities of securities held to maturity 31,094 429,647 Proceeds from calls and maturities of securities available for sale 369,786 349,382 Proceeds from sales of securities available for sale - 267,895 Purchases of securities held to maturity (103) (3,978) Purchases of securities available for sale (366,099) (1,127,658) Net decrease (increase) in federal funds sold and securities purchased under reverse repurchase agreements 21,422 (35,543) Net increase in loans (223,257) (218,389) Purchases of premises and equipment (12,218) (5,964) Proceeds from sales of premises and equipment 462 1,287 Proceeds from sales of other real estate 5,070 4,510 Net cash received (paid) in business combinations 4,622 (69,802) ---------- ---------- Net cash used in investing activities (169,221) (408,613) Financing Activities Net increase in deposits 34,170 100,839 Net decrease in federal funds purchased and securities sold under repurchase agreements (73,649) (130,268) Net increase in other borrowings 58,573 315,220 Cash dividends (33,066) (29,229) Proceeds from the exercise of stock options 1,602 1,995 Repurchase and retirement of common stock (13,539) (51,175) ---------- ---------- Net cash (used in) provided by financing activities (25,909) 207,382 ---------- ---------- Decrease in cash and cash equivalents (59,711) (72,648) Cash and cash equivalents at beginning of period 333,096 357,427 ---------- ---------- Cash and cash equivalents at end of period $ 273,385 $ 284,779 ========== ========== 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 accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Management is required to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. 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. Operating results for the three and nine month periods ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. The notes included herein should be read in conjunction with the notes to the consolidated financial statements included in Trustmark Corporation's (Trustmark) 2003 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 period presentation. NOTE 2 - BUSINESS COMBINATIONS On November 2, 2004, Trustmark announced the signing of an agreement in which Fisher-Brown, Inc. would become a wholly owned subsidiary of Trustmark National Bank. Founded in 1911, Fisher-Brown is the leading general lines insurance agency in Northwest Florida, providing a broad spectrum of risk management products to businesses and individuals in Northwest Florida. With annual revenues of $16 million, Fisher-Brown is headquartered in Pensacola, Florida and has offices in Milton, Mary Esther, Destin and Panama City, Florida. The transaction, which is subject to due diligence, is expected to close in the fourth quarter of 2004. On March 12, 2004, Trustmark acquired five branches of Allied Houston Bank in a business combination accounted for by the purchase method of accounting. In connection with the transaction, Trustmark acquired approximately $148.1 million in assets and assumed $161.7 million in deposits and other liabilities for a $10 million deposit premium. Assets consisted of $145.9 million of selected loans, $585 thousand in premises and equipment and $1.6 million in other assets. The assets and liabilities have been recorded at fair value based on market conditions and risk characteristics at the acquisition date. Loans were recorded at a $6.4 million discount, consisting of a discount for general credit risk of $7.3 million offset by a market valuation premium of $862 thousand. Included in the credit risk discount of $7.3 million was a specific amount for nonaccrual loans of $1.7 million. Subsequent to the purchase date, the unpaid principal for these nonaccrual loans was written down to net realizable value against the recorded discount. Excess cost over tangible net assets acquired totaled $15.7 million, of which $426 thousand and $15.3 million have been allocated to identifiable intangibles (core deposits) and goodwill, respectively. Trustmark's financial statements include the results of operations for this acquisition from the merger date. The pro forma impact of this acquisition on Trustmark's results of operations is insignificant. On August 29, 2003, Trustmark acquired seven Florida branches of The Banc Corporation of Birmingham, Alabama, in a business combination accounted for by the purchase method of accounting. These branches, known as the Emerald Coast Division, serve the markets from Destin to Panama City. In connection with the transaction, Trustmark paid a $46.8 million deposit premium in exchange for $232.8 million in assets and $209.2 million in deposits and other liabilities. Assets consisted of $224.3 million in selected loans, $6.8 million in premises and equipment and $1.7 million in other assets. These assets and liabilities have been recorded at fair value based on market conditions and risk characteristics at the acquisition date. Loans were recorded at a $1.9 million discount, consisting of a discount for general credit risk of $3.5 million offset by a market premium of $1.6 million. This net discount will be recognized as interest income over the estimated life of the loans. Excess costs over tangible net assets acquired totaled $49.5 million, of which $1.7 million and $47.8 million have been allocated to identifiable intangibles (core deposits) and goodwill, respectively. Trustmark's financial statements include the results of operations for this acquisition from the merger date. The pro forma impact of this acquisition on Trustmark's results of operations is insignificant.
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES For the periods presented, loans consisted of the following: September 30, December 31, 2004 2003 ------------ ------------ Real estate loans: Construction and land development $ 496,937 $ 406,257 Secured by 1-4 family residential properties 1,808,966 1,663,915 Secured by nonfarm, nonresidential properties 885,813 858,708 Other 142,028 156,524 Loans to finance agricultural production 41,789 30,815 Commercial and industrial 859,156 787,094 Consumer 793,447 787,316 Obligations of states and political subdivisions 179,821 173,296 Other loans 75,996 56,127 ------------ ------------ Loans 5,283,953 4,920,052 Less allowance for loan losses 74,179 74,276 ------------ ------------ Net loans $ 5,209,774 $ 4,845,776 ============ ============ The following table summarizes the activity in the allowance for loan losses for the periods presented ($ in thousands): Nine Months Ended September 30, ------------------ 2004 2003 -------- -------- Balance at beginning of year $ 74,276 $ 74,771 Provision charged to expense 3,916 7,420 Loans charged off (10,950) (14,675) Recoveries 6,937 6,970 -------- -------- Net charge-offs (4,013) (7,705) -------- -------- Balance at end of period $ 74,179 $ 74,486 ======== ======== At September 30, 2004 and 2003, the carrying amounts of nonaccrual loans were $27.1 million and $26.9 million, respectively. Included in these nonaccrual loans at September 30, 2004 and 2003, are loans that are considered to be impaired, which totaled $20.8 million and $19.6 million, respectively. At September 30, 2004, the total allowance for loan losses related to impaired loans was $7.0 million compared with $6.1 million at September 30, 2003. The average carrying amounts of impaired loans during the third quarter of 2004 and 2003 were $20.3 million and $20.4 million, respectively. No material amounts of interest income were recognized on impaired loans or nonaccrual loans for the three and nine month periods ended September 30, 2004 and 2003. NOTE 4 - MORTGAGE BANKING At September 30, 2004 and December 31, 2003, the carrying amount of mortgage servicing rights are as follows ($ in thousands): September 30, December 31, 2004 2003 ------------ ------------ Mortgage Servicing Rights $ 58,990 $ 65,574 Valuation Allowance (7,791) (15,867) ------------ ------------ Mortgage Servicing Rights, net $ 51,199 $ 49,707 ============ ============ Mortgage servicing rights are rights to service mortgage loans for others, whether the loans were acquired through purchase or loan origination. Purchased mortgage servicing rights are capitalized at cost. For loans originated and sold where the servicing rights are retained, Trustmark allocated the cost of the loan and the servicing right based on their relative fair values. Mortgage servicing rights are amortized over the estimated period of the related new servicing income. At September 30, 2004, Trustmark serviced $3.4 billion in mortgage loans for others. Impairment for mortgage servicing rights occurs when the estimated fair value falls below the underlying carrying value. Fair value is determined utilizing specific risk characteristics of the mortgage loan, current interest rates and current prepayment speeds. During the second quarter of 2004, Trustmark reclassified $6.6 million of mortgage servicing right impairment from temporary to other-than-temporary which reduced the valuation allowance for impairment and the gross mortgage servicing rights balance with no effect to the net mortgage servicing rights asset. Impairment is considered to be other-than-temporary when Trustmark determines that the carrying value is expected to exceed the fair value for an extended period of time.
