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 June 30, 2005 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 July 28, 2005. Title Outstanding Common stock, no par value 56,773,614
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Trustmark Corporation and Subsidiaries Consolidated Balance Sheets ($ in thousands) (Unaudited) June 30, December 31, 2005 2004 ------------ ------------ Assets Cash and due from banks (noninterest-bearing) $ 300,585 $ 343,125 Federal funds sold and securities purchased under reverse repurchase agreements 24,025 86,191 Securities available for sale (at fair value) 1,212,669 1,580,270 Securities held to maturity (fair value: $312,090-2005; $145,936-2004) 304,589 136,797 Loans held for sale 144,665 101,222 Loans 5,645,812 5,330,055 Less allowance for loan losses 65,902 64,757 ------------ ------------ Net loans 5,579,910 5,265,298 Premises and equipment 113,628 115,337 Mortgage servicing rights 51,561 52,463 Goodwill 137,412 137,225 Identifiable intangible assets 30,425 32,004 Other assets 204,930 203,025 ------------ ------------ Total Assets $ 8,104,399 $ 8,052,957 ============ ============ Liabilities Deposits: Noninterest-bearing $ 1,249,464 $ 1,354,749 Interest-bearing 4,271,260 4,095,344 ------------ ------------ Total deposits 5,520,724 5,450,093 Federal funds purchased 247,551 134,318 Securities sold under repurchase agreements 479,295 483,228 Short-term borrowings 827,347 980,318 Long-term FHLB advances 205,827 180,894 Other liabilities 79,017 73,710 ------------ ------------ Total Liabilities 7,359,761 7,302,561 Commitments and Contingencies Shareholders' Equity Common stock, no par value: Authorized: 250,000,000 shares Issued and outstanding: 56,751,801 shares - 2005; 57,858,497 shares - 2004 11,824 12,055 Capital surplus 91,619 121,705 Retained earnings 646,782 620,588 Accumulated other comprehensive loss, net of tax (5,587) (3,952) ------------ ------------ Total Shareholders' Equity 744,638 750,396 ------------ ------------ Total Liabilities and Shareholders' Equity $ 8,104,399 $ 8,052,957 ============ ============ See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Income ($ in thousands except per share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ------------------- ------------------- 2005 2004 2005 2004 -------- -------- -------- -------- <S> <C> <C> <C> <C> Interest Income Interest and fees on loans $ 84,589 $ 72,892 $162,623 $143,252 Interest on securities: Taxable 13,993 14,825 29,727 31,021 Tax exempt 1,896 1,967 3,757 3,963 Interest on federal funds sold and securities purchased under reverse repurchase agreements 143 63 416 106 Other interest income 22 9 42 21 -------- -------- -------- -------- Total Interest Income 100,643 89,756 196,565 178,363 Interest Expense Interest on deposits 18,326 13,326 34,694 26,712 Interest on federal funds purchased and securities sold under repurchase agreements 4,995 2,156 8,643 4,260 Other interest expense 9,413 4,726 16,910 9,484 -------- -------- -------- -------- Total Interest Expense 32,734 20,208 60,247 40,456 -------- -------- -------- -------- Net Interest Income 67,909 69,548 136,318 137,907 Provision for loan losses 1,429 1,703 4,225 2,755 -------- -------- -------- -------- Net Interest Income After Provision for Loan Losses 66,480 67,845 132,093 135,152 Noninterest Income Service charges on deposit accounts 13,541 13,959 25,925 27,285 Insurance commissions 8,370 4,346 16,232 7,531 Wealth management 5,414 4,958 10,657 9,974 Retail banking - other 5,284 4,685 10,036 8,817 Mortgage banking, net (3,246) 9,101 605 7,198 Other, net 2,644 1,821 5,097 4,041 Securities (losses) gains (4,057) 2 (4,054) 15 -------- -------- -------- -------- Total Noninterest Income 27,950 38,872 64,498 64,861 Noninterest Expense Salaries and employee benefits 37,245 32,974 74,604 64,083 Services and fees 8,104 8,846 17,062 17,225 Net occupancy - premises 3,661 3,517 7,352 6,730 Equipment expense 3,855 3,781 7,808 7,323 Other expense 7,396 6,660 14,577 13,364 -------- -------- -------- -------- Total Noninterest Expense 60,261 55,778 121,403 108,725 -------- -------- -------- -------- Income Before Income Taxes 34,169 50,939 75,188 91,288 Income taxes 11,963 17,916 26,201 31,514 -------- -------- -------- -------- Net Income $ 22,206 $ 33,023 $ 48,987 $ 59,774 ======== ======== ======== ======== Earnings Per Share Basic $ 0.39 $ 0.57 $ 0.86 $ 1.03 ======== ======== ======== ======== Diluted $ 0.39 $ 0.57 $ 0.86 $ 1.02 ======== ======== ======== ======== Dividends Per Share $ 0.20 $ 0.19 $ 0.40 $ 0.38 ======== ======== ======== ======== </TABLE> See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity ($ in thousands) (Unaudited) 2005 2004 -------- -------- Balance, January 1, $750,396 $689,573 Comprehensive income: Net income per consolidated statements of income 48,987 59,774 Net change in fair value of securities available for sale, net of tax (1,635) (5,599) -------- -------- Comprehensive income 47,352 54,175 Cash dividends paid (22,793) (22,080) Common stock issued, long-term incentive plan 1,315 1,100 Compensation expense, stock compensation plans 864 445 Repurchase and retirement of common stock (32,496) (13,412) -------- -------- Balance, June 30, $744,638 $709,801 ======== ======== See notes to consolidated financial statements.
Trustmark Corporation and Subsidiaries Consolidated Statements of Cash Flows ($ in thousands) (Unaudited) Six Months Ended June 30, ------------------- 2005 2004 -------- -------- Operating Activities Net income $ 48,987 $ 59,774 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 4,225 2,755 Depreciation and amortization/impairment 15,170 9,191 Net amortization of securities 4,472 11,576 Securities losses (gains) 4,054 (15) Gains on sales of loans (1,985) (3,550) Deferred income tax (benefit) provision (1,523) 6,518 Proceeds from sales of loans held for sale 415,767 430,488 Purchases and originations of loans held for sale (449,297) (399,624) Net increase in mortgage servicing rights (6,427) (6,703) Net increase in other assets (4,002) (1,488) Net increase in other liabilities 5,307 1,457 Other operating activities, net 1,048 710 -------- -------- Net cash provided by operating activities 35,796 111,089 Investing Activities Proceeds from calls and maturities of securities held to maturity 7,861 19,247 Proceeds from calls and maturities of securities available for sale 114,154 252,656 Proceeds from sales of securities available for sale 269,668 - Purchases of securities held to maturity (175,714) (103) Purchases of securities available for sale (27,649) (331,765) Net decrease in federal funds sold and securities purchased under reverse repurchase agreements 62,166 14,610 Net increase in loans (317,560) (242,840) Purchases of premises and equipment (5,368) (9,606) Proceeds from sales of premises and equipment 1,701 461 Proceeds from sales of other real estate 3,691 2,573 Cash received in business combination - 4,622 -------- -------- Net cash used in investing activities (67,050) (290,145) Financing Activities Net increase (decrease) in deposits 70,631 (10,192) Net increase (decrease) in federal funds purchased and securities sold under repurchase agreements 109,300 (13,014) Net (decrease) increase in other borrowings (237,243) 173,118 Proceeds from long-term FHLB advances 100,000 - Cash dividends (22,793) (22,080) Proceeds from exercise of stock options 1,315 1,100 Repurchase and retirement of common stock (32,496) (13,412) -------- -------- Net cash (used in) provided by financing activities (11,286) 115,520 -------- -------- Decrease in cash and cash equivalents (42,540) (63,536) Cash and cash equivalents at beginning of period 343,125 333,096 -------- -------- Cash and cash equivalents at end of period $300,585 $269,560 ======== ======== 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 six month periods ended June 30, 2005, are not necessarily indicative of the results that may be expected for the year ended December 31, 2005. The notes included herein should be read in conjunction with the notes to the consolidated financial statements included in Trustmark Corporation's (Trustmark) 2004 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 December 1, 2004, Trustmark acquired Fisher-Brown, Incorporated, located in Pensacola, Florida. This business combination was accounted for under the purchase method of accounting. Excess cost over tangible net assets acquired totaled $36.2 million, of which $9.3 million and $26.9 million have been allocated to identifiable intangible assets and goodwill, respectively. 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 $15.3 million have been allocated to identifiable intangibles (core deposits) and goodwill, respectively. The purchase price was finalized during the first quarter of 2005 after completion of an evaluation of the adequacy of the discount for general credit risk mentioned above. The resulting adjustment was immaterial. Trustmark's financial statements include the results of operations for the above purchase business combinations from the respective merger dates. The pro forma impact of these acquisitions on Trustmark's results of operations is immaterial. NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES For the periods presented, loans consisted of the following ($ in thousands): June 30, December 31, 2005 2004 ----------- ----------- Real estate loans: Construction and land development $ 606,339 $ 526,321 Secured by 1-4 family residential properties 1,973,807 1,849,267 Secured by nonfarm, nonresidential properties 943,037 882,507 Other 147,658 135,938 Loans to finance agricultural production 36,183 29,885 Commercial and industrial 866,493 865,436 Consumer 807,852 812,133 Obligations of states and political subdivisions 186,099 178,222 Other loans 78,344 50,346 ----------- ----------- Loans 5,645,812 5,330,055 Less allowance for loan losses 65,902 64,757 ----------- ----------- Net loans $ 5,579,910 $ 5,265,298 =========== ===========
The following table summarizes the activity in the allowance for loan losses for the periods presented ($ in thousands): Six Months Ended June 30, ----------------------- 2005 2004 ---------- ---------- Balance at beginning of year $ 64,757 $ 74,276 Provision charged to expense 4,225 2,755 Loans charged off (7,625) (7,655) Recoveries 4,545 4,803 ---------- ---------- Net charge-offs (3,080) (2,852) ---------- ---------- Balance at end of period $ 65,902 $ 74,179 ========== ========== At June 30, 2005 and 2004, the carrying amounts of nonaccrual loans were $32.7 million and $27.0 million, respectively. Included in these nonaccrual loans at June 30, 2005 and 2004, are loans that are considered to be impaired, which totaled $26.3 million and $20.2 million, respectively. At June 30, 2005, the total allowance for loan losses related to impaired loans was $8.0 million compared with $5.3 million at June 30, 2004. The average carrying amounts of impaired loans during the second quarter of 2005 and 2004 were $26.2 million and $20.0 million, respectively. No material amounts of interest income were recognized on impaired loans or nonaccrual loans for the three and six month periods ended June 30, 2005 and 2004. NOTE 4 - MORTGAGE BANKING At June 30, 2005 and December 31, 2004, the carrying amount of mortgage servicing rights are as follows ($ in thousands): June 30, December 31, 2005 2004 ----------- ----------- Mortgage Servicing Rights $ 59,694 $ 58,507 Valuation Allowance (8,133) (6,044) ----------- ----------- Mortgage Servicing Rights, net $ 51,561 $ 52,463 =========== =========== 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 net servicing income. At June 30, 2005, Trustmark serviced $3.5 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 2004, Trustmark reclassified $7.1 million of mortgage servicing right impairment from temporary to other-than-temporary which reduced the valuation allowance for impairment and the gross mortgage servicing rights balance with no effect to the net mortgage servicing rights asset. Impairment is considered to be other-than-temporary when Trustmark determines that the carrying value is expected to exceed the fair value for an extended period of time.
