Trustmark Corporation — Q2 2011 Form 10-Q
Business context and reporting period. Trustmark is a Mississippi-based bank holding company operating banking, mortgage, wealth management and insurance businesses across Mississippi, Tennessee, Florida and Texas. This unaudited report covers the quarter and six months ended June 30, 2011; balance-sheet comparisons are to December 31, 2010. Amounts below are in millions unless stated otherwise.
Financial performance and condition
- Q2 earnings: Net income was $31.6 million, up 20.8% from $26.2 million a year earlier; diluted EPS was $0.49 versus $0.41. Results included a $4.6 million after-tax bargain-purchase gain, approximately $0.07 per share, from the Heritage acquisition.
- First-half earnings: Net income was $55.6 million versus $49.6 million, and diluted EPS was $0.87 versus $0.78. The six-month results also included the Heritage gain.
- Revenue, margin and costs: Q2 net interest income was $87.8 million versus $88.5 million; first-half net interest income was $174.2 million versus $175.9 million. Fully taxable-equivalent net interest margin was 4.29% for both Q2 and the first half, down from 4.47% and 4.45%, respectively, in 2010. First-half noninterest income was $82.8 million versus $83.3 million; noninterest expense was $161.4 million versus $160.8 million. Lower loan-loss provision and lower foreclosure/ORE expense supported earnings.
- Returns and dividend: Q2 return on average assets was 1.32% and return on average tangible common equity was 14.71%. The quarterly dividend was $0.23 per share; the Board declared the same dividend for payment September 15, 2011.
- Cash flow: First-half operating cash flow was $136.4 million, investing cash flow was $95.7 million and financing cash flow was negative $171.7 million. Cash and cash equivalents ended at $221.9 million, up $60.3 million from year-end.
- Balance sheet and funding: Total assets were $9.70 billion, up from $9.55 billion at year-end. Deposits rose 8.3% to $7.63 billion. Loans held for investment excluding covered loans declined to $5.91 billion from $6.06 billion. Securities totaled $2.49 billion. Short-term liabilities were $629.8 million, down from $1.13 billion; long-term FHLB advances were $2.8 million, subordinated notes $49.8 million and junior subordinated debt $61.9 million. Shareholders’ equity was $1.19 billion.
- Liquidity and capital: Management said liquidity and capital resources were adequate. At June 30, the bank’s total risk-based capital ratio was 16.09%, Tier 1 risk-based ratio 14.09% and Tier 1 leverage ratio 9.92%; it was classified as well-capitalized. Trustmark’s corresponding ratios were 16.47%, 14.46% and 10.18%. Additional disclosed borrowing capacity included $1.86 billion of FHLB capacity and $834.5 million at the Federal Reserve Discount Window.
Material changes and credit quality
- Heritage acquisition: On April 15, Trustmark acquired substantially all assets and assumed deposits of Heritage Banking Group in an FDIC-assisted transaction. The FDIC shares 80% of covered losses on approximately $151.9 million of assets, subject to agreement terms. Heritage contributed $9.2 million of Q2 revenue and $5.2 million of net income available to common shareholders. Trustmark recorded a $7.5 million pretax bargain-purchase gain; fair-value estimates and final settlement remained subject to adjustment. No FDIC clawback was payable at June 30.
- Credit trends: Nonperforming assets excluding covered assets were $211.0 million, down 8.1% from year-end; nonaccrual loans fell to $121.0 million from $142.9 million. Net charge-offs were $22.3 million for the first half, versus $28.5 million in 2010, although Q2 charge-offs were higher year over year. The allowance was $86.8 million, down from $93.5 million; allowance to loans was 1.47% versus 1.54% at year-end. Troubled debt restructurings increased to $24.1 million from $19.2 million.
- Portfolio changes: Management was reducing construction and land-development lending and indirect auto exposure. Total loans held for investment excluding covered loans declined $153.9 million since year-end, including a $72.4 million decline in construction/land-development loans and a $70.1 million decline in consumer loans.
- Income mix: First-half deposit service charges fell 9.0%, partly reflecting Regulation E changes; mortgage banking income fell 26.6%, to $11.0 million. Wealth management income rose 7.6%. First-half noninterest income included the acquisition gain, so reported comparisons are affected by this unusual item.
Outlook, risks and contingencies
- Management described a weakening, uncertain economic recovery and expected pressure on asset quality and earnings to persist through at least the remainder of 2011. It provided no specific earnings or revenue guidance; interim results are not necessarily indicative of full-year results.
- Management cited credit deterioration, property values, foreclosures, interest-rate movements, deposit withdrawals and funding costs, competition, regulation, litigation and acquisition integration as risks. Loan concentrations in the company’s regional markets make real-estate recovery sensitive to local conditions.
- Interest-rate simulations estimated annual net interest income would decline 2.2% under a 200-basis-point rise and 3.6% under a 100-basis-point decline from June 30, 2011 static balances. These are modeled estimates, not forecasts. Management noted that regulatory changes to overdraft programs could reduce 2011 noninterest income by an estimated $1.5–$2.0 million, depending on implementation timing.
- Two Stanford Financial Group-related lawsuits against the bank subsidiary remained pending or stayed; plaintiffs had not quantified damages in the described claims. Management, based on counsel and its assessment, did not consider a material adverse outcome reasonably possible. Ordinary-course claims also remain.
- Off-balance-sheet commitments to extend credit were $1.6 billion. Letters of credit had a maximum exposure of $170.9 million, with $56.9 million of collateral held at June 30. These amounts are contingent exposures, not necessarily expected cash outflows.
- Trustmark’s assets were just below the $10 billion threshold discussed for certain regulatory provisions. Management said the debit-card interchange fee rule did not apply to the company at the time, but estimated a potential annual noninterest-income reduction of $6–$8 million if assets exceed the threshold and the rule applies.
Important facts for investors to verify
- How much of reported earnings growth was attributable to the nonrecurring Heritage bargain-purchase gain, and how Heritage performs after acquisition.
- Whether declines in nonperforming loans and net charge-offs continue, and whether the allowance remains adequate as loan and property conditions evolve.
- The impact of margin compression, loan runoff, deposit pricing and the company’s interest-rate exposure on future net interest income.
- Whether deposit growth is sustainable and how much reliance the company places on wholesale and other supplemental funding.
- Potential effects of overdraft regulation, the $10 billion asset threshold and other Dodd-Frank implementation on fee income, costs and capital.
- Updates on the Stanford-related litigation, mortgage servicing putback exposure and any revisions to Heritage acquisition fair values or FDIC loss-share estimates.