NOTE 5 - DEPOSITS At September 30, 2004 and December 31, 2003, deposits consisted of the following ($ in thousands): September 30, December 31, 2004 2003 ------------ ------------ DDA, NOW, MMDA $ 2,597,592 $ 2,543,694 Savings 867,618 828,256 Time 1,822,321 1,717,509 ------------ ------------ Total deposits $ 5,287,531 $ 5,089,459 ============ ============ NOTE 6 - STOCK-BASED COMPENSATION Effective January 1, 2003, Trustmark adopted the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" prospectively for all awards granted, modified or settled after January 1, 2003. Under the provisions of this statement, compensation expense is recognized by the straight line method for grants issued after January 1, 2003, utilizing the fair value of the grants over the vesting period. Trustmark estimates the fair value of each option granted using the Black-Scholes option-pricing model. Prior to January 1, 2003, Trustmark accounted for incentive stock options under the recognition and measurement provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." Under APB No. 25, because the exercise price of Trustmark's stock options equaled the market price for the underlying stock on the date of grant, no compensation expense was recognized. The following table reflects pro forma net income and earnings per share for the periods presented, had Trustmark elected to adopt the fair value approach for all outstanding options prior to January 1, 2003 ($ in thousands except per share data): <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------ 2004 2003 2004 2003 ------- ------- ------- ------- <S> <C> <C> <C> <C> Net income, as reported $28,087 $32,418 $87,861 $88,066 Add: Total stock-based employee compensation expense reported in net income, net of taxes 187 84 462 164 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (459) (439) (1,274) (1,227) ------- ------- ------- ------- Pro forma net income $27,815 $32,063 $87,049 $87,003 ======= ======= ======= ======= Earnings per share: As reported Basic $ 0.49 $ 0.55 $ 1.51 $ 1.49 Diluted 0.48 0.55 1.51 1.48 Pro forma Basic $ 0.48 $ 0.55 $ 1.50 $ 1.47 Diluted 0.48 0.54 1.49 1.46 </TABLE> NOTE 7 - CONTINGENCIES Standby Letters of Credit Trustmark issues financial and performance standby letters of credit in the normal course of business in order to fulfill the financing needs of its customers. Standby letters of credit are conditional commitments issued by Trustmark to insure the performance of a customer to a third party. A financial standby letter of credit is a commitment by Trustmark to guarantee a customer's repayment of an outstanding loan or debt instrument. Trustmark guarantees a customer's performance to a third party under a contractual nonfinancial obligation through the use of a performance standby letter of credit. When issuing letters of credit, Trustmark uses essentially the same policies regarding credit risk and collateral which are followed in the lending process. At September 30, 2004, the maximum potential amount of future payments Trustmark could be required to make under its standby letters of credit was $94.7 million, which also represented the maximum credit risk associated with these commitments. This amount consisted primarily of commitments with maturities of less than three years. These standby letters of credit have an immaterial carrying value. Trustmark holds collateral to support standby letters of credit when deemed necessary. As of September 30, 2004, the fair value of collateral held was $22.9 million.
Legal Proceedings Trustmark and its subsidiaries are parties to lawsuits and other claims that arise in the ordinary course of business. Some of the lawsuits assert claims related to the lending, collection, servicing, investment, trust and other business activities; and some of the lawsuits allege substantial claims for damages. The cases are being vigorously contested. In the regular course of business, Management evaluates estimated losses or costs related to litigation, and provision is made for anticipated losses whenever Management believes that such losses are probable and can be reasonably estimated. At the present time, Management believes, based on the advice of legal counsel and Management's evaluation, that the final resolution of pending legal proceedings will not have a material impact on Trustmark's consolidated financial position or results of operations; however, Management is unable to estimate a range of potential loss on these matters because of the nature of the legal environment in states where Trustmark conducts business. NOTE 8 - ASSOCIATE PENSION PLAN Trustmark maintains a noncontributory defined benefit pension plan which covers substantially all associates with more than one year of service. The plan provides pension benefits that are based on credited service, final average compensation and the benefit formula as defined in the plan. Trustmark's policy is to fund amounts allowable for federal income tax purposes, making sufficient contributions to satisfy the minimum funding requirement for each plan year and making additional contributions, as needed, based on the plan's funded status as of the October 31 measurement date. The following table presents information regarding net periodic pension costs for the nine months ended September 30, 2004 and 2003 ($ in thousands): 2004 2003 ------ ------ Service cost $1,228 $1,928 Interest cost 3,169 3,427 Expected return on plan assets (3,755) (4,136) Amortization of prior service cost (65) 182 Recognized net loss due to early retirement - 2,378 Recognized net actuarial loss 892 - ------ ------ Net Periodic Benefit Cost $1,469 $3,779 ====== ====== The table above shows the recognized net loss due to early retirement of $2.378 million, resulting from a voluntary early retirement program announced by Trustmark in February 2003. This program was offered to associates age 58 and above with ten years or more of service and was accepted by 116 associates, or 4.75% of Trustmark's workforce. The acceptable range of contributions to the plan is determined each year by the plan's actuary as of the measurement date, which is October 31st. Trustmark's minimum required contribution for the current year is zero; however, Trustmark's Management and Board of Directors approved a contribution of $11 million, which was made in October 2004. NOTE 9 - EARNINGS PER SHARE Basic earnings per share (EPS) is computed by dividing net income by the weighted average shares of common stock outstanding. Diluted EPS is computed by dividing net income by the weighted average shares of common stock outstanding, adjusted for the effect of dilutive stock options outstanding during the period. The following table reflects weighted average shares used to calculate basic and diluted EPS for the periods presented: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, --------------------- ---------------------- 2004 2003 2004 2003 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Basic 57,809,762 58,626,951 58,043,557 59,214,354 Dilutive shares (related to stock options) 304,558 271,346 289,964 191,656 ---------- ---------- ---------- ---------- Diluted 58,114,320 58,898,297 58,333,521 59,406,010 ========== ========== ========== ========== </TABLE>
NOTE 10 - STATEMENTS OF CASH FLOWS Trustmark paid income taxes of $37.4 million and $45.3 million during the nine months ended September 30, 2004 and 2003, respectively. Interest paid on deposit liabilities and other borrowings totaled $62.4 million in the first nine months of 2004 and $70.8 million in the first nine months of 2003. For the nine months ended September 30, 2004 and 2003, noncash transfers from loans to foreclosed properties were $3.8 million and $4.4 million, respectively. Assets acquired during the first quarter of 2004 as a result of the Allied Houston business combination totaled $148.1 million, while liabilities assumed totaled $161.7 million. During the first nine months of 2004, $175.0 million of long-term FHLB advances were transferred to short-term borrowings compared with net transfers of $42.3 million in the first nine months of 2003. NOTE 11 - RECENT PRONOUNCEMENTS In March 2004, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) issued EITF 03-1 "The Meaning of Other-than-Temporary and its Application to Certain Investments". EITF 03-1 requires an evaluation of investment securities to determine if impairment is "other-than-temporary". If impairment is deemed to be other-than-temporary based on certain criteria, an impairment loss equal to the difference between the investment's cost and its fair value is recognized. EITF 03-1 also requires additional disclosure related to unrealized losses. The disclosure requirements of EITF 03-1 are effective for annual reporting periods ending after June 15, 2004. The impairment requirements of EITF 03-1 are currently delayed pending clarification. On March 9, 2004, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 105, "Application of Accounting Principles to Loan Commitments". This bulletin summarizes the views of the SEC staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. The adoption of this bulletin did not impact Trustmark's consolidated financial statements. In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) No. 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer." SOP 03-3 addresses accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP 03-3 applies to loans and debt securities acquired individually, in pools or as part of a business combination and does not apply to originated loans. The application of SOP 03-3 limits the interest income, including accretion of purchase price discounts, that may be recognized for certain loans and debt securities. Additionally, SOP 03-3 does not allow the excess of contractual cash flows over cash flows expected to be collected to be recognized as an adjustment of yield, loss accrual or valuation allowance, such as the allowance for possible loan losses. SOP 03-3 requires that increases in expected cash flows subsequent to the initial investment be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. In the case of loans acquired in a business combination where the loans show signs of credit deterioration, SOP 03-3 represents a significant change from current purchase accounting practice whereby the acquiree's allowance for loan losses is typically added to the acquirer's allowance for loan losses. SOP 03-3 is effective for loans and debt securities acquired by Trustmark beginning January 1, 2005. The adoption of this new standard is not expected to have a material impact on Trustmark's financial statements. NOTE 12 - SEGMENT INFORMATION During the first quarter of 2004, Trustmark realigned its management reporting structure to include four segments that include general banking, wealth management, insurance and administration. The general banking segment realigns Trustmark's former consumer and commercial segment into a single group that delivers a full range of banking services to consumers, corporate, small and middle market businesses through its extensive branch network. Trustmark realigned its former investment segment into the wealth management segment incorporating trust, brokerage, investment advisory, and private banking service under one umbrella. The insurance segment, formerly included in the consumer segment, represents Trustmark's retail insurance agency that offers a diverse mix of insurance products and services. The administrative segment incorporates Trustmark's treasury function with various non-allocated corporate operation units and includes intangible assets and related amortization (except mortgage servicing rights and related amortization, which is included in the general banking segment). The accounting policies of each reportable segment are the same as those of the Corporation except for its internal allocations. Trustmark uses a match-funded transfer pricing process to assess operating segment performance. Non-interest expenses for back-office operations support are allocated to segments based on estimated uses of those services. Income tax expense for segments is calculated at the marginal statutory rate. The following table discloses financial information by reportable segment for the periods ended September 30, 2004 and 2003. The prior period has been restated to conform with the current period presentation.