NOTE 5 - DEPOSITS At June 30, 2005 and December 31, 2004, deposits consisted of the following ($ in thousands): June 30, December 31, 2005 2004 ----------- ----------- Noninterest-bearing demand $ 1,249,464 $ 1,354,749 Interest-bearing demand 987,774 1,362,437 Savings 1,378,787 892,643 Time 1,904,699 1,840,264 ----------- ----------- Total deposits $ 5,520,724 $ 5,450,093 =========== =========== Improved coverage of sweep eligible accounts resulting from the implementation of a third-party software product was the primary factor in an increase in savings accounts, which have no reserve requirement as defined by the Federal Reserve Bank, and a resulting decline in transaction based interest-bearing demand deposits and noninterest-bearing demand deposits. NOTE 6 - STOCK-BASED COMPENSATION On May 10, 2005, the shareholders of Trustmark, upon the recommendation of Trustmark's Board of Directors, approved the Trustmark Corporation 2005 Stock and Incentive Compensation Plan (the 2005 Plan), which was adopted by the Board of Directors, and replaces the Trustmark Corporation 1997 Long Term Incentive Plan (the 1997 Plan). The 2005 Plan became effective May 10, 2005, and subject to earlier termination by the Board of Directors, terminates on May 9, 2015. The 2005 Plan allows Trustmark to make grants of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units and performance units to key associates and directors. The maximum number of shares of Trustmark's common stock available for issuance under the 2005 Plan is the sum of (1) 6,000,000 common shares plus (2) the number of outstanding options under the 1997 Plan, which expire or are otherwise terminated or forfeited after May 10, 2005. Effective January 1, 2003, Trustmark adopted the fair value recognition provisions of Statement of Financial Accounting Standard (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. Compensation expense for stock options granted is estimated using the fair value of each option granted using the Black-Scholes option-pricing model. Compensation expense for restricted stock granted is recorded over the service period based on the fair value of the underlying common stock on the date of grant based on the number of restricted shares expected to vest. 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 Six Months Ended June 30, June 30, ------------------- ------------------- 2005 2004 2005 2004 -------- -------- -------- -------- <S> <C> <C> <C> <C> Net income, as reported $ 22,206 $ 33,023 $ 48,987 $ 59,774 Add: Total stock-based compensation expense reported in net income, net of related tax effects 232 186 421 275 Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects (385) (437) (795) (830) -------- -------- -------- -------- Pro forma net income $ 22,053 $ 32,772 $ 48,613 $ 59,219 ======== ======== ======== ======== Earnings per share: As reported Basic $ 0.39 $ 0.57 $ 0.86 $ 1.03 Diluted 0.39 0.57 0.86 1.02 Pro forma Basic $ 0.39 $ 0.56 $ 0.85 $ 1.02 Diluted 0.39 0.56 0.85 1.01 </TABLE> NOTE 7 - CONTINGENCIES Letters of Credit Standby and commercial letters of credit are conditional commitments issued by Trustmark to insure the performance of a customer to a third party. 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. A financial standby letter of credit irrevocably obligates Trustmark to pay a third-party beneficiary when a customer fails to repay an outstanding loan or debt instrument. A performance standby letter of credit irrevocably obligates Trustmark to pay a third-party beneficiary when a customer fails to perform some contractual, nonfinancial obligation. When issuing letters of credit, Trustmark uses essentially the same policies regarding credit risk and collateral which are followed in the lending process. At June 30, 2005 and 2004, Trustmark's maximum exposure to credit loss in the event of nonperformance by the other party for standby and commercial letters of credit was $114.5 million and $91.4 million, respectively. These amounts consist primarily of commitments with maturities of less than three years, which have an immaterial carrying value. Trustmark holds collateral to support standby letters of credit when deemed necessary. As of June 30, 2005, the fair value of collateral held was $26.0 million. Legal Proceedings Trustmark and its subsidiaries are parties to lawsuits and other claims that arise in the ordinary course of business. Some of the lawsuits assert claims related to the lending, collection, servicing, investment, trust and other business activities, and some of the lawsuits allege substantial claims for damages. The cases are being vigorously contested. In the regular course of business, Management evaluates estimated losses or costs related to litigation, and provision is made for anticipated losses whenever Management believes that such losses are probable and can be reasonably estimated. At the present time, Management believes, based on the advice of legal counsel and Management's evaluation, that the final resolution of pending legal proceedings will not have a material impact on Trustmark's consolidated financial position or results of operations; however, Management is unable to estimate a range of potential loss on these matters because of the nature of the legal environment in states where Trustmark conducts business.
NOTE 8 - BENEFIT PLANS Pension Plan Trustmark maintains a noncontributory defined benefit pension plan which covers substantially all associates with more than one year of service. The plan provides pension benefits that are based on the length of credited service and final average compensation as defined in the plan. Trustmark's policy is to fund amounts allowable as deductions for federal income tax purposes. The following table presents information regarding the plan's net periodic pension costs for the six months ended June 30, ($ in thousands): 2005 2004 ------- ------- Service cost - benefits earned during the period $ 1,090 $ 819 Interest cost on projected benefit obligation 2,135 2,113 Expected return on plan assets (2,704) (2,503) Amortization of prior service cost (45) (44) Recognized net actuarial loss 959 595 ------- ------- Net periodic benefit cost $ 1,435 $ 980 ======= ======= Supplemental Retirement Plan Trustmark maintains a non-qualified supplemental retirement plan covering directors that elect to defer fees, key executive officers and senior officers. The plan provides for defined death benefits and/or retirement benefits based on a participant's covered salary. Trustmark has acquired life insurance contracts on the participants covered under the plan which may be used to fund future payments. The following table presents information regarding the plan's net periodic benefit costs for the six months ended June 30, ($ in thousands): 2005 2004 ------- ------- Service cost - benefits earned during the period $ 723 $ 508 Interest cost on projected benefit obligation 783 702 Amortization of prior service cost 101 - Recognized net actuarial loss 52 - ------- ------- Net periodic benefit cost $ 1,659 $ 1,210 ======= ======= 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 potentially 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 Six Months Ended June 30, June 30, ----------------------- ----------------------- 2005 2004 2005 2004 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Basic shares 56,828,841 58,055,793 57,112,559 58,161,738 Dilutive shares (related to stock options) 139,154 255,539 138,838 287,624 ---------- ---------- ---------- ---------- Diluted shares 56,967,995 58,311,332 57,251,397 58,449,362 ========== ========== ========== ========== </TABLE> For the quarters ended June 30, 2005 and 2004, options to purchase 1.0 million and 767 thousand shares, respectively, were outstanding, but not included in the computation of diluted earnings per share because they were antidilutive.
