Trustmark - 10-Q quarterly report FY

See notes to consolidated financial statements.

See notes to consolidated financial statements.

See notes to consolidated financial statements.

See notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The consolidated financial statements in this quarterly report on Form 10-Q include the accounts of Trustmark Corporation (Trustmark) and all other entities in which Trustmark has a controlling financial interest.  All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles 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 U.S. generally accepted accounting principles for complete financial statements and should be read in conjunction with the consolidated financial statements, and notes thereto, included in Trustmark’s 2007 annual report on Form 10-K.  Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.  Certain reclassifications have been made to prior period amounts to conform to the current period presentation.

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.

NOTE 2 – LOANS AND ALLOWANCE FOR LOAN LOSSES

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 in SEC Staff Accounting Bulletin (SAB) 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 ratings, homogeneous risk pools and specific loss allocations, with adjustments considering environmental factors such as current economic events, industry and geographical conditions and portfolio performance indicators.  The provision for loan losses reflects loan quality trends, including the levels of and trends related to nonaccrual loans, past due loans, potential problem loans and net charge-offs or recoveries, among other factors, in compliance with the Interagency Policy Statement on the Allowance for Loan and Lease Losses published by the governmental regulating agencies for financial services companies.  This evaluation is inherently subjective, as it requires material estimates, including the amounts and timings of future cash flows expected to be received and valuation adjustments on impaired loans that may be susceptible to significant changes. Management believes that the allowance for loan losses adequately provides for probable losses in its loan portfolio at September 30, 2008.

At September 30, 2008 and December 31, 2007, the carrying amounts of nonaccrual loans, which are considered for impairment in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” were $105.3 million and $65.2 million, respectively.  When a loan is deemed to be impaired, the full difference between the carrying amount of the loan and the most likely estimate of the assets net realizable value is charged-off and, as such, the impaired loan has no specific allowance for loan loss reserves.  At September 30, 2008 and December 31, 2007, specifically evaluated impaired loans totaled $42.7 million and $6.5 million, respectively.  For the first nine months of 2008, specific charge-offs related to impaired loans totaled $28.9 million while the provisions charged to net income totaled $18.5 million.  For the first nine months of 2007, both charge-offs related to specifically evaluated impaired loans and provisions charged to net income were zero.

At September 30, 2008 and December 31, 2007, nonaccrual loans, not specifically impaired and written down to net realizable value, totaled $62.6 million and $58.7 million, respectively.  In addition, these nonaccrual loans had allocated allowance for loan losses of $11.8 million and $12.5 million at the end of the respective periods.  No material interest income was recognized in the income statement on impaired or nonaccrual loans during the nine months ended September 30, 2008 and 2007.

NOTE 3 – MORTGAGE BANKING

The fair value of mortgage servicing rights (MSR) is determined using discounted cash flow techniques which are periodically benchmarked against third-party opinions of value. Estimates of fair value involve several assumptions, including the key valuation assumptions about market expectations of future prepayment rates, interest rates and discount rates. Prepayment rates are projected using an industry standard prepayment model. The model considers other key factors, such as a wide range of standard industry assumptions tied to specific portfolio characteristics such as remittance cycles, escrow payment requirements, geographic factors, foreclosure loss exposure, VA no-bid exposure, delinquency rates and cost of servicing, including base cost and cost to service delinquent mortgages. Prevailing market conditions at the time of analysis are factored into the accumulation of assumptions and determination of servicing value.

Trustmark utilizes derivative instruments, specifically exchange-traded Treasury note futures and option contracts, to offset changes in the fair value of MSR attributable to changes in interest rates. Changes in the fair value of these derivative instruments are recorded in mortgage banking income and are offset by the changes in the fair value of MSR, as shown in the accompanying table.  MSR fair values represent the effect of present value decay and the effect of changes in interest rates.  Ineffectiveness of hedging MSR fair value is measured by comparing total hedge position to the fair value of the MSR asset attributable to market changes.  Changes in yields created fluctuating values in both MSR and the hedge during the third quarter of 2008.  Lower mortgage rates experienced during the third quarter resulted in a decrease of $903 thousand in the MSR value due to market changes which contrasts the second quarter of 2008 when the MSR value increased by $13.1 million due to rising mortgage rates.  Conversely, the hedge value increased by $1.7 million during the third quarter of 2008 due to falling yields on ten-year Treasury notes, compared to a second quarter decrease of $10.5 million.  The result was $777 thousand of positive net ineffectiveness during the third quarter compared to $2.6 million during the second quarter.