Trustmark Corporation Segment Information ($ in thousands) <TABLE> <CAPTION> General Banking Wealth Mgt Insurance Admin Division Division Division Division Total ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> For the three months ended September 30, 2004 - -------------------------- Net interest income from external customers $ 60,452 $ 1,174 $ - $ 8,297 $ 69,923 Internal funding (756) (85) - 841 - ---------- ---------- ---------- ---------- ---------- Net interest income 59,696 1,089 - 9,138 69,923 Provision for loan losses 1,143 20 - (2) 1,161 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 58,553 1,069 - 9,140 68,762 Noninterest income 19,973 5,179 5,201 622 30,975 Noninterest expense 40,267 4,603 3,718 8,334 56,922 ---------- ---------- ---------- ---------- ---------- Income before income taxes 38,259 1,645 1,483 1,428 42,815 Income taxes 13,174 597 576 381 14,728 ---------- ---------- ---------- ---------- ---------- Segment net income $ 25,085 $ 1,048 $ 907 $ 1,047 $ 28,087 ========== ========== ========== ========== ========== Selected Financial Information Average assets $5,861,478 $ 100,582 $ 28,262 $2,298,878 $8,289,200 Depreciation and amortization/impairment $ 8,282 $ 132 $ 39 $ 989 $ 9,442 For the three months ended September 30, 2003 - -------------------------- Net interest income from external customers $ 55,787 $ 1,149 $ - $ 6,895 $ 63,831 Internal funding 7,473 234 - (7,707) - ---------- ---------- ---------- ---------- ---------- Net interest income 63,260 1,383 - (812) 63,831 Provision for loan losses 1,709 61 - 1 1,771 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 61,551 1,322 - (813) 62,060 Noninterest income 28,725 5,222 6,922 (1) 40,868 Noninterest expense 43,238 4,825 4,033 1,585 53,681 ---------- ---------- ---------- ---------- ---------- Income before income taxes 47,038 1,719 2,889 (2,399) 49,247 Income taxes 16,364 617 1,159 (1,311) 16,829 ---------- ---------- ---------- ---------- ---------- Segment net income $ 30,674 $ 1,102 $ 1,730 $ (1,088) $ 32,418 ========== ========== ========== ========== ========== Selected Financial Information Average assets $5,333,992 $ 94,251 $ 28,712 $2,042,515 $7,499,470 Depreciation and amortization/impairment $ 527 $ 100 $ 31 $ 1,049 $ 1,707 </TABLE>
Trustmark Corporation Segment Information ($ in thousands) <TABLE> <CAPTION> General Banking Wealth Mgt Insurance Admin Division Division Division Division Total ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> For the nine months ended September 30, 2004 - ------------------------- Net interest income from external customers $ 174,067 $ 3,377 $ - $ 30,386 $ 207,830 Internal funding 82 (260) - 178 - ---------- ---------- ---------- ---------- ---------- Net interest income 174,149 3,117 - 30,564 207,830 Provision for loan losses 4,287 (7) - (364) 3,916 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 169,862 3,124 - 30,928 203,914 Noninterest income 66,934 15,329 12,703 281 95,247 Noninterest expense 120,512 13,472 8,844 22,230 165,058 ---------- ---------- ---------- ---------- ---------- Income before income taxes 116,284 4,981 3,859 8,979 134,103 Income taxes 40,249 1,827 1,449 2,717 46,242 ---------- ---------- ---------- ---------- ---------- Segment net income $ 76,035 $ 3,154 $ 2,410 $ 6,262 $ 87,861 ========== ========== ========== ========== ========== Selected Financial Information Average assets $5,708,616 $ 98,814 $ 19,799 $2,326,942 $8,154,171 Depreciation and amortization/impairment $ 15,279 $ 359 $ 107 $ 2,888 $ 18,633 For the nine months ended September 30, 2003 - ------------------------- Net interest income from external customers $ 162,742 $ 3,587 $ - $ 34,888 $ 201,217 Internal funding 19,003 212 - (19,215) - ---------- ---------- ---------- ---------- ---------- Net interest income 181,745 3,799 - 15,673 201,217 Provision for loan losses 7,011 39 - 370 7,420 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 174,734 3,760 - 15,303 193,797 Noninterest income 63,409 14,905 13,992 10,792 103,098 Noninterest expense 128,890 13,551 8,798 11,076 162,315 ---------- ---------- ---------- ---------- ---------- Income before income taxes 109,253 5,114 5,194 15,019 134,580 Income taxes 38,123 1,864 2,130 4,397 46,514 ---------- ---------- ---------- ---------- ---------- Segment net income $ 71,130 $ 3,250 $ 3,064 $ 10,622 $ 88,066 ========== ========== ========== ========== ========== Selected Financial Information Average assets $5,182,819 $ 93,180 $ 19,623 $2,017,808 $7,313,430 Depreciation and amortization/impairment $ 24,177 $ 310 $ 67 $ 3,478 $ 28,032 </TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following provides a narrative discussion and analysis of Trustmark Corporation's (Trustmark) financial condition and results of operations. This discussion should be read in conjunction with the consolidated financial statements and the supplemental financial data included elsewhere in this report. Forward-Looking Statements Certain statements contained in Management's Discussion and Analysis are not statements of historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements relate to anticipated future operating and financial performance measures, including net interest margin, credit quality, business initiatives, growth opportunities and growth rates, among other things. Words such as "expects," "anticipates," "believes," "estimates" and other similar expressions are intended to identify these forward-looking statements. 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. These risks could cause actual results to differ materially from current expectations of Management and include the following: o The level of nonperforming assets, charge-offs and provision expense can be affected by local, state and national economic and market conditions as well as Management's judgments regarding collectability of loans. o Material changes in market interest rates can materially affect many aspects of Trustmark's financial condition and results of operations. Trustmark is exposed to the potential of losses arising from adverse changes in market interest rates and prices which can adversely impact the value of financial products, including securities, loans, deposits, debt and derivative financial instruments. Factors that may affect the market interest rates include local, regional and national economic conditions; utilization and effectiveness of market interest rate contracts; and the availability of wholesale and retail funding sources to Trustmark. Many of these factors are outside Trustmark's control. o Increases in prepayment speeds of mortgage loans resulting from a historically low interest rate environment would have an impact on the fair value of the mortgage servicing portfolio. In addition, premium amortization on mortgage related securities included in Trustmark's securities portfolio would also be accelerated as prepayment of the mortgage loans securing these securities occur. The combination of these events could materially affect Trustmark's results of operations. o The costs and effects of litigation and of unexpected or adverse outcomes in such litigation can materially affect Trustmark's results of operations. o Competition in loan and deposit pricing, as well as the entry of new competitors into our markets through de novo expansion and acquisitions, among other means, could have an effect on Trustmark's operations in our existing markets. o Trustmark is subject to regulation by federal banking agencies and authorities and the Securities and Exchange Commission. Changes in existing regulations or the adoption of new regulations could make it more costly for Trustmark to do business or could force changes in the manner Trustmark does business, which could have an impact on Trustmark's financial condition or results of operations. 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. These statements are representative only as of the date hereof, and Trustmark does not assume any obligation to update these forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements. Overview Trustmark is an integrated provider of banking, wealth management and insurance solutions with over 145 branches and 185 ATMs in Mississippi, Florida, Tennessee and Texas. Trustmark National Bank (TNB), Trustmark's wholly-owned subsidiary, accounts for substantially all of the assets and revenues of Trustmark. In addition to banking activities, TNB provides investment and insurance products and services to its customers through three wholly-owned subsidiaries, Trustmark Securities, Inc., Trustmark Investment Advisors, Inc. and The Bottrell Insurance Agency, Inc. Trustmark also engages in banking activities through its wholly-owned subsidiary, Somerville Bank & Trust Company (Somerville), which serves the Fayette County, Tennessee market.