NOTE 10 - STATEMENTS OF CASH FLOWS Trustmark paid income taxes of $22.4 million and $21.2 million during the six months ended June 30, 2005 and 2004, respectively. Interest paid on deposit liabilities and other borrowings approximated $45.8 million in the first six months of 2005 and $40.8 million in the first six months of 2004. For the six months ended June 30, 2005 and 2004, noncash transfers from loans to foreclosed properties were $1.1 million and $3.3 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 six months of 2005, $75.0 million of long-term FHLB advances were converted to short-term borrowings compared with conversions of $150.0 million in the first six months of 2004. NOTE 11 - RECENT PRONOUNCEMENTS In May 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154, "Accounting Changes and Error Corrections." SFAS No. 154 is a replacement of APB No. 20, "Accounting Changes" and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements." SFAS No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. This statement applies to voluntary changes in accounting principle as well as changes required by an accounting pronouncement that provide no specific transition provisions. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The effects of this statement are not expected to have a material impact on Trustmark's statement of position or results of operations. In December 2004, the FASB issued a revision of SFAS No. 123 (SFAS No. 123r), "Share-Based Payment." This statement revises SFAS No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123r establishes standards for the accounting for transactions in which a company exchanges equity instruments for goods or services. This statement requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. As of the required effective date, public companies using the fair-value-based method for recognition or disclosure under SFAS No. 123, will apply this statement using a modified version of prospective application. Trustmark adopted the provisions of SFAS No. 123 effective January 1, 2003; therefore, Trustmark will recognize compensation cost for the portion of outstanding awards for which the requisite service has not yet been rendered (unvested awards). For public companies, this statement is effective as of the beginning of the first annual reporting period beginning after June 15, 2005. The effects of this statement are not expected to have a material impact on Trustmark's statement of position or results of operations. NOTE 12 - SEGMENT INFORMATION Trustmark's management reporting structure includes four segments: general banking, wealth management, insurance and administration. General banking is responsible for all traditional banking products and services, including loans and deposits. Wealth management provides customized solutions for affluent customers by integrating financial services with traditional banking products and services such as private banking, money management, full-service brokerage, financial planning, risk management, personal and institutional trust, and retirement services. Wealth management includes three wholly-owned subsidiaries of TNB: Trustmark Securities, Inc., Trustmark Investment Advisors, Inc., and TRMK Risk Management, Inc. Insurance includes two wholly-owned subsidiaries of TNB: The Bottrell Insurance Agency and Fisher-Brown, Incorporated. Through Bottrell, Trustmark provides a full range of retail insurance products, including commercial risk management products, bonding, group benefits and personal lines coverages. Fisher-Brown operates as a full-service insurance agency, selling a broad spectrum of insurance services. Administration includes all other activities that are not directly attributable to one of the major lines of business. Administration consists of internal operations such as Human Resources, Executive Administration, Property Management, Treasury (Funds Management) and Corporate Finance. 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. Noninterest 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 June 30, 2005 and 2004.
Trustmark Corporation Segment Information ($ in thousands) <TABLE> <CAPTION> General Wealth Banking Management Insurance Admin. Division Division Division Division Total For the three months ended ---------- ---------- ---------- ---------- ---------- June 30, 2005 - -------------------------- <S> <C> <C> <C> <C> <C> Net interest income from external customers $ 65,837 $ 1,257 $ (3) $ 818 $ 67,909 Internal funding (4,312) (348) - 4,660 - ---------- ---------- ---------- ---------- ----------- Net interest income 61,525 909 (3) 5,478 67,909 Provision for loan losses 3,416 - - (1,987) 1,429 ---------- ---------- ---------- ---------- ----------- Net interest income after provision for loan losses 58,109 909 (3) 7,465 66,480 Noninterest income 18,442 5,562 8,348 (4,402) 27,950 Noninterest expense 41,247 4,547 5,631 8,836 60,261 ---------- ---------- ---------- ---------- ----------- Income before income taxes 35,304 1,924 2,714 (5,773) 34,169 Income taxes 12,174 715 1,120 (2,046) 11,963 ---------- ---------- ---------- ---------- ----------- Segment net income $ 23,130 $ 1,209 $ 1,594 $ (3,727) $ 22,206 ========== ========== ========== ========== =========== Selected Financial Information Average assets $6,156,930 $ 98,349 $ 17,897 $1,981,421 $8,254,597 Depreciation and amortization/impairment $ 10,007 $ 134 $ 93 $ 1,178 $ 11,412 For the three months ended June 30, 2004 - -------------------------- Net interest income from external customers $ 58,108 $ 1,095 $ - $ 10,345 $ 69,548 Internal funding 652 (102) - (550) - ---------- ---------- ---------- ---------- ----------- Net interest income 58,760 993 - 9,795 69,548 Provision for loan losses 1,758 (6) - (49) 1,703 ---------- ---------- ---------- ---------- ----------- Net interest income after provision for loan losses 57,002 999 - 9,844 67,845 Noninterest income 28,969 5,042 4,333 528 38,872 Noninterest expense 40,712 4,558 2,835 7,673 55,778 ---------- ---------- ---------- ---------- ----------- Income before income taxes 45,259 1,483 1,498 2,699 50,939 Income taxes 15,700 551 583 1,082 17,916 ---------- ---------- ---------- ---------- ----------- Segment net income $ 29,559 $ 932 $ 915 $ 1,617 $ 33,023 ========== ========== ========== ========== =========== Selected Financial Information Average assets $5,755,605 $ 97,912 $ 16,336 $2,372,565 $8,242,418 Depreciation and amortization/impairment $ (1,386) $ 122 $ 34 $ 972 $ (258) </TABLE>
Trustmark Corporation Segment Information ($ in thousands) <TABLE> <CAPTION> General Wealth Banking Management Insurance Admin. Division Division Division Division Total For the six months ended ---------- ---------- ---------- ---------- ---------- June 30, 2005 - ------------------------ <S> <C> <C> <C> <C> <C> Net interest income from external customers $ 126,446 $ 2,413 $ (5) $ 7,464 $ 136,318 Internal funding (6,014) (575) - 6,589 - ---------- ---------- ---------- ---------- ----------- Net interest income 120,432 1,838 (5) 14,053 136,318 Provision for loan losses 4,186 (7) - 46 4,225 ---------- ---------- ---------- ---------- ----------- Net interest income after provision for loan losses 116,246 1,845 (5) 14,007 132,093 Noninterest income 40,910 10,939 16,193 (3,544) 64,498 Noninterest expense 83,892 9,354 11,027 17,130 121,403 ---------- ---------- ---------- ---------- ----------- Income before income taxes 73,264 3,430 5,161 (6,667) 75,188 Income taxes 25,243 1,268 2,126 (2,436) 26,201 ---------- ---------- ---------- ---------- ----------- Segment net income $ 48,021 $ 2,162 $ 3,035 $ (4,231) $ 48,987 ========== ========== ========== ========== =========== Selected Financial Information Average assets $6,077,468 $ 98,748 $ 16,639 $2,004,164 $8,197,019 Depreciation and amortization/impairment $ 12,368 $ 267 $ 182 $ 2,353 $ 15,170 For the six months ended June 30, 2004 - ------------------------ Net interest income from external customers $ 113,615 $ 2,203 $ - $ 22,089 $ 137,907 Internal funding 838 (175) - (663) - ---------- ---------- ---------- ---------- ----------- Net interest income 114,453 2,028 - 21,426 137,907 Provision for loan losses 3,144 (27) - (362) 2,755 ---------- ---------- ---------- ---------- ----------- Net interest income after provision for loan losses 111,309 2,055 - 21,788 135,152 Noninterest income 46,961 10,150 7,502 248 64,861 Noninterest expense 80,245 8,869 5,126 14,485 108,725 ---------- ---------- ---------- ---------- ----------- Income before income taxes 78,025 3,336 2,376 7,551 91,288 Income taxes 27,075 1,230 873 2,336 31,514 ---------- ---------- ---------- ---------- ----------- Segment net income $ 50,950 $ 2,106 $ 1,503 $ 5,215 $ 59,774 ========== ========== ========== ========== =========== Selected Financial Information Average assets $5,631,345 $ 97,920 $ 15,521 $2,341,128 $8,085,914 Depreciation and amortization/impairment $ 6,997 $ 227 $ 68 $ 1,899 $ 9,191 </TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS The following provides a narrative discussion and analysis of Trustmark Corporation's (Trustmark) financial condition and results of operations. This discussion should be read in conjunction with the consolidated financial statements and the supplemental financial data included elsewhere in this report. FORWARD-LOOKING STATEMENTS Certain statements contained in 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 and encompass any estimate, prediction, expectation, projection, opinion, anticipation, outlook or statement of belief included therein as well as the management assumptions underlying these forward-looking statements. Should one or more of these risks materialize, or should any such underlying assumptions prove to be significantly different, actual results may vary significantly from those anticipated, estimated, projected or expected. These risks could cause actual results to differ materially from current expectations of Management and include 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 rapidly declining 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. Trustmark undertakes no obligation to update or revise any of this information, whether as the result of new information, future events or developments or otherwise. OVERVIEW Trustmark is a multi-bank holding company headquartered in Jackson, Mississippi, incorporated under the Mississippi Business Corporation Act on August 5, 1968. Trustmark commenced doing business in November 1968. Through its subsidiaries, Trustmark operates as a financial services organization providing banking and financial solutions through over 145 offices and 2,616 associates predominantly within the states of Florida, Mississippi, Tennessee and Texas.