NOTE 4 - DEPOSITS

At September 30, 2008 and December 31, 2007, deposits consisted of the following ($ in thousands):

NOTE 5 – STOCK AND INCENTIVE COMPENSATION PLANS

Trustmark accounts for stock and incentive compensation following the provisions of Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment,” a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.”  This statement establishes fair value as the measurement objective in accounting for stock awards and requires the application of a fair value based measurement method in accounting for compensation cost, which is recognized over the requisite service period.  Trustmark implemented the provisions of this statement using the modified prospective approach, which applies to new awards, as well as, any previously granted awards outstanding on January 1, 2006.  Compensation cost for the portion of awards for which the requisite service had not been rendered as of the date of adoption, is being recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes previously under SFAS No. 123.

During the first nine months of 2008, there were no grants of stock option awards.  Stock option-based compensation expense totaled $681 thousand and $949 thousand for the first nine months of 2008 and 2007, respectively.  Stock option-based compensation expense totaled $179 thousand and $338 thousand for the three months ended September 30, 2008 and 2007, respectively.

Performance Awards

During the first nine months of 2008, Trustmark awarded 76,464 shares of performance based restricted stock to 28 key members of Trustmark’s executive management team and board of directors.  These performance awards vest based on performance goals of return on average tangible equity (ROATE) and total shareholder return (TSR) compared to a defined peer group.  The awards are restricted until December 31, 2010 and are valued in accordance with SFAS No. 123R.  The TSR portion of the award is valued utilizing a Monte Carlo simulation to estimate fair value of the awards at the grant date, while the ROATE portion is valued utilizing fair value of Trustmark’s stock at the grant date based on the estimated number of shares expected to vest.

The performance based restricted stock issued in May 2005, vested on December 31, 2007. The stock related to this grant was issued to the participants free of restriction during the first quarter of 2008. As a result of achieving 132% of the performance goals during the performance period, 21,060 excess shares were awarded and will vest at either the date of Trustmark’s Annual meeting of Shareholders in 2010 or May 31, 2010, whichever comes first.

Time-Vested Awards

Trustmark’s time-vested awards are granted as an incentive in both employee recruitment and retention and are issued to Trustmark’s directors, the executive management team and non-executive management associates. During the first nine months of 2008, Trustmark awarded 100,368 shares of time-vested restricted stock to key members of Trustmark’s management team and board of directors.  These time-vested awards are restricted for thirty-six months from the award dates.  The weighted average share price of the shares awarded during the first nine months of 2008 was $20.99.

During the first nine months of 2008 and 2007, Trustmark recorded compensation expense for restricted stock awards of $2.5 million and $1.5 million, respectively.  During the three-month period ended September 30, 2008 and 2007, Trustmark recorded compensation expense for restricted stock awards of $884 thousand and $497 thousand, respectively.

NOTE 6 – BENEFIT PLANS

Pension Plan 

Trustmark maintains a noncontributory defined benefit pension plan (Trustmark Capital Accumulation Plan), which covers substantially all associates employed prior to January 1, 2007. The plan provides retirement benefits that are based on the length of credited service and final average compensation as defined in the plan and vests upon five years of service.

In December 2006, Trustmark adopted the provisions of SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" and elected to move its measurement date for the plan to December 31 from October 31.  The following table presents information regarding the net periodic benefit cost for the periods ended September 30, 2008 and 2007 ($ in thousands):

The acceptable range of contributions to the plan is determined each year by the plan's actuary.  Trustmark's policy is to fund amounts allowable for federal income tax purposes.  The actual amount of the contribution will be determined based on the plan's funded status and return on plan assets as of the measurement date, which was December 31, 2007 for amounts related to 2008.  In 2008, Trustmark’s minimum required contribution is expected to be zero.

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 under the plan.  The measurement date for the plan is December 31.

The following table presents information regarding the plan's net periodic benefit cost for periods ended September 30, 2008 and 2007 ($ in thousands):

 

 

NOTE 7 – CONTINGENCIES

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 September 30, 2008 and 2007, Trustmark’s maximum exposure to credit loss in the event of nonperformance by the other party for standby and commercial letters of credit was $182.8 million and $171.9 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 September 30, 2008, the fair value of collateral held was $44.8 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 – 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 grants outstanding during the period.  The following table reflects weighted-average shares used to calculate basic and diluted EPS for the periods presented (in thousands):

NOTE 9 - STATEMENTS OF CASH FLOWS

NOTE 10 – 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, personal and institutional trust, and retirement services, as well as life insurance and risk management services provided by TRMK Risk Management, Inc., a wholly-owned subsidiary of Trustmark National Bank (TNB).  Insurance includes two wholly-owned subsidiaries of TNB:  The Bottrell Insurance Agency and Fisher-Brown, Incorporated.  Through Bottrell and Fisher-Brown, Trustmark provides a full range of retail insurance products, including commercial risk management products, bonding, group benefits and personal lines coverages.  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, Treasury and Corporate Finance.