Basic earnings per share were $0.49 for the third quarter of 2004, which resulted from net income of $28.1 million. Included in the results for the third quarter of 2004 is a non-cash after-tax charge of $1.9 million, or $0.033 per share, for impairment of the Company's home mortgage servicing portfolio related to declines in long-term interest rates during the quarter. In the third quarter of 2003, basic earnings per share were $0.55 and included a reversal of previously recorded mortgage servicing impairment charges, which increased the quarter's after-tax net income by $3.1 million, or $0.052 per share. Net income for the nine months ended September 30, 2004, totaled $87.9 million, compared with $88.1 million for the nine months ended September 30, 2003. Basic earnings per share were $1.51 for the first nine months of 2004, an increase of 1.3% when compared with $1.49 for the same period in 2003. Diluted earnings per share for the first nine months of 2004 were $1.51, an increase of 2.0% compared with $1.48 for the first nine months of 2003. Management utilizes certain financial ratios to gauge Trustmark's performance. Trustmark achieved a return on average assets of 1.35% and a return on average equity of 15.26% for the three months ended September 30, 2004. These compared with ratios of 1.71% for return on average assets and 19.03% for return on average equity for the three months ended September 30, 2003. For the nine months ended September 30, 2004, Trustmark achieved a return on average assets of 1.44% and a return on average equity of 16.34%. These compare to a return on average assets of 1.61% and a return on average equity of 17.58% for the same period in 2003. Critical Accounting Policies and Estimates Trustmark's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of estimates and assumptions that affect the amounts reported in those consolidated financial statements. Critical accounting policies and estimates are defined as policies that are important to the portrayal of Trustmark's financial condition and results of operations and that require Management's most difficult, subjective or complex judgments. Actual financial results could differ significantly if different judgments are applied to these policies and estimates. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in Trustmark's 2003 Annual Report on Form 10-K, filed on March 10, 2004, in the Notes to the Consolidated Financial Statements. Because of recent developments in mortgage servicing rights, additional information is shown below. Mortgage Servicing Rights Impairment for mortgage servicing rights occurs when the estimated fair value falls below the underlying carrying value. Fair value is determined utilizing specific risk characteristics of the mortgage loan, current interest rates and current prepayment speeds. During the second quarter of 2004, Trustmark reclassified $6.6 million of mortgage servicing right impairment from temporary to other-than-temporary which reduced the valuation allowance for impairment and the gross mortgage servicing rights balance with no effect to the net mortgage servicing rights asset. Impairment is considered to be other-than-temporary when Trustmark determines that the carrying value is expected to exceed the fair value for an extended period of time. Business Combinations On November 2, 2004, Trustmark announced the signing of an agreement in which Fisher-Brown, Inc. would become a wholly owned subsidiary of Trustmark National Bank. Founded in 1911, Fisher-Brown is the leading general lines insurance agency in Northwest Florida, providing a broad spectrum of risk management products to businesses and individuals in Northwest Florida. With annual revenues of $16 million, Fisher-Brown is headquartered in Pensacola, Florida and has offices in Milton, Mary Esther, Destin and Panama City, Florida. The transaction, which is subject to due diligence, is expected to close in the fourth quarter of 2004. During March 2004, Trustmark completed its entry into the dynamic Houston, Texas, market with the purchase of five branches of Allied Houston Bank. These offices, with loans of $145.9 million and deposits and other liabilities of $161.7 million, are located in one of Houston's most attractive areas. In August 2003, Trustmark completed its expansion into Florida's vibrant Emerald Coast market with the purchase of seven branches of The Banc Corporation. The Emerald Coast branches, with $224.3 million in loans and $209.2 million in deposits and other liabilities, are located in thriving areas and well positioned for additional growth. Strategic acquisitions, which enhance internal growth, will continue to be an important component of Trustmark's strategic plan. Trustmark's financial statements include the results of operations for the above purchase business combinations from the respective merger dates. The pro forma impact of these acquisitions on Trustmark's results of operations is immaterial. Please see the notes to the consolidated financial statements for further details concerning these acquisitions.
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 Table on pages 18 and 19 shows the average balances for all assets and liabilities of Trustmark and the interest income or expense associated with earning assets and interest-bearing liabilities. The yields and rates have been computed based upon interest income and expense adjusted to a fully taxable equivalent (FTE) basis using a 35% federal marginal tax rate for all periods shown. Nonaccruing loans have been included in the average loan balances and interest collected prior to these loans having been placed on nonaccrual has been included in interest income. Loan fees included in interest associated with the average loan balances are immaterial. Yield/Rate Analysis Table ($ in thousands) <TABLE> <CAPTION> For the Three Months Ended September 30, --------------------------------------------------------------- 2004 2003 ------------------------------ ------------------------------ 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 $ 30,574 $ 120 1.56% $ 20,535 $ 60 1.16% Securities - taxable 1,967,154 16,162 3.27% 1,757,429 12,065 2.72% Securities - nontaxable 156,955 2,961 7.51% 154,781 3,005 7.70% Loans, including loans held for sale 5,386,084 75,711 5.59% 4,933,252 72,049 5.79% ---------- -------- ---------- -------- Total interest-earning assets 7,540,767 94,954 5.01% 6,865,997 87,179 5.04% Cash and due from banks 334,298 282,239 Other assets 488,363 426,066 Allowance for loan losses (74,228) (74,832) ---------- ---------- Total Assets $8,289,200 $7,499,470 ========== ========== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing deposits $4,006,694 13,547 1.35% $3,645,418 14,167 1.54% Federal funds purchased and securities sold under repurchase agreements 966,420 3,243 1.33% 929,774 2,269 0.97% Borrowings 1,241,519 6,179 1.98% 918,984 4,918 2.12% ---------- -------- ---------- -------- Total interest-bearing liabilities 6,214,633 22,969 1.47% 5,494,176 21,354 1.54% -------- -------- Noninterest-bearing demand deposits 1,262,756 1,260,135 Other liabilities 79,427 69,231 Shareholders' equity 732,384 675,928 ---------- ---------- Total Liabilities and Shareholders' Equity $8,289,200 $7,499,470 ========== ========== Net Interest Margin 71,985 3.80% 65,825 3.80% Less tax equivalent adjustment 2,062 1,994 -------- -------- Net Interest Margin per Consolidated Statements of Income $ 69,923 $ 63,831 ======== ======== </TABLE>
Net interest income-FTE for the three-month and nine-month periods of 2004 increased $6.2 million, or 9.4%, and $6.7 million, or 3.2%, respectively, when compared to the same periods of 2003. Excluding the business combinations with Emerald Coast and Allied Houston, net interest income - FTE increased $1.2 million, or 1.9% for the three months ended September 30, 2004, and decreased $6.5 million, or 3.1%, for the nine-month period ended September 30, 2004. Yield/Rate Analysis Table ($ in thousands) <TABLE> <CAPTION> For the Nine Months Ended September 30, --------------------------------------------------------------- 2004 2003 ------------------------------ ------------------------------ 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 $ 24,005 $ 226 1.26% $ 27,063 $ 236 1.17% Securities - taxable 1,982,676 47,183 3.18% 1,728,241 50,610 3.92% Securities - nontaxable 158,912 9,058 7.61% 157,416 9,282 7.88% Loans, including loans held for sale 5,246,443 221,082 5.63% 4,765,364 216,009 6.06% ---------- -------- ---------- -------- Total interest-earning assets 7,412,036 277,549 5.00% 6,678,084 276,137 5.53% Cash and due from banks 336,210 296,854 Other assets 480,195 413,530 Allowance for loan losses (74,270) (75,038) ---------- ---------- Total Assets $8,154,171 $7,313,430 ========== ========== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing deposits $4,036,538 40,259 1.33% $3,617,219 45,882 1.70% Federal funds purchased and securities sold under repurchase agreements 917,772 7,503 1.09% 965,417 8,096 1.12% Borrowings 1,150,630 15,663 1.82% 788,852 14,681 2.49% ---------- -------- ---------- -------- Total interest-bearing liabilities 6,104,940 63,425 1.39% 5,371,488 68,659 1.71% -------- -------- Noninterest-bearing demand deposits 1,267,936 1,206,457 Other liabilities 63,134 65,587 Shareholders' equity 718,161 669,898 ---------- ---------- Total Liabilities and Shareholders' Equity $8,154,171 $7,313,430 ========== ========== Net Interest Margin 214,124 3.86% 207,478 4.15% Less tax equivalent adjustment 6,294 6,261 -------- -------- Net Interest Margin per Consolidated Statements of Income $207,830 $201,217 ======== ======== </TABLE>
Interest income-FTE for the third quarter of 2004 increased $7.8 million, or 8.9%, when compared to the third quarter of 2003 and $3.1 million, or 3.4%, when compared to the second quarter of 2004. Interest and fees on loans were positively impacted by increases in short-term rates based on changes made by the Federal Reserve Bank during the third quarter while interest earned on the securities portfolio benefited from the slow-down in mortgage refinancing in response to higher long-term interest rates during the second quarter of 2004. In reaction, prepayments of mortgage-backed securities have slowed and reduced the acceleration of premium amortization on these investments that had negatively affected interest income during the second quarter of 2004. In addition, interest income-FTE has been positively impacted by an increase in average earning assets of $674.8 million, or 9.8%, when the third quarter of 2004 is compared with the third quarter of 2003. Without the Emerald Coast and Allied Houston branch purchases, the increase in average interest-earning assets for the third quarter of 2004 is $249.4 million, or 3.6%. When compared with the second quarter of 2004, average-earning assets for the third quarter of 2004 increased $47.9 million, or 0.6%. In this comparison, loan growth increased $97.8 million, or 1.8%, while securities decreased $56.3 million, or 2.6%. During the third quarter, Trustmark utilized the liquidity provided by maturing investments to reduce its reliance on wholesale funding which helped mitigate the exposure to the increase in short-term rates. As a result of these actions, the yield on earning assets for the third quarter of 2004 was lower than that experienced during the same period of 2003 (5.01% versus 5.04%), however, this yield increased by 8 basis points (from 4.93%) when compared to the second quarter of 2004. Increases in short-term rates also had an impact on interest expense during the third quarter of 2004. Interest expense increased $1.6 million, or 7.6%, when compared to the third quarter of 2003 and $2.8 million, or 13.7%, when compared to the second quarter of 2004. A greater reliance on wholesale funding, including federal funds purchased, securities sold under repurchase agreements and Federal Home Loan Bank (FHLB) advances, during the third quarter of 2004 was necessary in order to compensate for reduced funding from deposits. This is illustrated by the increase in wholesale funding products of $129.4 million when the third quarter of 2004 is compared with the second quarter of 2004, which offset a decline of $101.9 million in interest-bearing deposits during the same time period. While the cost of interest-bearing liabilities for the third quarter of 2004 was lower than that experienced during the same period of 2003 (1.47% versus 1.54%), it had increased by 16 basis points (from 1.31%) when compared to the second quarter of 2004. The combination of these factors resulted in no change in the NIM for the third quarter of 2004 (3.80%) when compared to the same quarter of 2003 and a decrease of 4 basis points (from 3.84%) when compared to the second quarter of 2004. Provision for Loan Losses Trustmark's provision for loan losses totaled $1.2 million and $3.9 million, respectively, for the three and nine months ended September 30, 2004, compared with $1.8 million and $7.4 million, respectively, for the same periods in 2003. During the nine months ended September 30, 2004, the provision for loan losses equaled 97.6% of net charge-offs compared with 96.3% in the prior year period. As a percentage of average loans, the provision was 0.10% for the first nine months of 2004 compared with 0.21% for the first nine months of 2003. 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 expected economic conditions. Based on recent improvements in economic conditions in both national and local markets, increased diversification of the loan portfolio from a geographic and product standpoint and continued improvement in both underwriting and oversight of loan processes, Management feels that the current provision for loan losses for the three and nine month periods ending September 30, 2004 is sufficient to maintain the allowance for loan losses at an appropriate reserve level for present and potential risk exposure. Noninterest Income Noninterest income (NII) consists of revenues generated from a broad range of banking and financial services. NII totaled $95.2 million in the first nine months of 2004 compared with $103.1 million in the first nine months of 2003. NII represented 26.0% of total revenues in the first nine months of 2004 versus 27.6% in the first nine months of 2003. The comparative components of noninterest income for the nine-month periods ended September 30, 2004 and 2003 are shown in the accompanying table. Noninterest income contributed by the Emerald Coast and Allied Houston branch purchases during 2004 is considered immaterial.