Trustmark National Bank (TNB), Trustmark's wholly-owned subsidiary, accounts for substantially all of the assets and revenues of Trustmark. Chartered by the state of Mississippi in 1889, TNB is also headquartered in Jackson, Mississippi. In addition to banking activities, TNB provides investment and insurance products and services to its customers through four wholly-owned subsidiaries, Trustmark Securities, Inc. (formerly Trustmark Financial Services, Inc.), Trustmark Investment Advisors, Inc., The Bottrell Insurance Agency, Inc. (Bottrell) and Fisher-Brown, Incorporated. In January 2005, Trustmark established a de novo subsidiary, Trustmark Risk Management, Inc. (TRMI). TRMI commenced doing business on January 31, 2005, and engages in insurance agency activities as an agent for individual life, disability and long-term care insurance, and also as agent for the sale of fixed annuities. These activities were previously provided by Bottrell. Trustmark also engages in banking activities through its wholly-owned subsidiary, Somerville Bank & Trust Company (Somerville), headquartered in Somerville, Tennessee. Somerville was acquired in a business combination during 2001 and presently has five locations in Somerville, Hickory Withe and Rossville, Tennessee. In addition to its banking subsidiaries, Trustmark also owns all of the stock of F. S. Corporation and First Building Corporation, both inactive nonbank Mississippi corporations. Neither Trustmark nor its subsidiaries have any foreign activities. Net income for the three months ended June 30, 2005 and 2004, totaled $22.2 million and $33.0 million, respectively. Basic and diluted earnings per share were $0.39 for the second quarter of 2005, compared with $0.57 for the second quarter of 2004. Earnings during the second quarter of 2005 included a pre-tax, non-cash charge of $4.8 million for impairment of the home mortgage servicing portfolio related to declines in long-term interest rates during the quarter. Also included in earnings for the second quarter of 2005 is a pre-tax charge of $4.1 million related to the sale of certain investment securities. See the section captioned "Noninterest Income" elsewhere in this discussion for further analysis of these items. Net income for the six months ended June 30, 2005 and 2004, totaled $49.0 million and $59.8 million, respectively. Basic and diluted earnings per share for the six months ended June 30, 2005 were $0.86 compared with basic earnings per share of $1.03 and diluted earnings per share of $1.02 for the six months ended June 30, 2004. At June 30, 2005, Trustmark reported gross loans, including loans held for sale, of $5.790 billion, total assets of $8.104 billion, total deposits of $5.521 billion and shareholders' equity of $744.6 million. Management utilizes certain financial ratios to gauge Trustmark's performance. Trustmark achieved a return on average assets of 1.08% and a return on average equity of 11.84% for the three months ended June 30, 2005. These compared with ratios of 1.61% for return on average assets and 18.51% for return on average equity for the three months ended June 30, 2004. For the six months ended June 30, 2005, Trustmark achieved a return on average assets of 1.21% and a return on average equity of 13.13%. These compare to a return on average assets of 1.49% and a return on average equity of 16.91% for the same periods of 2004. CRITICAL ACCOUNTING POLICIES Trustmark's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the financial services industry. Application of these accounting principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual financial results could differ from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. These critical accounting policies are described in detail below. Allowance for Loan Losses The allowance for loan losses is established through provisions for estimated loan losses charged against earnings. The allowance for loan losses is maintained at a level believed adequate by management, based on estimated probable losses within the existing loan portfolio. Trustmark's allowance for loan loss methodology is based on guidance provided by SEC Staff Accounting Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues," as well as other regulatory guidance. Accordingly, Trustmark's methodology is based on historical loss experience by type of loan and internal risk rating, homogeneous risk pools and specific allocations, with adjustments considering current economic events and conditions. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.
Mortgage Servicing Rights Mortgage servicing rights are rights to service mortgage loans for others, whether the loans were acquired through purchase or loan origination. Purchased mortgage servicing rights are capitalized at cost. For loans originated and sold where the servicing rights have been retained, Trustmark allocates the cost of the loan and the servicing right based on their relative fair value. Mortgage servicing rights are amortized over the estimated period of the related net servicing income. Mortgage servicing rights are evaluated quarterly for impairment. Impairment occurs when the estimated fair value falls below the underlying carrying value. For purposes of evaluating impairment, Trustmark stratifies its mortgage servicing portfolio on the basis of certain risk characteristics including loan type, term and note rate. Changes in interest rates, prepayment speeds or other factors could result in impairment or recovery of the servicing asset. Impairment or impairment recovery is recognized through a valuation allowance with a corresponding charge to mortgage banking noninterest income. Benefit Plans Benefit plan assets, liabilities and pension costs are determined utilizing actuarially present value calculations. The valuation of the benefit obligation and net periodic expense is considered critical, as it requires Management and its actuaries to make estimates regarding the amount and timing of expected cash outflows including assumptions about mortality, expected service periods, rate of compensation increases and the long-term return on plan assets. Note 8 - Benefit Plans, included in the accompanying Notes to the Consolidated Financial Statements, provides further discussion on the accounting for Trustmark's benefit plans (pension and supplemental retirement plan) and the estimates used in determining the actuarial present value of the benefit obligations and the net periodic benefit expense. Fair Value Accounting Estimates Generally accepted accounting principles require the use of fair values in determining the carrying values of assets and liabilities, as well as for specific disclosures. The most significant include securities, derivative instruments, loans held for sale, mortgage servicing rights and net assets acquired in a business combination. Certain of these assets do not have a readily available market to determine fair value and require an estimate based on specific parameters. When market prices are unavailable, Trustmark determines fair values utilizing parameters, which are constantly changing, including interest rates, duration, prepayment speeds and other specific conditions. In most cases, these specific parameters require a significant amount of judgment by Management. Contingent Liabilities Trustmark estimates contingent liabilities based on Management's evaluation of the probability of outcomes and their ability to estimate the range of exposure. As stated by Statement of Financial Accounting Standards (SFAS) No. 5, "Accounting for Contingencies," a liability is contingent if the amount is not presently known, but may become known in the future as a result of the occurrence of some uncertain future event. Accounting standards require that a liability be recorded if Management determines that it is probable that a loss has occurred and the loss can be reasonably estimated. In addition, it must be probable that the loss will be confirmed by some future event. As part of the estimation process, Management is required to make assumptions about matters that are, by their nature, highly uncertain. The assessment of contingent liabilities, including legal contingencies and income tax liabilities, involves the use of critical estimates, assumptions and judgments. Management's estimates are based on their belief that future events will validate the current assumptions regarding the ultimate outcome of these exposures. However, there can be no assurance that future events, such as court decisions or Internal Revenue Service positions, will not differ from Management's assessments. Whenever practicable, Management consults with outside experts (attorneys, independent accountants, claims administrators, etc.) to assist with the gathering and evaluation of information related to contingent liabilities. BUSINESS COMBINATIONS Trustmark's strategic acquisition program is based on efforts to evaluate opportunities to expand and invest in higher-growth markets by implementing market-specific business initiatives. This approach is designed to maximize financial profitability, bolster growth prospects and enhance shareholder value. In the first quarter of 2004, Trustmark entered the dynamic Houston banking market with the purchase of five branch offices from Allied Houston Bank. The Houston MSA is among the largest and highest-growth markets in the country. In December 2004, Trustmark continued to expand insurance services, as well as its presence in the Florida Panhandle, with the acquisition of Fisher-Brown, Incorporated, Northwest Florida's leading insurance agency, headquartered in Pensacola, with offices in Milton, Mary Esther, Destin and Panama City. This transaction enhances Trustmark's strategic goal of becoming a more diversified financial services organization. For more information on these business combinations, please refer to Note 2 of the Notes to the Consolidated Financial Statements.