The accounting policies of each reportable segment are the same as those of Trustmark except for its internal allocations. Noninterest expenses for back-office operations support are allocated to segments based on estimated uses of those services. Trustmark measures the net interest income of its business segments with a process that assigns cost of funds or earnings credit on a matched-term basis.  This process, called "funds transfer pricing", charges an appropriate cost of funds to assets held by a business unit, or credits the business unit for potential earnings for carrying liabilities.  The net of these charges and credits flows through to the Administration Division, which contains the management team responsible for determining the bank's funding and interest rate risk strategies.   During the first nine months of 2008, net interest income increased in the Administration Division primarily from two factors; first, as a result of a steeper yield curve, the earnings credit to segments on deposits declined by a greater amount than the cost of funds charged to segments on loans and secondly, additional interest income was recognized from growth in the securities portfolio which is held in the Administration Division.

The following tables disclose financial information by reportable segment for the periods ended September 30, 2008 and 2007.

 

NOTE 11 – FAIR VALUE

On January 1, 2008, Trustmark adopted SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 established a framework for measuring fair value in generally accepted accounting principles and expanded disclosures about fair value measurements.  In accordance with Financial Accounting Standards Board Staff Position (FSP) No. 157-2, “Effective Date of Financial Accounting Standards Board (FASB) Statement No. 157,” Trustmark will defer application of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities until January 1, 2009.  The application of SFAS No. 157 in situations where the market for a financial asset is not active was clarified by the issuance of FSP No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” in October 2008.  FSP No. 157-3 became effective for Trustmark’s interim financial statements as of September 30, 2008 and did not significantly impact the methods by which Trustmark determines the fair value of its financial assets.

Trustmark measures a portion of its assets and liabilities on a fair value basis. Fair value is used for certain assets and liabilities in which fair value is the primary basis of accounting. Examples of these include derivative instruments, available for sale securities, loans held for sale and MSR. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, Trustmark uses various valuation techniques and assumptions when estimating fair value, which are in accordance with SFAS No. 157.

In accordance with SFAS No. 157, Trustmark groups its assets and liabilities carried at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of assumptions used to determine fair value.  These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active.

Level 3 – Valuation is based on significant valuation assumptions that are not readily observable in the market.

When determining the fair value measurements for assets and liabilities required or permitted to be recorded at and/or marked to fair value, Trustmark considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, Trustmark looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, Trustmark looks to observable market data of similar assets and liabilities. Nevertheless, certain assets and liabilities are not actively traded in observable markets and Trustmark must use alternative valuation techniques to derive a fair value measurement.

The methodologies Trustmark uses in determining the fair values are based primarily on the use of independent, market-based data to reflect a value that would be reasonably expected upon exchange of the position in an orderly transaction between market participants at the measurement date.  The large majority of assets that are stated at fair value are of a nature that can be valued using prices or inputs that are readily observable through a variety of independent data providers.  The providers selected by Trustmark for fair valuation data are widely recognized and accepted vendors whose evaluations support the pricing functions of financial institutions, investment and mutual funds, and portfolio managers.  Trustmark has documented and evaluated the pricing methodologies used by the vendors and has maintained internal processes that regularly test valuations for anomalies.

Mortgage loan commitments are valued based on the securities prices of similar collateral, term, rate and delivery for which the loan is eligible to deliver in place of the particular security.  Trustmark acquires a broad array of mortgage security prices that are supplied by a market data vendor, which in turn accumulates prices from a broad list of securities dealers.  Prices are processed through a mortgage pipeline management system that accumulates and segregates all loan commitment and forward-sale transactions according to the similarity of various characteristics (maturity, term, rate, and collateral).  Prices are matched to those positions that are deemed to be an eligible substitute or offset (i.e. “deliverable”) for a corresponding security observed in the market place.

Trustmark uses an independent valuation firm to estimate fair value of MSR through the use of prevailing market participant assumptions and market participant valuation processes.  This valuation is periodically tested and validated against other third-party firm valuations.

At this time, Trustmark presents no fair values that are derived through internal modeling.  Should positions requiring fair valuation arise that are not relevant to existing methodologies, Trustmark will make every reasonable effort to obtain market participant assumptions, or independent evaluation.