Noninterest Income ($ in thousands) Nine Months Ended September 30, ------------------ 2004 2003 $ Change % Change -------- -------- -------- -------- Service charges on deposit accounts $ 42,295 $ 40,054 $ 2,241 5.6% Wealth management 15,054 14,616 438 3.0% Retail banking - other 13,495 13,826 (331) -2.4% Insurance commissions 12,728 14,050 (1,322) -9.4% Mortgage banking 6,267 3,599 2,668 74.1% Securities gains 21 12,226 (12,205) -99.8% Other income 5,387 4,727 660 14.0% -------- -------- -------- -------- Total Noninterest Income $ 95,247 $103,098 $ (7,851) -7.6% ======== ======== ======== ======== The single largest component of noninterest income continues to be service charges for deposit products and services, which increased 5.6% in the first nine months of 2004 over the same period in 2003. The growth in services charges for 2004 is primarily attributed to an increase in fees charged for NSF and overdrafts combined with increased transaction volumes when compared with the same time period in 2003. Wealth management income was $15.1 million for the first nine months of 2004, an increase of $438 thousand when compared with the same period of 2003. Wealth management consists of all income related to trust and advisory services, including income generated from Trustmark Securities, Inc. and Trustmark Investment Advisors, Inc. Recent improvements in the performance of the capital markets positively impacted growth in this area. Increases in fees related to trust and investment services were offset by a decrease in income derived from annuities during the period. In addition, further integration of the Wealth Management Division into Trustmark's Florida and Tennessee markets has begun to impact income as well. Trustmark's assets under administration decreased by approximately $800 million during the third quarter of 2004 as a result of the finalization of a corporate bankruptcy, which eliminated promissory notes held in a custodial relationship. Wealth management fees related to this relationship were immaterial. At September 30, 2004, Trustmark held assets under administration of $6.1 billion and remained one of the largest providers of asset management services in Mississippi. Retail banking - other income totaled $13.5 million in the first nine months of 2004, a decrease of $331 thousand, or 2.4%, when compared with the same period in 2003. Retail banking - other income consists primarily of ATM fees, fees from the sale of checks, bank card fees and safe deposit box fees. The primary factor in the decrease is bank card fees, which has been negatively impacted by changes in the pricing of interchange fees. Mortgage banking income was $6.3 million for the nine months ended September 30, 2004, compared to $3.6 million for the same period of 2003. As shown in the accompanying table, mortgage banking income primarily includes mortgage servicing fees, gain on sale of mortgage loans, amortization and impairment of mortgage servicing rights, guaranty fees and the valuation adjustment on fair value hedges used in conjunction with the mortgage servicing portfolio. For the nine months ended September 30, 2004, the primary factor for the increase in mortgage banking income is a reduction in amortization and impairment of mortgage servicing rights. During the first nine months of 2004, amortization expense for mortgage servicing rights was $9.1 million. For the same period in 2003, amortization expense for mortgage servicing rights was $11.6 million. During the first nine months of 2004, Trustmark recognized a $1.5 million recovery of impairment charges. During the same period of 2003, impairment charges of $5.0 million were recognized. While impairment charges increased in the third quarter of 2004, rising interest rates in the second quarter of 2004 stabilized impairment and reduced the impairment of mortgage servicing rights for the nine months ended September 30, 2004. Future changes in amortization and impairment of mortgage servicing rights will continue to be closely tied to fluctuations in long-term mortgage rates. Offsetting improvements in amortization and impairment of mortgage servicing rights were a reduction in gains on sales of mortgage loans, which totaled $3.9 million during the first nine months of 2004 compared to $12.6 million for the same period of 2003, a decrease of $8.7 million. The overall total of loan sales from secondary marketing activities declined from $1.202 billion in the first nine months of 2003 to $636.0 million in the first nine months of 2004 as a sporadic rate environment affected both the pricing of loans as well as the consumer demand.
The following table illustrates the components of mortgage banking included in noninterest income in the accompanying income statements: Mortgage Banking Income ($ in thousands) Nine Months Ended September 30, ----------------- 2004 2003 ------- ------- Mortgage servicing income $12,612 $12,652 Mortgage guaranty fees (3,302) (3,454) ------- ------- Mortgage servicing, net 9,310 9,198 Amortization of mortgage servicing rights (9,076) (11,621) Recovery (impairment) of mortgage servicing rights, net 1,516 (4,999) Gain on sales of loans 3,926 12,602 Other, net 591 (1,581) ------- ------- Mortgage banking $ 6,267 $ 3,599 ======= ======= Securities gains totaled $21 thousand during the first nine months of 2004 compared with $12.2 million during the first nine months of 2003. During the first nine months of 2003, significant price changes in certain available for sale (AFS) portfolio securities enabled Trustmark to sell securities with a total fair value of $290.1 million, which provided the opportunity to restructure a portion of the portfolio to reduce price volatility in an extremely low interest rate cycle. Management considers the investment portfolio as an integral tool in the management of interest rate risk. Noninterest Expense Trustmark's noninterest expense increased $2.7 million, or 1.7%, in the first nine months of 2004 to $165.1 million, compared with $162.3 million in the first nine months of 2003. Excluding the Emerald Coast and Allied Houston branch purchases, noninterest expense for the nine months ended September 30, 2004 would total $159.5 million. Noninterest expenses for the first nine months of 2003 include $6.3 million associated with Trustmark's voluntary early retirement program. If this were eliminated, noninterest expenses for the first nine months of 2003 would total $156.0 million. Eliminating these adjustments, noninterest expense for the first nine months of 2004 increased $3.5 million, or 2.2% when compared to the same time period in 2003. Management continues to consider expense control a major component of improving shareholder value. The comparative components of noninterest expense for the nine months ended September 30, 2004 and 2003 are shown in the accompanying table. Noninterest Expense ($ in thousands) Nine Months Ended September 30, ------------------ 2004 2003 $ Change % Change -------- -------- -------- -------- Salaries and employee benefits $ 95,475 $ 96,855 $ (1,380) -1.4% Services and fees 26,415 23,696 2,719 11.5% Equipment expense 11,122 11,104 18 0.2% Net occupancy - premises 10,773 9,541 1,232 12.9% Other expense 21,273 21,119 154 0.7% -------- -------- -------- Total Noninterest Expense $165,058 $162,315 $ 2,743 1.7% ======== ======== ======== Salaries and employee benefits, the largest category of noninterest expense, decreased $1.4 million, or 1.4%, in the first nine months of 2004 to $95.5 million, compared with $96.9 million in the same time period in 2003. Excluding the Emerald Coast and Allied Houston branch purchases, salaries and employee benefits for the nine months ended September 30, 2004 would total $92.0 million. Salaries and employee benefits for the first nine months of 2003 include $6.3 million associated with Trustmark's voluntary early retirement program, which was accepted by 116 employees, or 4.75% of the workforce. If this were eliminated, salaries and employee benefits for the first three quarters of 2003 would total $90.6 million. Eliminating these adjustments, salaries and employee benefits for the first three quarters of 2004 grew $1.4 million, or 1.5% when compared to the same time period in 2003. Trustmark's full-time equivalent employees were 2,444 and 2,365 at September 30, 2004 and 2003, respectively.
