Trustmark - 10-Q quarterly report FY

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.

Certain statements contained in this 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 include, but are not limited to, statements relating 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, but are not limited to, changes in the level of nonperforming assets and charge offs, local, state and national economic and market conditions, material changes in market interest rates, the costs and effects of litigation and of unexpected or adverse outcomes in such litigation, competition in loan and deposit pricing, as well as the entry of new competitors into our markets through de novo expansion and acquisitions, changes in existing regulations or the adoption of new regulations, natural disasters, acts of war or terrorism, changes in consumer spending, borrowings and savings habits, technological changes, changes in the financial performance or condition of Trustmark’s borrowers, the ability to control expenses, changes in Trustmark’s compensation and benefit plans, greater than expected costs or difficulties related to the integration of new products and lines of business and other risks described in Trustmark’s filings with the Securities and Exchange Commission.

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.

 

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 2,600 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. Initially 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, TRMK 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 September 30, 2005 and 2004, totaled $26.2 million and $28.1 million, respectively. Basic and diluted earnings per share were $0.46 for the third quarter of 2005, compared with basic and diluted earnings per share of $0.49 and $0.48, respectively, for the third quarter of 2004. Net income for the nine months ended September 30, 2005 and 2004, totaled $75.2 million and $87.9 million, respectively. Basic and diluted earnings per share for the nine months ended September 30, 2005 were $1.32 compared with basic and diluted earnings per share of $1.51 for the nine months ended September 30, 2004. At September 30, 2005, Trustmark reported gross loans of $5.873 billion, total assets of $8.329 billion, total deposits of $5.845 billion and shareholders’ equity of $732.6 million.

Management utilizes certain financial ratios to gauge Trustmark’s performance. Trustmark achieved a return on average assets of 1.27% and a return on average equity of 13.81% for the three months ended September 30, 2005. These compared with ratios of 1.35% for return on average assets and 15.26% for return on average equity for the three months ended September 30, 2004. For the nine months ended September 30, 2005, Trustmark achieved a return on average assets of 1.23% and a return on average equity of 13.36%. These compare to a return on average assets of 1.44% and a return on average equity of 16.34% for the same periods of 2004.

 

 

On August 29, 2005, Hurricane Katrina struck the Mississippi Gulf Coast, central and eastern Mississippi causing significant damages. Immediately following the storm, Trustmark initiated a process to assess the impact on its customers and on Trustmark’s consolidated financial statements. In accordance with Statement of Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies," Trustmark has determined, through reasonable estimates, that specific losses were probable and have been reflected in the consolidated financial statements as of September 30, 2005.

While no Trustmark facilities sustained significant damage, a number of Trustmark’s offices were temporarily closed until utility services were restored. Trustmark identified customers impacted by the storm in an effort to estimate the loss of collateral value and customer payment abilities. As a result of customer surveys, collateral inspections and a review of risk characteristics, management increased its allowance for loan losses due to the storm by $9.8 million, which reduced third quarter net income by $6.1 million. Trustmark also recorded mortgage related charges, including adjusted fair values on residential mortgage loans held for sale, mortgage servicing rights impairment for increases in prepayment speeds on mortgage loans and waived fees in the affected area, which collectively reduced third quarter net income by $1.4 million. Lower noninterest revenue as a result of waived retail account charges and hurricane relief efforts also reduced Trustmark’s third quarter net income by $839 thousand and $333 thousand, respectively.

Trustmark evaluated its strategic alternatives in payment processing systems and selected NOVA Information systems as its provider of card processing services for its commercial merchant services customers. In connection with this alliance, Trustmark sold its existing payment processing portfolio in the third quarter for a pre-tax gain of $5.75 million, which is included in other noninterest income.

 

Management is presenting in the accompanying table adjustments to net income as reported in accordance with generally accepted accounting principles for significant items resulting from Hurricane Katrina and the sale of its merchant services portfolio. Management believes this information will help users compare Trustmark’s current results to prior periods.

 

 

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.

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 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 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.

 

Generally accepted accounting principles require the use of fair values in determining the carrying values of certain 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.

 

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.

 

 

Net interest income-FTE for the three-month and nine-month periods of 2005 decreased $946 thousand, or 1.3%, and $2.7 million, or 1.3%, when compared with the same periods of 2004. Increases in the target fed funds rate of 275 basis points throughout 2004 and the first nine months 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 of 4 basis points for the nine months ended September 30, 2005 and 1 basis point for the quarter ended September 30, 2005 when compared with the same period in 2004. For additional discussion, see Market/Interest Rate Risk Management included later in the Management’s Discussion and Analysis.

 

 

 

Average interest-earning assets for the first nine months of 2005 were $7.404 billion, compared with $7.412 billion for the first nine months of 2004, a decrease of $7.8 million, or 0.1%. Growth in average loans, which increased $446.0 million, or 8.5%, was offset by a decrease in average securities of $462.3 million, or 21.6%, when the first nine 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 275 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 these sales were used to reduce balances of higher-cost funding sources. In addition, the flat yield curve experienced during the third quarter of 2005 along with expectations of higher rates provided limited opportunity to carry securities profitably, therefore, Management utilized the liquidity generated by maturing securities to fund additional loan growth as well as reduce balances of higher-cost funding sources during that time period.