RESULTS OF OPERATIONS Net Interest Income Net interest income is the principal component of Trustmark's income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates, as well as volume and mix changes in earning assets and interest-bearing liabilities, can materially impact net interest income. The net interest margin (NIM) is computed by dividing fully taxable equivalent net interest income by average interest-earning assets and measures how effectively Trustmark utilizes its interest-earning assets in relationship to the interest cost of funding them. The accompanying Yield/Rate Analysis Table shows the average balances for all assets and liabilities of Trustmark and the interest income or expense associated with earning assets and interest-bearing liabilities. The yields and rates have been computed based upon interest income and expense adjusted to a fully taxable equivalent (FTE) basis using a 35% federal marginal tax rate for all periods shown. Nonaccruing loans have been included in the average loan balances, and interest collected prior to these loans having been placed on nonaccrual has been included in interest income. Loan fees included in interest associated with the average loan balances are immaterial. Yield/Rate Analysis Table ($ in thousands) <TABLE> <CAPTION> For the Three Months Ended June 30, --------------------------------------------------------------- 2005 2004 ----------------------------- ------------------------------- 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 $ 18,308 $ 143 3.13% $ 24,132 $ 63 1.05% Securities - taxable 1,600,322 13,993 3.51% 2,021,527 14,825 2.95% Securities - nontaxable 157,178 2,917 7.44% 158,896 3,026 7.66% Gross loans, including loans held for sale 5,669,110 85,663 6.06% 5,288,298 73,917 5.62% ---------- -------- ------ ---------- -------- ------ Total interest-earning assets 7,444,918 102,716 5.53% 7,492,853 91,831 4.93% Cash and due from banks 343,117 337,596 Other assets 532,805 486,184 Allowance for loan losses (66,243) (74,215) ---------- ---------- Total Assets $8,254,597 $8,242,418 ========== ========== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing deposits $4,277,848 18,326 1.72% $4,108,546 13,326 1.30% Federal funds purchased and securities sold under repurchase agreements 745,858 4,995 2.69% 894,158 2,156 0.97% Borrowings 1,138,709 9,413 3.32% 1,184,423 4,726 1.60% ---------- -------- ------ ---------- -------- ------ Total interest-bearing liabilities 6,162,415 32,734 2.13% 6,187,127 20,208 1.31% -------- -------- Noninterest-bearing demand deposits 1,261,788 1,283,043 Other liabilities 78,121 54,867 Shareholders' equity 752,273 717,381 ---------- ---------- Total Liabilities and Shareholders' Equity $8,254,597 $8,242,418 ========== ========== Net Interest Margin 69,982 3.77% 71,623 3.84% Less tax equivalent adjustment 2,073 2,075 -------- -------- Net Interest Margin per Consolidated Statements of Income $ 67,909 $ 69,548 ======== ======== </TABLE>
Net interest income-FTE for the three-month and six-month periods of 2005 decreased $1.6 million, or 2.3%, and $1.7 million, or 1.2%, when compared with the same periods of 2004. Increases in the target fed funds rate of 225 basis points throughout 2004 and the first half of 2005 resulted in increased interest income-FTE and interest expense. While interest expense on interest-bearing liabilities, primarily federal funds purchased, repurchase agreements and borrowings, increased substantially, the increase in interest income on earning assets was sufficient to offset the additional interest expense. The combination of these factors resulted in a nominal decline in the NIM during the six months ended June 30, 2005 of 6 basis points when compared with the same period of 2004. For additional discussion, see Market/Interest Rate Risk Management included later in the Management's Discussion and Analysis. Yield/Rate Analysis Table ($ in thousands) <TABLE> <CAPTION> For the Six Months Ended June 30, --------------------------------------------------------------- 2005 2004 ----------------------------- ------------------------------- 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 $ 33,087 $ 416 2.54% $ 20,685 $ 106 1.03% Securities - taxable 1,617,348 29,727 3.71% 1,990,523 31,021 3.13% Securities - nontaxable 154,744 5,780 7.53% 159,901 6,097 7.67% Gross loans, including loans held for sale 5,579,561 164,727 5.95% 5,175,855 145,371 5.65% ---------- -------- ------ ---------- -------- ------ Total interest-earning assets 7,384,740 200,650 5.48% 7,346,964 182,595 5.00% Cash and due from banks 345,944 337,176 Other assets 531,903 476,066 Allowance for loan losses (65,568) (74,292) ---------- ---------- Total Assets $8,197,019 $8,085,914 ========== ========== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing deposits $4,273,634 34,694 1.64% $4,051,625 26,712 1.33% Federal funds purchased and securities sold under repurchase agreements 717,198 8,643 2.43% 893,181 4,260 0.96% Borrowings 1,089,795 16,910 3.13% 1,104,686 9,484 1.73% ---------- -------- ------ ---------- -------- ------ Total interest-bearing liabilities 6,080,627 60,247 2.00% 6,049,492 40,456 1.34% -------- -------- Noninterest-bearing demand deposits 1,289,311 1,270,554 Other liabilities 74,461 54,897 Shareholders' equity 752,620 710,971 ---------- ---------- Total Liabilities and Shareholders' Equity $8,197,019 $8,085,914 ========== ========== Net Interest Margin 140,403 3.83% 142,139 3.89% Less tax equivalent adjustment 4,085 4,232 Net Interest Margin per Consolidated -------- -------- Statements of Income $136,318 $137,907 ======== ======== </TABLE>
Average interest-earning assets for the first half of 2005 were $7.385 billion, compared with $7.347 billion for the first half of 2004, an increase of $37.8 million, or 0.5%. Without the Allied Houston branch purchase, the increase in average interest-earning assets for the first half of 2005 is $11.8 million, or 0.2%. Growth in average loans for the first half of 2005, which increased 7.8% (7.3% without Allied Houston) when compared with the first half of 2004, was offset by a decrease in average securities, which decreased 17.6% when the first six months of 2005 and 2004 are compared. Since the fourth quarter of 2003, Management has been adjusting the balance sheet in anticipation of the risk of rising rates. This strategy has been well founded as short-term rates have risen 225 basis points over that time period. However, the upward shift in the short-term rates without a proportionate upward shift in long-term rates has diminished the profitability of holding long-term assets. If ignored, persistent interest rate behavior of this nature could lead to significant negative impact on margin. In preparation for potential adverse risks to margin, Management implemented a strategy of exiting certain assets and reducing balances of funding sources that would bear the highest costs in such a rate environment. This began in the fourth quarter of 2004, with the sale of $304 million in mortgage-related and U. S. Treasury securities and continued during the second quarter of 2005 when Trustmark sold $256 million in U. S. Government Agency and U. S. Treasury securities. Projected funding costs to carry these investments to their remaining maturity may have generated a greater negative margin impact than the actual losses incurred at sale. Proceeds from sales were used to reduce balances of higher-cost funding sources. The rising interest rate environment positively impacted yields as the yield on average earning assets increased from 5.00% during the first half of 2004 to 5.48% for the first half of 2005, an increase of 48 basis points. The combination of these factors resulted in an increase in interest income-FTE during the first six months of 2005 of $18.1 million, or 9.9%, when compared with the first six months of 2004. Average interest-bearing liabilities for the first half of 2005 totaled $6.081 billion, compared with $6.049 billion for the first half of 2004, an increase of $31.1 million, or 0.5%. Without the Allied Houston branch purchase, average interest-bearing liabilities for the first half of 2005 decreased $11.6 million, or 0.2%. Average interest-bearing deposits and short-term borrowings increased during the first six months of 2005, which offset decreases in federal funds purchased, repurchase agreements and long-term FHLB advances resulting from liquidity created from the sale of securities mentioned above. The rising interest rate environment negatively impacted yields on interest-bearing liabilities as seen in the increase in rates on interest-bearing deposits of 31 basis points, federal funds purchased and repurchase agreements of 147 basis points as well as the increase in rates on borrowings of 140 basis points when the first six months of 2005 and 2004 are compared. The average rates on interest-bearing liabilities for the first half of 2005 and 2004 were 2.00% and 1.34%, respectively, representing an increase of 66 basis points during 2005. As a result of these factors, total interest expense for the first six months of 2005 increased $19.8 million, or 48.9%, when compared with the first six months of 2004. Provision for Loan Losses The provision for loan losses is determined by Management as the amount to adjust the allowance for loan losses to a level, which, in Management's best estimate, is necessary to absorb probable losses within the existing loan portfolio. The provision for loan losses for the three and six months ended June 30, 2005, totaled $1.4 million and $4.2 million, respectively, compared with $1.7 million and $2.8 million, respectively, for the same periods of 2004. The increase for the six months ended June 30, 2005, is primarily the result of an additional provision of $1.9 million related to a single commercial credit recognized during the first quarter of 2005. As a percentage of average loans, the provision was 0.15% for the first half of 2005 and 0.11% for the same period of 2004. See the section captioned "Loans and Allowance for Loan Losses" elsewhere in this discussion for further analysis of the provision for loan losses. Noninterest Income Noninterest income (NII) consists of revenues generated from a broad range of banking and financial services. NII totaled $64.5 million in the first six months of 2005 compared with $64.9 million in the first six months of 2004. The comparative components of noninterest income for the six months ended June 30, 2005 and 2004 are shown in the accompanying table.
Noninterest Income ($ in thousands) Six Months Ended June 30, ------------------- 2005 2004 $ Change % Change -------- -------- -------- -------- Service charges on deposit accounts $ 25,925 $ 27,285 $ (1,360) -5.0% Insurance commissions 16,232 7,531 8,701 115.5% Wealth management 10,657 9,974 683 6.8% Retail banking - other 10,036 8,817 1,219 13.8% Mortgage banking, net 605 7,198 (6,593) -91.6% Other, net 5,097 4,041 1,056 26.1% Securities (losses) gains (4,054) 15 (4,069) n/m -------- -------- -------- -------- Total Noninterest Income $ 64,498 $ 64,861 $ (363) -0.6% ======== ======== ======== ======== n/m - not meaningful The single largest component of noninterest income continues to be service charges for deposit products and services, which decreased 5.0% in the first six months of 2005 over the same period in 2004. The primary reason for the decrease in service charges is a decline in fees earned on deposit accounts as a result of increased usage of accounts that do not charge a monthly service fee. An additional component of this decrease relates to increases in earnings credits earned by commercial depositors as a result of the rising interest rate environment, which has negatively impacted the overall service charges earned on these accounts. Insurance commissions were $16.2 million in the first six months of 2005, compared with $7.5 million in the first six months of 2004, an increase of $8.7 million or 115.5%. The increase in insurance commissions is primarily due to the Fisher-Brown acquisition, which occurred during the fourth quarter of 2004 and contributed approximately $8.5 million, or 98% of the increase. Wealth management income was $10.7 million during the first six months of 2005, compared with $10.0 million in the first six months of 2004. Wealth management consists of income related to trust and advisory services, including income generated from Trustmark Securities, Inc. and Trustmark Investment Advisors, Inc. The growth in wealth management income is largely attributed to an increase in trust fee income resulting from new account growth, asset appreciation on existing accounts and changes in the fee structure related to certain managed accounts. In addition, the increased presence of wealth management teams in Florida, Houston and Memphis and the creation of the Wealth Management Center in Jackson have begun to positively impact income. At June 30, 2005, 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 totaled $10.0 million for the six months ended June 30, 2005, an increase of $1.2 million, or 13.8%, when compared with the same period of 2004. Retail banking - other income consists primarily of ATM fees, fees from the sale of checks, bank card fees and safe deposit box fees. This growth is a result of increased fees related to electronic transactions such as ACH and debit card transactions resulting from increased transaction volume. Mortgage banking income was $605 thousand for the first six months of 2005, compared to $7.2 million for the first six months of 2004. As shown in the accompanying table, net mortgage servicing income has remained constant, resulting from consistent balances in the mortgage servicing portfolio. Loans serviced for others totaled $3.5 billion and $3.4 billion at June 30, 2005 and 2004, respectively. As a result, the factors that drive the change in mortgage banking income are primarily those factors that are sensitive to changes in interest rates such as amortization and impairment of mortgage servicing rights as well as gains on sales of loans. For the first six months of 2005, the primary factor for the decrease in mortgage banking income is an increase of $6.7 million in impairment of mortgage servicing rights resulting from declines in long-term interest rates during the second quarter. This non-cash charge against income could be reversed, in whole or in part, if long-term interest rates rise, refinancing slows and the expected life of home mortgages lengthens. Amortization expense decreased to $5.2 million for the first six months of 2005 when compared with $6.4 million for the same period in 2004, as the expected life of the portfolio has lengthened in response to a rise in interest rates from the historically low environment of the first quarter of 2004. Future changes in amortization and impairment of mortgage servicing rights will continue to be closely tied to fluctuations in long-term mortgage rates. Gain on sales of loans decreased from $2.3 million during the six months ended June 30, 2004, to $708 thousand during the six months ended June 30, 2005. The overall total of loan sales from secondary marketing activities declined from $426.9 million during the first half of 2004 to $415.1 million in the first half of 2005. The volatile interest rate environment experienced during 2005 has presented fewer gain on sale opportunities when compared to the first half of 2004.