The changes in Level 3 assets measured at fair value on a recurring basis as of September 30, 2008 are summarized as follows ($ in thousands):

Trustmark may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. Assets at September 30, 2008 which have been measured at fair value on a nonrecurring basis include impaired loans.  Loans for which it is probable Trustmark will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, Management measures impairment in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.”  Specific allowances for impaired loans are based on comparisons of the recorded carrying values of the loans to the present value of the estimated cash flows of these loans at each loan’s original effective interest rate, the fair value of the collateral or the observable market prices of the loans. At September 30, 2008, Trustmark had outstanding balances of $42.7 million in impaired loans that were specifically identified for evaluation in accordance with SFAS No. 114 and were written down to net realizable value based on the fair value of the collateral or other unobservable input.  These impaired loans are classified as Level 3 in the fair value hierarchy.

Certain nonfinancial assets and nonfinancial liabilities measured at fair value on a recurring basis include reporting units measured at fair value in the first step of a goodwill impairment test, as well as intangible assets.  As stated above, SFAS No. 157 will be applicable to these fair value measurements beginning January 1, 2009.

NOTE 12 – RECENT PRONOUNCEMENTS

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.”  SFAS No. 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument-by-instrument basis, is typically irrevocable once elected. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, and early application is allowed under certain circumstances. Management elected not to apply the fair value option to any of its assets or liabilities at January 1, 2008.

In June 2007, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.”  EITF 06-11 states that an entity should recognize a realized tax benefit associated with dividends on nonvested equity shares, nonvested equity share units and outstanding equity share options charged to retained earnings as an increase in additional paid in capital.  EITF 06-11 should be applied prospectively to income tax benefits of dividends on equity-classified share-based payment awards that are declared in fiscal years beginning after December 15, 2007.  The adoption of EITF 06-11 did not have a material impact on Trustmark’s balance sheets or results of operations.

In November 2007, the SEC issued SAB No. 109 (SAB 109), “Written Loan Commitments Recorded at Fair Value Through Earnings.” SAB 109 rescinds SAB 105’s prohibition on inclusion of expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. SAB 109 also applies to any loan commitments for which fair value accounting is elected under SFAS No. 159. SAB 109 is effective prospectively for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007.  The adoption of SAB 109 did not have a material impact on Trustmark’s balance sheets or results of operations.

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 this document 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, and relating to the anticipated investment by the U.S. Treasury in Trustmark as part of its Capital Purchase Program, 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, including the extent and duration of current volatility in the credit and financial markets, 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.

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 approximately 150 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 over 98% 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 its wholly-owned subsidiaries, Trustmark Investment Advisors, Inc., The Bottrell Insurance Agency, Inc. (Bottrell), TRMK Risk Management, Inc., and Fisher-Brown, Incorporated (Fisher-Brown). TNB also owns all of the stock of Trustmark Securities, Inc., an inactive subsidiary.

Trustmark also engages in banking activities through its wholly-owned subsidiary, Somerville Bank & Trust Company (Somerville), headquartered in Somerville, Tennessee.  Somerville presently has five locations in Somerville, Hickory Withe and Rossville, Tennessee.  Trustmark also owns all of the stock of F. S. Corporation and First Building Corporation, both inactive nonbank Mississippi corporations.

In order to facilitate a private placement of trust preferred securities, Trustmark formed a Delaware trust affiliate, Trustmark Preferred Capital Trust I (Trustmark Trust).  Also, as a result of the acquisition of Republic Bancshares of Texas, Inc., Trustmark owns Republic Bancshares Capital Trust I (Republic Trust), a Delaware trust affiliate.  As defined in applicable accounting standards, both Trustmark Trust and Republic Trust, wholly-owned subsidiaries of Trustmark, are considered variable interest entities for which Trustmark is not the primary beneficiary.  Accordingly, the accounts of both trusts are not included in Trustmark’s consolidated financial statements.

 

CRITICAL ACCOUNTING POLICIES

Trustmark’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles 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.  There have been no significant changes in Trustmark’s critical accounting estimates during the first nine months of 2008.

FINANCIAL HIGHLIGHTS

Trustmark’s net income totaled $23.4 million in the third quarter of 2008, which represented basic and diluted earnings per share of $0.41.  Trustmark’s third quarter 2008 net income produced returns on average tangible equity and average assets of 15.16% and 1.02%, respectively.  During the first nine months of 2008, Trustmark’s net income totaled $67.1 million, which represented basic and diluted earnings per share of $1.17.  Trustmark’s performance during this period resulted in returns on average tangible equity and average assets of 14.80% and 0.99%, respectively.