Services and fees for the first nine months of 2004 totaled $26.4 million compared to $23.7 million for the first nine months of 2003. The increase is attributed to professional and audit-related fees resulting from the implementation of requirements under the Sarbanes-Oxley Act of 2002 as well as growth in consulting and communication expense. Net occupancy-premises expense increased $1.2 million, or 12.9%, from $9.5 million in the first nine months of 2003 to $10.8 million in the first nine months of 2004. The increase is attributable to occupancy costs associated with facilities acquired in the Emerald Coast and Allied Houston business combinations. Business combinations accounted for approximately 58% of the increase. Income Taxes For the nine months ended September 30, 2004, Trustmark's combined effective tax rate was 34.5%, compared with 34.6% for the first nine months of 2003. The decrease in Trustmark's effective tax rate is due to immaterial changes in various permanent items as a percentage of pretax income. Liquidity The liquidity position of Trustmark is monitored on a daily basis by Trustmark's Treasury Department. 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 anticipated balance sheet or cash flow changes. Also, on a monthly basis, Management compares Trustmark's liquidity position to established corporate policies. 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. With mortgage rates at historical lows, increased prepayments on mortgage loans have also provided an additional source of liquidity for Trustmark. Liquidity on the liability side of the balance sheet is generated primarily through growth in core deposits. To provide additional liquidity, Trustmark utilizes economical short-term wholesale funding arrangements for federal funds purchased and securities sold under repurchase agreements in both regional and national markets. At September 30, 2004, these arrangements gave Trustmark approximately $1.114 billion in borrowing capacity, which approximated the level at the end of 2003. In addition, Trustmark maintains a borrowing relationship with the FHLB, which provided $500.0 million in short-term advances and $355.9 million in long-term advances at September 30, 2004, compared with $300.0 million in short-term advances and $531.0 million in long-term advances at December 31, 2003. These advances are collateralized by a blanket lien on Trustmark's single-family, multi-family, home equity and commercial mortgage loans. Under the existing borrowing agreement, Trustmark has $752.5 million available in unused FHLB advances. Another borrowing source is the Federal Reserve Discount Window (Discount Window). At September 30, 2004, Trustmark had approximately $591.4 million available in borrowing capacity at the Discount Window from pledges of auto loans and securities, compared with $539.9 million available at December 31, 2003. In June 2002, Trustmark entered into a two-year line of credit arrangement enabling borrowings up to $50 million. When this line matured during the third quarter of 2004, Trustmark entered into a revolving credit agreement with the same lender enabling borrowings up to $50 million, subject to certain financial covenants. This agreement matures on September 30, 2006. As of September 30, 2004, Trustmark had not drawn upon this line of credit. During 2003, Trustmark filed a registration statement on Form S-3 with the Securities and Exchange Commission (SEC) utilizing a "shelf" registration process. Under this shelf process, Trustmark may offer from time to time any combination of securities described in the prospectus in one or more offerings up to a total amount of $200 million. The securities described in the prospectus include common and preferred stock, depositary shares, debt securities, junior subordinated debt securities and trust preferred securities. Net proceeds from the sale of the offered securities may be used to redeem or repurchase outstanding securities, repay outstanding debt, finance acquisitions of companies and other assets and provide working capital. During 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 with no par value. 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. As of September 30, 2004, no such shares have been issued.
Capital Resources At September 30, 2004, Trustmark's shareholders' equity was $734.2 million, an increase of $44.7 million, or 6.5%, from its level at December 31, 2003. This increase is primarily related to net income for the first nine months of 2004, which totaled $87.9 million and additional accumulated other comprehensive income of $1.1 million, offset by dividends of $33.1 million and common stock repurchases of $13.5 million. Common Stock Repurchase Program Trustmark currently has remaining authorization for the repurchase of up to 3.0 million shares of its common stock subject to market conditions and management discretion. Collectively, the capital management plans adopted by Trustmark since 1998 have authorized the repurchase of 21.5 million shares of common stock. Pursuant to these plans, Trustmark has repurchased approximately 18.5 million shares for $398.6 million, including 4,500 shares during the third quarter of 2004. See further discussion of the Common Stock Repurchase Program on page 31 in Part II, Item 2, "Changes in Securities and Use of Proceeds". Dividends Another strategy designed to enhance shareholder value has been to maintain a consistent dividend payout ratio, which is dividends per share divided by earnings per share. Dividends for the first nine months of 2004 were $ 0.57 per share, an increase of 15.2% when compared with dividends of $ 0.495 per share in the same period in 2003. Trustmark's dividend payout ratio was 37.75% for the first nine months of 2004, compared with 33.22% for the same period in 2003. During October 2004, the Board of Directors of Trustmark announced a 5.3% increase in its regular quarterly dividend to $0.20 per share from $0.19 per share. The Board declared the dividend payable on December 15 to shareholders of record as of December 1, 2004. This action raises the indicated annual dividend rate to $0.80 per share from $0.76 per share. Regulatory Capital Trustmark and TNB are subject to minimum capital requirements, which are administered by various federal regulatory agencies. These capital requirements, as defined by federal guidelines, involve quantitative and qualitative measures of assets, liabilities and certain off-balance sheet instruments. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the financial statements of both Trustmark and TNB. Trustmark aims not only to exceed the minimum capital standards, but also the well-capitalized guidelines for regulatory capital. Management believes, as of September 30, 2004, that Trustmark and TNB have met or exceeded all of the minimum capital standards for the parent company and its primary banking subsidiary as established by regulatory requirements. At September 30, 2004, the most recent notification from the Office of the Comptroller of the Currency (OCC), TNB's primary federal banking regulator, categorized TNB as well capitalized. To be categorized in this manner, TNB must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios (defined in applicable regulations) as set forth in the accompanying table. There are no significant conditions or events that have occurred since the OCC's notification that Management believes have affected TNB's present classification. Regulatory Capital Table ($ in thousands) <TABLE> <CAPTION> September 30, 2004 --------------------------------------------------------- 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 $669,178 12.12% $441,805 8.00% - - Trustmark National Bank 632,807 11.67% 433,699 8.00% $542,124 10.00% Tier 1 Capital (to Risk Weighted Assets) Trustmark Corporation $600,082 10.87% $220,903 4.00% - - Trustmark National Bank 564,994 10.42% 216,850 4.00% $325,274 6.00% Tier 1 Capital (to Average Assets) Trustmark Corporation $600,082 7.36% $244,579 3.00% - - Trustmark National Bank 564,994 7.06% 239,936 3.00% $399,893 5.00% </TABLE>
Earning Assets Earning assets serve as the primary revenue streams for Trustmark and are comprised of securities, loans, federal funds sold and securities purchased under resale agreements. At September 30, 2004, earning assets were $7.468 billion, or 91.6% of total assets, compared with $7.183 billion, or 90.8% of total assets at December 31, 2003, an increase of $285.2 million, or 4.0%. Excluding the Allied Houston branch purchase, earning assets totaled $7.350 billion, an increase of $167.6 million when compared with December 31, 2003. Securities The securities portfolio consists primarily of debt securities, which are utilized to provide Trustmark with a quality investment alternative and 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. When evaluating the performance of the securities portfolio, Management considers not only interest income but also the flexibility and liquidity provided by changes in fair value. At September 30, 2004, Trustmark's securities portfolio totaled $2.063 billion, compared to $2.112 billion at December 31, 2003, a decrease of $49.1 million, or 2.3%. The securities portfolio is a powerful risk management tool that enables Management to control both the invested balance and the duration of securities. The estimated duration of the portfolio measured 2.04 years on September 30, 2003 primarily due to expected high cash flow levels during an environment of heavy prepayments on mortgage related securities. Since then, estimated portfolio duration was measured at 2.30 years at December 31, 2003 and September 30, 2004. Management intends to keep the portfolio near these historically low duration levels while the interest rate cycle is in a stage of lower yields. AFS securities are carried at their estimated fair value with unrealized gains or losses recognized, net of taxes, in accumulated other comprehensive loss, a separate component of shareholders' equity. At September 30, 2004, AFS securities totaled $1.916 billion, which represented 92.9% of the securities portfolio, compared to $ 1.934 billion, or 91.6%, at December 31, 2003. At September 30, 2004, unrealized losses on AFS securities of $3.9 million, net of $1.5 million of deferred income taxes, were included in accumulated other comprehensive loss, compared with losses of $ 5.6 million, net of $2.1 million in deferred income taxes, at December 31, 2003. At September 30, 2004, AFS securities consisted of U.S. Treasury and Agency securities, obligations of states and political subdivisions, mortgage related securities, corporate securities and other securities, primarily Federal Reserve Bank and FHLB stock. Held to maturity (HTM) securities are carried at amortized cost and represent those securities that Trustmark both intends and has the ability to hold to maturity. At September 30, 2004, HTM securities totaled $147.2 million and represented 7.1% of the total portfolio, compared with $178.4 million, or 8.4%, at the end of 2003. This decline in HTM securities as a percentage of the securities portfolio should continue as Management utilizes the increased flexibility in AFS securities to manage its investment strategy. Management continues to focus on asset quality as one of the strategic goals of the securities portfolio, which is evidenced by the investment of over 89% of the portfolio in U.S. Treasury, U.S. Government agencies obligations and other AAA rated securities. Loans and Allowance for Loan Losses Loans, including loans held for sale, represented 72.2% of earning assets at September 30, 2004, compared with 70.1% at year-end 2003. At September 30, 2004, loans totaled $5.388 billion, a 7.1% increase from its level of $5.033 billion at December 31, 2003. Adjusted loan growth was $277.8 million, or 5.5%, for the first nine months of 2004, if both the Allied Houston branch purchase and the sale of $39.6 million in student loans are excluded. Real estate lending, primarily construction and land development as well as loans secured by 1-4 family properties, continued to be positively impacted by low interest rates. In addition, commercial and industrial loans have also increased when compared to December 31, 2003, as a result of improvement in economic conditions as evidenced by growth in Corporate Lending as well as loans originating in the Trustmark's Emerald Coast branches. Trustmark makes loans in the normal course of business to certain directors, including their immediate families and companies in which they are principal owners. Such loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility at the time of the transaction.