The following table illustrates the components of mortgage banking included in noninterest income in the accompanying income statements. Mortgage Banking Income ($ in thousands) Six Months Ended June 30, ------------------ 2005 2004 ------- ------- Mortgage servicing income $ 8,412 $ 8,445 Mortgage guaranty fees (2,228) (2,221) ------- ------- Mortgage servicing, net 6,184 6,224 Amortization of mortgage servicing rights (5,240) (6,401) (Impairment)/Recovery of mortgage servicing rights, net (2,089) 4,627 Gain on sales of loans 708 2,347 Other, net 1,042 401 ------- ------- Mortgage banking, net $ 605 $ 7,198 ======= ======= Securities losses totaled $4.1 million during the six months ended June 30, 2005, compared with securities gains of $15 thousand during the same period of 2004. The losses for the six months ended June 30, 2005, primarily resulted from the sale of $256 million in U.S. Government Agency and U.S. Treasury securities during the second quarter of 2005. The sale of these securities resulted from an intentional reduction in the investment portfolio due to the declining profitability of holding longer-term investment securities. Noninterest Expense Trustmark's noninterest expense increased $12.7 million, or 11.7%, in the first six months of 2005 to $121.4 million, compared with $108.7 million in the same period of 2004. Excluding the Fisher-Brown acquisition and Allied Houston branch purchase, noninterest expense for the first six months of 2005 would total $112.8 million, an increase of $5.3 million, or 4.9%, compared with the same period of 2004. Management continues to consider expense control a major component of improving shareholder value. The comparative components of noninterest expense for the six months ended June 30, 2005 and 2004 are shown in the accompanying table. Noninterest Expense ($ in thousands) Six Months Ended June 30, ------------------- 2005 2004 $ Change % Change -------- -------- -------- -------- Salaries and employee benefits $ 74,604 $ 64,083 $ 10,521 16.4% Services and fees 17,062 17,225 (163) -0.9% Net occupancy - premises 7,352 6,730 622 9.2% Equipment expense 7,808 7,323 485 6.6% Other expense 14,577 13,364 1,213 9.1% -------- -------- -------- -------- Total Noninterest Expense $121,403 $108,725 $ 12,678 11.7% ======== ======== ======== ======== Salaries and employee benefits, the largest category of noninterest expense, were $74.6 million for the first six months of 2005, compared with $64.1 million for the same period of 2004. Business combinations, primarily Fisher-Brown, accounted for 58% of the increase. Eliminating adjustments for business combinations, salaries and employee benefits for the six months ended June 30, 2005, grew $5.3 million, or 8.3%, when compared to the same time period in 2004 primarily from merit salary increases as well as salaries and benefits for additional employees added as Trustmark continues to consider that its investment in people is one of the critical components of adding shareholder value. Trustmark's full-time equivalent employees were 2,616 and 2,465 at June 30, 2005 and 2004, respectively. During the first six months of 2005, net occupancy-premises expense increased $622 thousand, or 9.2%. The increase during the first half of 2005 is attributable to occupancy costs associated with facilities acquired in the Fisher-Brown acquisition and Allied Houston branch purchase. Business combinations accounted for approximately 80% of the increase. The increase was also the result of additional maintenance on existing premises.
Equipment expense totaled $7.8 million for the six months ended June 30, 2005, compared with $7.3 million for the same period of 2004, an increase of $485 thousand or 6.6%. The increase is a result of additional costs related to data processing and depreciation of office equipment. Business combinations accounted for approximately 40% of the increase. Income Taxes For the six months ended June 30, 2005, Trustmark's combined effective tax rate was 34.8%, compared with 34.5% for the first six months of 2004. The slight increase in Trustmark's effective tax rate for 2005 is due to immaterial changes in permanent items as a percentage of pretax income. LIQUIDITY Liquidity is the ability to meet asset funding requirements and operational cash outflows in a timely manner, in sufficient amount and without excess cost. Consistent cash flows from operations and adequate capital provide internally generated liquidity. Furthermore, Management maintains funding capacity from a variety of external sources to meet daily funding needs, such as those required to meet deposit withdrawals, loan disbursements and security settlements. Liquidity strategy also includes the use of wholesale funding sources to provide for the seasonal fluctuations of deposit and loan demand and the cyclical fluctuations of the economy that impact the availability of funds. Management keeps excess funding capacity available to meet potential demands associated with adverse circumstances. The primary source of liquidity on the asset side of the balance sheet are maturities and cash flows from both loans and securities, as well as the ability to sell certain loans and securities. Liquidity on the liability side of the balance sheet is generated primarily through growth in core deposits. To provide additional liquidity, Trustmark utilizes economical short-term wholesale funding arrangements for federal funds purchased and securities sold under repurchase agreements in both regional and national markets. At June 30, 2005, Trustmark estimated gross fed funds borrowing capacity at $1.319 billion, compared to $1.137 billion at December 31, 2004. In addition, Trustmark maintains a borrowing relationship with the FHLB, which provided $575.0 million in short-term advances and $205.8 million in long-term advances at June 30, 2005, compared with $650.0 million in short-term advances and $180.9 million in long-term advances at December 31, 2004. These advances are collateralized by a blanket lien on Trustmark's single-family, multi-family, home equity and commercial mortgage loans. Under the existing borrowing agreement, Trustmark has $695.0 million available in unused FHLB advances. Another borrowing source is the Federal Reserve Discount Window (Discount Window). At June 30, 2005, Trustmark had approximately $511.7 million available in collateral capacity at the Discount Window from pledges of auto loans and securities, compared with $597.5 million available at December 31, 2004. In September 2004, Trustmark entered into a two-year revolving credit arrangement enabling borrowings of up to $50.0 million, subject to certain financial covenants. At June 30, 2005, Trustmark was in compliance with all financial covenants and had borrowings on this line of credit that totaled $11.0 million. During 2003, Trustmark filed a registration statement on Form S-3 with the Securities and Exchange Commission (SEC) utilizing a "shelf" registration process. Under this shelf process, Trustmark may offer from time to time any combination of securities described in the prospectus in one or more offerings up to a total amount of $200 million. The securities described in the prospectus include common and preferred stock, depositary shares, debt securities, junior subordinated debt securities and trust preferred securities. Net proceeds from the sale of the offered securities may be used to redeem or repurchase outstanding securities, repay outstanding debt, finance acquisitions of companies and other assets and provide working capital. The Board of Directors currently has the authority to issue up to 20 million preferred shares with no par value. The ability to issue preferred shares in the future will provide Trustmark with additional financial and management flexibility for general corporate and acquisition purposes. At June 30, 2005, no such shares have been issued. Liquidity position and strategy are reviewed regularly by the Asset/Liability Committee and continuously adjusted in relationship to Trustmark's overall strategy. Management believes that Trustmark has sufficient liquidity and capital resources to meet presently known cash flow requirements arising from ongoing business transactions.