Selected Income Statement Data

Management is presenting, in the accompanying table, adjustments to net income as reported in accordance with generally accepted accounting principles resulting from significant items occurring during the periods presented. Management believes this information will help users compare Trustmark’s current results to those of prior periods as presented in the table below ($ in thousands):

 

MasterCard Class A Common

During the second quarter of 2008, MasterCard offered Class B shareholders the right to convert their stock into marketable Class A shares.  Trustmark exercised its right to convert its shares and sold them through a liquidation program.  The conversion and sale resulted in an after-tax gain of $3.3 million.

Visa Litigation Contingency

In the first quarter of 2008, Trustmark recognized an after-tax gain of $936 thousand resulting from the Visa initial public offering.  This gain more than offsets an after-tax accrual of $494 thousand that Trustmark recorded in the fourth quarter of 2007 for the Visa litigation contingency relating to the Visa USA Inc. antitrust lawsuit settlement with American Express and other pending Visa litigation (reflecting Trustmark’s share as a Visa member).

Hurricane Katrina

In the third quarter of 2005, immediately following the aftermath of Hurricane Katrina, Trustmark estimated possible pre-tax losses resulting from this storm of $11.7 million.  Trustmark revised these estimates quarterly and any subsequent adjustments are reflected in the table above, net of taxes.  At September 30, 2008, the allowance for loan losses included $364 thousand related to possible Hurricane Katrina losses.

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 on 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 income associated with the average loan balances are immaterial.

Net interest income-FTE for the three and nine months ended September 30, 2008, increased $4.3 million and $10.6 million, respectively, when compared with the same time periods in 2007. Trustmark has expanded its net interest margin in a falling rate environment during the third quarter of 2008.  This was accomplished through continued deposit pricing discipline, afforded to Trustmark due to a strong liquidity position and stable deposit base. In addition, net interest income has now begun to recognize the full impact of the decision to purchase securities during 2008 given the opportunities afforded by a positively sloped yield curve.  The combination of these factors resulted in a six basis point increase in NIM to 3.95%, when the first nine months of 2008 is compared with the same time period in 2007, while the third quarter NIM of 4.01% was twelve basis points higher than in the third quarter of 2007. For additional discussion, see Market/Interest Rate Risk Management included later in Management’s Discussion and Analysis.

Average interest-earning assets for the first nine months of 2008 were $8.074 billion, compared with $7.845 billion for the same time period in 2007, an increase of $229.5 million. The increase was primarily due to an increase in average total loans during the first nine months of 2008, which increased $254.0 million, or 3.7%, relative to the same time period in 2007.  The increase in average total loans was partially offset by a decrease of $22.3 million in fed funds sold and reverse repos.  However, interest rates continued to fall during the first nine months of 2008 which contributed to a decline in the yield on loans of 101 basis points when compared to the same time period in 2007.  Although average total securities decreased slightly during the first nine months of 2008, recent purchases have provided significantly higher yields when compared to previous periods partially due to a slightly longer duration of the securities portfolio.  The overall yield of securities during 2008 has increased 53 and 32 basis points when compared to the third quarter of 2007 and the nine months ended September 30, 2007, respectively.  This improvement has helped to offset decreasing loan yields seen during the periods discussed above.  The combination of these factors resulted in a decline in interest income-FTE of $38.6 million, or 9.4%, when the first nine months of 2008 is compared with the same time period in 2007.  The impact of these factors is also illustrated by the yield on total earning assets decreasing from 6.99% for the first nine months of 2007, to 6.14% for the same time period of 2008, a decrease of 85 basis points.

Average interest-bearing liabilities for the first nine months of 2008 totaled $6.549 billion compared with $6.326 billion for the same time period in 2007, an increase of $223.5 million, or 3.5%.  However, the mix of these liabilities has changed when these two periods are compared.  Management’s strategy of disciplined deposit pricing resulted in a 1.8% increase in interest-bearing deposits during the first nine months of 2008 while the combination of federal funds purchased, securities sold under repurchase agreements and borrowings increased by 16.3%. The impact of utilizing these higher cost interest-bearing liabilities was offset somewhat by the decrease in the overall yield of 220 basis points on these products when the first nine months of 2008 is compared with the same time period in 2007.  As a result of these factors, total interest expense for the first nine months of 2008 decreased $49.2 million, or 27.0%, when compared with the same time period in 2007.