Trustmark's lending policies have resulted in consistently sound asset quality. One measure of asset quality in the financial services industry is the level of nonperforming assets. The details of Trustmark's nonperforming assets at September 30, 2004 and December 31, 2003, are shown in the accompanying table. Total nonperforming assets increased $2.1 million, or 6.9%, during the first nine months of 2004. Excluding the Allied Houston branch purchases, nonperforming assets decreased $3.3 million, or 11.2%. The allowance coverage of nonperforming loans remains strong at 274.1% at September 30, 2004, compared with 310.5% at December 31, 2003. Nonperforming Assets ($ in thousands) September 30, December 31, 2004 2003 ------------- ------------ Nonaccrual and restructured loans $ 27,062 $ 23,921 Other real estate (ORE) 4,844 5,929 ------------- ------------ Total nonperforming assets $ 31,906 $ 29,850 ============= ============ Accruing loans past due 90 days or more $ 7,553 $ 2,606 ============= ============ Nonperforming assets/total loans and ORE 0.59% 0.59% ============= ============ At September 30, 2004, the allowance for loan losses was $74.2 million compared with $74.3 million at December 31, 2003. The allowance for loan losses represented 1.38% of total loans outstanding at September 30, 2004, compared to 1.48% at December 31, 2003. This decline in the allowance for loan losses to loans is directly related to the accounting treatment for the acquired loans of Allied Houston Bank. Generally accepted accounting principles provide that the purchase of selected loans be recorded at fair value net of any credit or market discounts; therefore, no specific allowance for loan losses has been recorded for the Allied Houston loans purchased. Loans purchased totaled $145.9 million, which included a $6.4 million discount; consisting of a discount for general credit risk of $7.3 million offset by a market premium of $862 thousand. As of September 30, 2004, Management believes that the allowance for loan losses provides adequate protection in regards to charge-off experience and the current level of nonperforming assets. Net charge-offs were $4.0 million, or 0.10% of average loans, for the first nine months of 2004, compared with $7.7 million, or 0.22% of average loans, for the same period of 2003. This improvement can primarily be attributed to the continued decline in charge-offs recorded during 2004 resulting from the improvement in credit quality experienced during 2003 and 2004. Other Earning Assets Federal funds sold and securities purchased under reverse repurchase agreements were $16.3 million at September 30, 2004, a decrease of $21.4 million when compared with year-end 2003. Trustmark utilizes these products as a short-term investment alternative whenever it has excess liquidity. Deposits and Other Interest-Bearing Liabilities Trustmark's deposit base is its primary source of funding and consists of core deposits from the communities served by Trustmark. Deposits include interest-bearing and noninterest-bearing demand accounts, savings, money market, certificates of deposit, individual retirement accounts and brokered CD's. Total deposits were $5.288 billion at September 30, 2004, compared with $5.089 billion at December 31, 2003, an increase of $198.1 million, or 3.9%. Excluding the Allied Houston branch purchase, deposits increased $62.9 million, or 1.2%, when compared with December 31, 2003. Noninterest bearing deposits have decreased $86.8 million during the first nine months of 2004 due to seasonal run-offs while interest-bearing deposits have increased $284.9 million during the same time period. During 2003, Trustmark began a brokered CD program to provide additional deposit funding. At September 30, 2004, brokered CD's totaled $236.9 million, an increase of $137.9 million when compared to the end of 2003. Additional growth in interest-bearing deposits may be attributed to uncertain financial market conditions, which have lead to more growth in traditional deposit products such as interest-bearing demand deposits. Trustmark will continue to seek deposits by expanding its presence in higher growth markets and evaluating additional wholesale deposit funding sources. Trustmark uses short-term borrowings and long-term FHLB advances to fund growth of earning assets in excess of deposit growth. Short-term borrowings consist of federal funds purchased, securities sold under repurchase agreements, short-term FHLB advances and the treasury tax and loan note option account. Short-term borrowings totaled $1.710 billion at September 30, 2004, an increase of $160.0 million, compared with $1.550 billion at year-end 2003. Long-term FHLB advances totaled $355.9 million at September 30, 2004, a decrease of $175.1 million from December 31, 2003. On a consolidated basis, total borrowings have decreased $15.1 million when compared to December 31, 2003.
Segment Information Internal funding costs for both the General Banking and Administrative divisions saw significant changes when both the three and nine months ended September 30, 2004 are compared with the same periods in 2003. As part of the annual evaluation of the match-funded transfer pricing process used to assess operating segment performance, Management lowered the internal funding rate paid on transactional deposits, primarily Savings, MMDA, NOW and DDA, at the beginning of 2004. This reduction was based on a downward trend in yields and earnings generated from these deposits in recent years. The impact of this change was felt primarily in the General Banking Division where internal funding income was reduced when 2004 is compared with 2003. Additionally, the Treasury Department, included in the Administrative Division, received additional internal funding income resulting from these same changes. Legal Environment Trustmark and its subsidiaries are parties to lawsuits and other claims that arise in the ordinary course of business. Some of the lawsuits assert claims related to the lending, collection, servicing, investment, trust and other business activities; and some of the lawsuits allege substantial claims for damages. The cases are being vigorously contested. In the regular course of business, Management evaluates estimated losses or costs related to litigation, and provision is made for anticipated losses whenever Management believes that such losses are probable and can be reasonably estimated. In recent years, the legal environment in Mississippi has been considered by many to be adverse to business interests in regards to the overall treatment of tort and contract litigation as well as the award of punitive damages. However, tort reform legislation that became effective during 2003 and 2004 may reduce the likelihood of unexpected sizable awards. At the present time, Management believes, based on the advice of legal counsel and Management's evaluation, that the final resolution of pending legal proceedings will not have a material impact on Trustmark's consolidated financial position or results of operations; however, Management is unable to estimate a range of potential loss on these matters because of the nature of the legal environment in states where Trustmark conducts business. Off-Balance Sheet Arrangements Trustmark makes commitments to extend credit and issues standby and commercial letters of credit in the normal course of business in order to fulfill the financing needs of its customers. These loan commitments and letters of credit are off-balance sheet arrangements. Commitments to extend credit are agreements to lend money to customers pursuant to certain specified conditions. Commitments generally have fixed expiration dates or other termination clauses. Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Trustmark applies the same credit policies and standards as it does in the lending process when making these commitments. The collateral obtained is based upon the assessed creditworthiness of the borrower. At September 30, 2004 and 2003, Trustmark had commitments to extend credit of $1.344 billion and $1.131 billion, respectively. Standby and commercial letters of credit are conditional commitments issued by Trustmark to insure the performance of a customer to a third party. When issuing letters of credit, Trustmark uses essentially the same policies regarding credit risk and collateral which are followed in the lending process. At September 30, 2004 and 2003, Trustmark's maximum exposure to credit loss in the event of nonperformance by the other party for letters of credit was $95.5 million and $76.7 million, respectively. These amounts consist primarily of commitments with maturities of less than three years. Trustmark holds collateral to support certain letters of credit when deemed necessary.