CAPITAL RESOURCES At June 30, 2005, Trustmark's shareholders' equity was $744.6 million, a decrease of $5.8 million, or 0.8%, from its level at December 31, 2004. This decrease is primarily related to dividends of $22.8 million, shares repurchased at a cost of $32.5 million and a net increase in accumulated other comprehensive loss of $1.6 million being offset by net income of $49.0 million for the first six months of 2005. Management will continue to hold sufficient capital to provide for growth opportunities, protect the balance sheet against sudden adverse market conditions and maintain an attractive return on equity to shareholders. Common Stock Repurchase Program Trustmark currently has remaining authorization for the repurchase of up to 1.8 million shares of its common stock, which will be executed at the discretion of management, subject to capital needs and market conditions. 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 19.7 million shares for $432.0 million, including 287 thousand shares during the second quarter of 2005 and 1.2 million shares for the six months ended June 30, 2005. Dividends Dividends for the first six months of 2005 were $0.40 per share, increasing 5.3% when compared with dividends of $0.38 per share in the first six months of 2004. Regulatory Capital Trustmark and TNB are subject to minimum capital requirements, which are administered by various federal regulatory agencies. These capital requirements, as defined by federal guidelines, involve quantitative and qualitative measures of assets, liabilities and certain off-balance sheet instruments. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the financial statements of both Trustmark and TNB. Trustmark aims not only to exceed the minimum capital standards but also the well-capitalized guidelines for regulatory capital. Management believes, as of June 30, 2005, that Trustmark and TNB have met or exceeded all of the minimum capital standards for the parent company and its primary banking subsidiary as established by regulatory requirements. At June 30, 2005, the most recent notification from the Office of the Comptroller of the Currency (OCC), TNB's primary federal banking regulator, categorized TNB as well capitalized. To be categorized in this manner, TNB must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios (defined in applicable regulations) as set forth in the accompanying table. There are no significant conditions or events that have occurred since the OCC's notification that Management believes have affected TNB's present classification. Regulatory Capital Table ($ in thousands) <TABLE> <CAPTION> June 30, 2005 ----------------------------------------------------------- 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 $640,540 10.98% $466,486 8.00% - - Trustmark National Bank 615,976 10.75% 458,476 8.00% $573,096 10.00% Tier 1 Capital (to Risk Weighted Assets) Trustmark Corporation $574,638 9.85% $233,243 4.00% - - Trustmark National Bank 552,641 9.64% 229,238 4.00% $343,857 6.00% Tier 1 Capital (to Average Assets) Trustmark Corporation $574,638 7.11% $242,448 3.00% - - Trustmark National Bank 552,641 6.97% 238,030 3.00% $396,717 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 June 30, 2005, earning assets were $7.332 billion, or 90.5% of total assets, compared with $7.235 billion, or 89.8% of total assets at December 31, 2004, an increase of $97.2 million, or 1.3%. Securities Interest-bearing investment securities are held to provide a stable alternative source of interest income and to collateralize public deposits and repurchase agreements. Trustmark's portfolio of investment securities also supports liquidity and profitability strategies and may be used to offset potential market risks in the various segments. The primary objective of the investment portfolio is to make an adequate contribution to net interest income. Management evaluates this contribution in relation to potential adverse market value risk that may impact strategic flexibility, liquidity or future earnings. During the fourth quarter of 2004, Management implemented a strategy of exiting certain assets and reducing balances of funding sources that would bear the highest costs in a rising interest rate environment. This strategy is illustrated by the sale of $304 million in mortgage-related and U. S. Treasury securities during the fourth quarter of 2004, which generated losses of $4.7 million, and continued during the second quarter of 2005 when Trustmark sold $256 million in U. S. Government Agency and U. S. Treasury securities, which incurred losses of $4.1 million. The average maturity of these securities was 2.14 years with an average book yield of 2.94%. Management believes projected funding costs to carry these investments to their remaining maturity may have generated a greater negative margin impact than the actual losses incurred at sale. Proceeds from sales were used to reduce balances of higher-cost funding sources. Trustmark intends to maintain lower balances in investment securities and reduce dependency on wholesale funding until market conditions provide more attractive opportunities. At June 30, 2005, Trustmark's securities portfolio totaled $1.517 billion compared with $1.717 billion at December 31, 2004, a decrease of $199.8 million, or 11.6%. The securities portfolio can serve as a powerful tool that Management uses to control exposure to interest rate risk. Interest rate risk can be adjusted by altering both the duration of the portfolio and the balance of the portfolio. Trustmark has maintained a strategy of offsetting potential exposure to higher interest rates by keeping both the duration and the balances of investment securities at relatively low levels. The estimated duration of the portfolio was 2.46 years at June 30, 2005, 2.47 years at December 31, 2004, and 2.44 years at June 30, 2004. While this is a slight extension of the duration of Trustmark's securities portfolio, duration remains near historically low levels. Management does not expect to extend duration by a material amount during 2005. AFS securities are carried at their estimated fair value with unrealized gains or losses recognized, net of taxes, in accumulated other comprehensive loss, a separate component of shareholders' equity. At June 30, 2005, AFS securities totaled $1.213 billion, which represented 79.9% of the securities portfolio, compared to $1.580 billion, or 92.0%, at December 31, 2004. At June 30, 2005, unrealized losses on AFS securities of $4.8 million, net of $1.9 million of deferred income taxes, were included in accumulated other comprehensive loss, compared with unrealized losses of $2.2 million, net of $841 thousand in deferred income taxes, at December 31, 2004. At June 30, 2005, 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 June 30, 2005, HTM securities totaled $304.6 million and represented 20.1% of the total portfolio, compared with $136.8 million, or 8.0%, at the end of 2004. Management continues to focus on asset quality as one of the strategic goals of the securities portfolio, which is evidenced by the investment of over 85% of the portfolio in U.S. Treasury, U.S. Government agencies obligations and other AAA rated securities. Loans and Allowance for Loan Losses Loans, including loans held for sale, represented 79.0% of earning assets at June 30, 2005, compared with 75.1% at December 31, 2004. At June 30, 2005, loans totaled $5.790 billion, a 6.6% increase from its level of $5.431 billion at December 31, 2004, due in part to growth in Trustmark's Florida Gulf Coast, Mortgage Banking, Commercial Real Estate and Indirect Auto portfolios. Trustmark makes loans in the normal course of business to certain directors, including their immediate families and companies in which they are principal owners. Such loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility at the time of the transaction.
Trustmark's lending policies have resulted in consistently sound asset quality. One measure of asset quality in the financial services industry is the level of nonperforming assets. The details of Trustmark's nonperforming assets at June 30, 2005 and December 31, 2004, are shown in the accompanying table. Total nonperforming assets increased $8.8 million, or 32.2%, during the first six months of 2005. The increase from December 31, 2004, is primarily attributable to a single commercial credit of approximately $14.9 million, of which $13.6 million was placed on nonaccrual during the first quarter of 2005. The allowance coverage of nonperforming loans was 201.63% at June 30, 2005. Loans held for sale past due 90 days or more represents $6.6 million in loans serviced by Trustmark and fully guaranteed by the Government National Mortgage Association that are eligible for repurchase. Nonperforming Assets and Past Due Loans ($ in thousands) June 30, December 31, 2005 2004 ----------- ----------- Nonaccrual and restructured loans $ 32,684 $ 21,864 Other real estate (ORE) 3,634 5,615 ----------- ----------- Total nonperforming assets $ 36,318 $ 27,479 =========== =========== Loans past due 90 days or more: Loan portfolio $ 1,698 $ 5,284 Loans held for sale 6,612 - ----------- ----------- Total loans past due 90 days or more $ 8,310 $ 5,284 =========== =========== Nonperforming assets/total loans and ORE 0.63% 0.51% =========== =========== The allowance for loan losses is established through provisions for estimated loan losses charged against earnings. The allowance for loan losses is maintained at a level believed adequate by Management, based on estimated probable losses within the existing loan portfolio. Trustmark's allowance for loan loss methodology is based on guidance provided by the SEC Staff Accounting Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues," as well as other regulatory guidance. Accordingly, Trustmark's methodology is based on historical loss experience by type of loan and internal risk rating, homogeneous risk pools and specific allocations, with adjustments considering current economic events and conditions. The allowance for loan losses consists of three elements: (i) specific valuation allowances established for probable losses on specific loans; (ii) historical valuation allowances calculated based on historical loan experience for similar loans with similar characteristics and trends and (iii) unallocated general valuation allowances determined based on general economic conditions and other qualitative risk factors, both internal and external, to Trustmark. At June 30, 2005, the allowance for loan losses was $65.9 million compared with $64.8 million at December 31, 2004. The allowance represented 1.17% of total loans outstanding at June 30, 2005, compared to 1.21% at December 31, 2004. As of June 30, 2005, Management believes that the allowance for loan losses provides adequate protection in regards to charge-off experience and the current level of nonperforming assets. Loans identified as losses by Management, internal loan review and/or bank examiners are charged-off against the allowance, while consumer loans are charged-off based on regulatory requirements. Net charge-offs for the first six months of 2005 totaled $3.1 million compared to $2.9 million for the same period of 2004. The continued stability in net charge-offs is a result of realignments of specific underwriting standards and changes to risk management analysis over the past 24 months. Other Earning Assets Federal funds sold and securities purchased under reverse repurchase agreements were $24.0 million at June 30, 2005, a decrease of $62.2 million when compared with December 31, 2004. Trustmark utilizes these products as a short-term investment alternative whenever it has excess liquidity.
DEPOSITS AND OTHER INTEREST-BEARING LIABILITIES Trustmark's deposit base is its primary source of funding and consists of core deposits from the communities served by Trustmark. Deposits include interest-bearing and noninterest-bearing demand accounts, savings, money market, certificates of deposit, individual retirement accounts and brokered CDs. Total deposits were $5.521 billion at June 30, 2005, compared with $5.450 billion at December 31, 2004, an increase of $70.6 million, or 1.3%. Noninterest-bearing deposits have decreased $105.3 million during the first six months of 2005, while interest-bearing deposits have increased $175.9 million during the same time period. At June 30, 2005, brokered CDs totaled $189.2 million, a decrease of $34.5 million when compared to December 31, 2004. Trustmark will continue to utilize a brokered CD program to provide additional deposit funding. Additional growth in interest-bearing deposits may be attributed to uncertain financial market conditions, which have led to more growth in traditional deposit products such as interest-bearing demand deposits. Management has refocused on initiatives to expand deposits in our market area as a key to providing low cost funding for loan growth. 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 $1.554 billion at June 30, 2005, a decrease of $43.7 million, compared with $1.598 billion at December 31, 2004. Long-term FHLB advances totaled $205.8 million at June 30, 2005, an increase of $24.9 million from December 31, 2004. On a consolidated basis, total borrowings have decreased $18.7 million when compared to December 31, 2004, as Trustmark utilized liquidity from the sale of securities to reduce Trustmark's dependency on wholesale funding products. LEGAL ENVIRONMENT Trustmark and its subsidiaries are parties to lawsuits and other claims that arise in the ordinary course of business. Some of the lawsuits assert claims related to the lending, collection, servicing, investment, trust and other business activities, and some of the lawsuits allege substantial claims for damages. The cases are being vigorously contested. In the regular course of business, Management evaluates estimated losses or costs related to litigation, and provision is made for anticipated losses whenever Management believes that such losses are probable and can be reasonably estimated. In recent years, the legal environment in Mississippi has been considered by many to be adverse to business interests, with regards to the overall treatment of tort and contract litigation as well as the award of punitive damages. However, tort reform legislation that became effective during recent years may reduce the likelihood of unexpected, sizable awards. At the present time, Management believes, based on the advice of legal counsel and Management's evaluation, that the final resolution of pending legal proceedings will not have a material impact on Trustmark's consolidated financial position or results of operations; however, Management is unable to estimate a range of potential loss on these matters because of the nature of the legal environment in states where Trustmark conducts business. OFF-BALANCE SHEET ARRANGEMENTS Trustmark makes commitments to extend credit and issues standby and commercial letters of credit in the normal course of business in order to fulfill the financing needs of its customers. These loan commitments and letters of credit are off-balance sheet arrangements. Commitments to extend credit are agreements to lend money to customers pursuant to certain specified conditions. Commitments generally have fixed expiration dates or other termination clauses. Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Trustmark applies the same credit policies and standards as it does in the lending process when making these commitments. The collateral obtained is based upon the assessed creditworthiness of the borrower. At June 30, 2005 and 2004, Trustmark had commitments to extend credit of $1.434 billion and $1.240 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 June 30, 2005 and 2004, Trustmark's maximum exposure to credit loss in the event of nonperformance by the other party for letters of credit was $114.9 million and $92.8 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 +/- two 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 two 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 June 30, 2005, it is estimated that net interest income may decrease 0.58%, in a one-year, shocked, up 200 basis point rate shift scenario, compared to a base case, flat rate scenario for the same time period. This minor change in forecasted net interest income illustrates Management's strategy to mitigate Trustmark's exposure to cyclical increases in rates by maintaining a neutral position in its interest rate risk position. This projection does not contemplate any additional actions Trustmark could undertake in response to changes in interest rates. In the event of a 100 basis point decrease in interest rates (utilized in place of a 200 basis point drop scenario due to the historically low interest rate environment), it is estimated net interest income may decrease by 1.87%. Management cannot provide any assurance about the actual effect of changes in interest rates on net interest income. The estimates provided do not include the effects of possible strategic changes in the balances of various assets and liabilities throughout 2005. Management will continue to prudently manage the balance sheet in an effort to control interest rate risk and maintain profitability over the long term. 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. 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 June 30, 2005, reflected an asset gap of $50 million compared with a liability gap of $189 million at March 31, 2005. One-year gap analysis projected at June 30, 2005, reflected a liability gap of $151 million compared with a liability gap of $571 million at March 31, 2005. The three-month and one-year gap positions were primarily impacted during the second quarter of 2005 by increases in variable rate loans, as well as an increase in prepayment projections on mortgage loans and mortgage related securities as a result of a flattening yield curve. In addition, the sale of certain investment securities reduced reliance on overnight and other short-term wholesale funding such as federal funds. Of the primary asset groups, Trustmark expects maturities and repricing of approximately $3.365 billion in loans and $401.7 million in securities during the next twelve months. 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.
As part of Trustmark's risk management strategy in the mortgage banking area, various derivative instruments such as interest rate lock commitments and forward sales contracts are utilized. Forward contracts are agreements to purchase or sell securities or other money market instruments at a future specified date at a specified price or yield. Trustmark's obligations under forward contracts consist of commitments to deliver mortgage loans, originated and/or purchased, in the secondary market at a future date. As permitted by Statement of Financial Accounting Standards (SFAS) No. 133, during 2003 Trustmark redesignated these derivative instruments as fair value hedges. In accordance with SFAS No. 133, changes in the values of derivatives designated as fair value hedges are recognized in earnings. In this case, Trustmark recognizes changes in the values of the designated derivatives in earnings simultaneously with changes in the values of the designated hedged loans. To the extent changes in the values of the derivatives are 100% effective in offsetting changes in the values of hedged loans, the fair value adjustments on the derivatives and hedged loans would offset one another. Management anticipates that this change will help mitigate the potential for earnings volatility related to the valuation of these hedging instruments in the future. The fair value of these derivatives was negative $787 thousand at June 30, 2005. Trustmark continued a risk controlling strategy utilizing caps and floors, which may be further implemented over time. As of June 30, 2005, Trustmark was not utilizing interest rate floors but had interest rate cap contracts with notional amounts totaling $300 million, which mature in 2006. The intent of utilizing these financial instruments is to reduce the risk associated with the effects of significant movements in interest rates. Caps and floors, which are not designated as hedging instruments for accounting purposes, are options linked to a notional principal amount and an underlying indexed interest rate. Exposure to loss on these options will increase or decrease as interest rates fluctuate. At June 30, 2005, the fair value of these contracts was $25 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 fair value of these interest rate swaps at June 30, 2005 was negative $940 thousand. RECENT PRONOUNCEMENTS In May 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154, "Accounting Changes and Error Corrections." SFAS No. 154 is a replacement of Accounting Principles Board Opinion (APB) No. 20, "Accounting Changes" and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements." SFAS No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. This statement applies to voluntary changes in accounting principle as well as changes required by an accounting pronouncement that provide no specific transition provisions. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The effects of this statement are not expected to have a material impact on Trustmark's statement of position or results of operations. In December 2004, the FASB issued a revision of SFAS No. 123 (SFAS No. 123r), "Share-Based Payment." This Statement revises SFAS No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123r establishes standards for the accounting for transactions in which a company exchanges equity instruments for goods or services. This statement requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. As of the required effective date, public companies using the fair-value-based method for recognition or disclosure under SFAS No. 123, will apply this statement using a modified version of prospective application. Trustmark adopted the provisions of SFAS No. 123 effective January 1, 2003; therefore, Trustmark will recognize compensation cost for the portion of outstanding awards for which the requisite service has not yet been rendered (unvested awards). For public companies, this statement is effective as of the beginning of the first annual reporting period beginning after June 15, 2005. The effects of this statement are not expected to have a material impact on Trustmark's statement of position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is included in the discussion of Market/Interest Rate Risk Management found in Management's Discussion and Analysis. ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Trustmark, under the supervision and with the participation of its management, including the Chief Executive Officer and the Treasurer (Principal Financial Officer), evaluated the effectiveness of the design and operation of Trustmark's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Principal Financial Officer concluded that as of the end of the second quarter of 2005, Trustmark's disclosure controls and procedures were effective in ensuring that information required to be disclosed in the reports Trustmark files and submits under the Securities Exchange Act of 1934 are recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Changes in Internal Control over Financial Reporting There has been no change in Trustmark's internal control over financial reporting during the quarter ended June 30, 2005 that has materially affected, or is reasonably likely to materially affect, Trustmark's internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS There were no material developments for the quarter ended June 30, 2005, other than those disclosed in the Notes to Consolidated Financial Statements and Management's Discussion and Analysis of this Form 10-Q. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The following table shows information relating to the repurchase of common shares by Trustmark Corporation during the three months ended June 30, 2005: <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> April 1, 2005 through April 30, 2005 147,700 $ 27.51 147,700 1,935,569 May 1, 2005 through May 31, 2005 74,700 $ 27.03 74,700 1,860,869 June 1, 2005 through June 30, 2005 64,600 $ 28.41 64,600 1,796,269 ------------ ------------------- Total 287,000 287,000 ============ =================== </TABLE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The annual meeting of Trustmark's shareholders was held on May 10, 2005. At this meeting, the following matters were voted on by Trustmark's shareholders: A. Election of Directors The following individuals were elected to serve as Directors of Trustmark until the annual meeting of shareholders in 2006 or until their respective successors are elected and qualified. The vote was cast as follows: Votes Cast Votes Cast in Favor Against/Withheld ------------------- ----------------- Number % Number % ---------- ------ --------- ----- J. Kelly Allgood 48,815,112 97.75% 1,124,040 2.25% Reuben V. Anderson 48,630,175 97.38% 1,308,977 2.62% William C. Deviney, Jr. 49,213,017 98.55% 726,135 1.45% C. Gerald Garnett 49,039,904 98.20% 899,248 1.80% Richard G. Hickson 49,189,501 98.50% 749,651 1.50% Matthew L. Holleman III 49,194,469 98.51% 744,683 1.49% John M. McCullouch 48,930,454 97.98% 1,008,698 2.02% Richard H. Puckett 49,055,434 98.23% 883,718 1.77% Carolyn C. Shanks 48,760,590 97.64% 1,178,562 2.36% R. Michael Summerford 48,814,553 97.75% 1,124,599 2.25% Kenneth W. Williams 49,056,234 98.23% 882,918 1.77% William G. Yates, Jr. 49,356,422 98.83% 582,730 1.17% B. Approval of the 2005 Stock and Incentive Compensation Plan A proposal was made to adopt the 2005 Stock and Incentive Compensation Plan. The vote was cast as follows: Votes Cast Votes Cast Votes in Favor Against Abstained ---------- ---------- --------- 2005 Stock and Incentive Compensation Plan 32,131,180 6,860,348 379,593 ITEM 6. EXHIBITS The exhibits listed in the Exhibit Index are filed herewith or are incorporated herein by reference.
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. TRUSTMARK CORPORATION BY: /s/ Richard G. Hickson BY: /s/ Zach L. Wasson ---------------------- --------------------- Richard G. Hickson Zach L. Wasson Chairman of the Board, President Treasurer (Principal & Chief Executive Officer Financial Officer) DATE: August 9, 2005 DATE: August 9, 2005
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. 32-b Certification by Chief Financial Officer pursuant to 18 U.S.C. ss. 1350. All other exhibits are omitted, as they are inapplicable or not required by the related instructions.