Asset/Liability Management Overview Market risk is the risk of loss arising from adverse changes in market prices and rates. Trustmark has risk management policies to monitor and limit exposure to market risk. Trustmark's market risk is comprised primarily of interest rate risk created by core banking activities. Interest rate risk is the risk to net interest income represented by the impact of higher or lower interest rates. Management continually develops and applies cost-effective strategies to manage these risks. The Asset/Liability Committee sets the day-to-day operating guidelines, approves strategies affecting net interest income and coordinates activities within policy limits established by the Board of Directors. A key objective of the asset/liability management program is to quantify, monitor and manage interest rate risk and to assist Management in maintaining stability in the net interest margin under varying interest rate environments. Market/Interest Rate Risk Management The primary purpose in managing interest rate risk is to invest capital effectively and preserve the value created by the core banking business. This is accomplished through the development and implementation of lending, funding, pricing and hedging strategies designed to maximize net interest income performance under varying interest rate environments subject to specific liquidity and interest rate risk guidelines. The primary tool utilized by the Asset/Liability Committee is a third-party modeling system, which is widely accepted in the financial institutions industry. This system provides information used to evaluate exposure to interest rate risk, project earnings and manage balance sheet growth. This modeling system utilizes the following scenarios in order to give Management a method of evaluating Trustmark's interest rate, basis and prepayment risk under different conditions: 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. Based on the results of the simulation models using static balances at September 30, 2004, it is estimated that net interest income may increase 0.29%, in a one-year, shocked, up 200 basis point rate shift scenario, compared to a base case, flat rate scenario for the same time period. This same simulation as of June 30, 2004 yielded a decrease in net interest income of 0.19%. This minor change in forecasted net interest income illustrates Management's strategy to mitigate Trustmark's exposure to cyclical increases in rates by maintaining a neutral position in its interest rate risk position. This projection does not contemplate any additional actions Trustmark could undertake in responses to changes in interest rates. In the event of a 100 basis point decrease in interest rates (utilized in place of a 200 basis point drop scenario due to the historically low interest rate environment), it is estimated net interest income may decrease by 3.08%. Management cannot provide any assurance about the actual effect of changes in interest rates on net interest income. The estimates provided do not include the effects of possible strategic changes in the balances of various assets and liabilities throughout 2004. Management will continue to prudently manage the balance sheet in an effort to control interest rate risk and maintain profitability over the long term.
A static gap analysis is a tool used mainly for interest rate risk measurement, in which the balance sheet amounts as of a certain date are stratified based on repricing frequency. The assets and liabilities repricing in a certain time frame are then compared to determine the gap between assets and liabilities for that period. If assets are greater than liabilities for the specified time period, then the balance sheet is said to be in an asset gap, or asset sensitive, position. Management feels that this method for analyzing interest rate sensitivity does not provide a complete picture of Trustmark's exposure to interest rate changes since it illustrates a point-in-time measurement and, therefore, does not incorporate the effects of future balance sheet trends, repricing behavior of certain deposit products or varying interest rate scenarios. This analysis is a relatively straightforward tool that is helpful in highlighting 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, 2004, reflected a liability gap of $372 million compared with a liability gap of $470 million at May 31, 2004. One-year gap analysis projected at September 30, 2004, reflected a liability gap of $303 million compared with a liability gap of $466 million at May 31, 2004. Liability sensitivity has resulted from Trustmark's increased reliance on wholesale funding during 2004 in response to decreased funding from deposits. This scenario would indicate that Trustmark would benefit in a falling interest rate environment, however, the simulation model indicates repricing sensitivity on various deposit products is different when compared with a static gap analysis. For example, traditional core deposit products typically are slower to react to changes in interest rates when they occur. As part of Trustmark's risk management strategy in the mortgage banking area, various derivative instruments such as interest rate lock commitments and forward sales contracts are utilized. Forward contracts are agreements to purchase or sell securities or other money market instruments at a future specified date at a specified price or yield. Trustmark's obligations under forward contracts consist of commitments to deliver mortgage loans, originated and/or purchased, in the secondary market at a future date. As permitted by Statement of Financial Accounting Standards (SFAS) No. 133, during 2003 Trustmark redesignated these derivative instruments as fair value hedges. In accordance with SFAS No. 133, changes in the values of derivatives designated as fair value hedges are recognized in earnings. In this case, Trustmark recognizes changes in the values of the designated derivatives in earnings simultaneously with changes in the values of the designated hedged loans. To the extent changes in the values of the derivatives are 100% effective in offsetting changes in the values of hedged loans, the fair value adjustments on the derivatives and hedged loans would offset one another. Management anticipates that this change will help mitigate the potential for earnings volatility related to the valuation of these hedging instruments in the future. The market valuation balance for these fair value hedges was negative $502.6 thousand at September 30, 2004. Trustmark continued a risk controlling strategy utilizing caps and floors, which may be further implemented over time. As of September 30, 2004, Trustmark was not utilizing interest rate floors but had interest rate cap contracts with notional amounts totaling $300 million, which mature in 2006. The intent of utilizing these financial instruments is to reduce the risk associated with the effects of significant movements in interest rates. Caps and floors, which are not designated as hedging instruments for accounting purposes, are options linked to a notional principal amount and an underlying indexed interest rate. Exposure to loss on these options will increase or decrease as interest rates fluctuate. At September 30, 2004, the fair value of these contracts was $43 thousand. Another tool used for interest rate risk management is interest rate swaps. Interest rate swaps are derivative contracts under which two parties agree to make interest payments on a notional principal amount. In a generic swap, one party pays a fixed interest rate and receives a floating interest rate while the other party receives a fixed interest rate and pays a floating interest rate. During April 2003, Trustmark initiated four separate interest rate swaps with a total notional principal amount of $100 million. During July 2003, Trustmark added another interest rate swap with a notional principal amount of $25 million. These swaps are designated as fair value hedges. Trustmark initiated these swaps to mitigate the effects of further changes in the fair value of specific noncallable, fixed rate advances from the FHLB by agreeing to pay a floating interest rate tied to LIBOR. Although this strategy exposes Trustmark somewhat to a rising rate environment, Management felt this was more economical in light of the significant prepayment charges associated with these advances. The swap contracts are tied to the maturity of five separate FHLB advances maturing between 2005 and 2006. The market valuation balance for interest rate swaps at September 30, 2004 was negative $676 thousand.
Recent Pronouncements Please see Note 11 of the Notes to Consolidated Financial Statements for more information on recent pronouncements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is included in "Market/Interest Rate Risk Management" (pages 29-30) of "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations." ITEM 4. CONTROLS AND PROCEDURES Disclosure Controls and Procedures For the period ended September 30, 2004, Trustmark evaluated the effectiveness of the design and operation of its disclosure controls and procedures under the supervision and with the participation of its management, including the Chief Executive Officer and the Treasurer (the Principal Financial Officer). Based upon this evaluation, the Chief Executive Officer and the Treasurer concluded that Trustmark's disclosure controls and procedures were effective as of September 30, 2004. Internal Control over Financial Reporting For the period ended September 30, 2004, there have been no changes in Trustmark's internal control over financial reporting that have materially affected or are reasonably likely to materially affect Trustmark's internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS There were no material developments for the quarter ended September 30, 2004, other than those disclosed in the Notes to Consolidated Financial Statements and Management's Discussion and Analysis of this Form 10-Q. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS The following table shows information relating to the repurchase of common shares by Trustmark Corporation during the three months ended September 30, 2004: <TABLE> <CAPTION> Total Number of Maximum Number Shares Purchased of Shares that May Total Number Average as Part of Publicly Yet be Purchased of Shares Price Paid Announced Plans Under the Plans Period Purchased Per Share or Programs or Programs - ------------------------- ------------ ---------- ------------------- ------------------ <S> <C> <C> <C> <C> July 1, 2004 through July 31, 2004 4,500 $ 28.05 4,500 2,995,565 August 1, 2004 through August 31, 2004 - $ - - 2,995,565 September 1, 2004 through September 30, 2004 - $ - - 2,995,565 ------------ ------------------- Total 4,500 4,500 ============ =================== </TABLE> On October 15, 2002, the Board of Directors of Trustmark authorized a plan to repurchase 5% of current outstanding shares, or 3,083,020 shares. The Board of Directors approved an additional plan on July 15, 2003, also allowing for a 5% repurchase of current outstanding shares, or 2,936,571 shares. Both of these plans are subject to market conditions and management discretion and will continue to be implemented through open market purchases or privately negotiated transactions. No expiration date has been given to either of these plans.
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 July 20, 2004, Trustmark filed a report on Form 8-K announcing its financial results for the period ended June 30, 2004. 2. On September 14, 2004, Trustmark filed a report on Form 8-K announcing the resignation of a member of the Board of Directors. 3. On September 16, 2004, Trustmark filed a report on Form 8-K announcing the withdrawal of its application to convert to a state-chartered member bank.
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 9, 2004 DATE: November 9, 2004
EXHIBIT INDEX 31-a Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31-b Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32-a Certification by Chief Executive Officer pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32-b Certification by Chief Financial Officer pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. All other exhibits are omitted, as they are inapplicable or not required by the related instructions.