TRUSTMARK CORP quarterly report, Q2 FY2013

Trustmark Corporation — Q2 2013 Form 10-Q

Business context and period. Trustmark is a regional financial-services holding company operating in Alabama, Florida, Mississippi, Tennessee and Texas. This unaudited report covers the three and six months ended June 30, 2013. Results include BancTrust from its February 15, 2013 acquisition, so year-over-year comparisons reflect both acquisition effects and underlying changes.

Financial performance and position

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Net interest income	$99.2m	$86.4m	$188.2m	$173.4m
Net income	$31.1m	$29.3m	$56.0m	$59.7m
Diluted EPS	$0.46	$0.45	$0.84	$0.92
Net interest margin, fully taxable equivalent	4.02%	4.15%	4.00%	4.17%

• Q2 pretax income was $42.1m versus $39.9m. For the first half, it was $76.2m versus $81.8m. First-half noninterest expense rose 20.5% to $209.3m, while first-half net income fell 6.2%.
• Q2 noninterest income was broadly flat at $43.7m. Mortgage banking income fell 25.8% year over year in Q2 to $8.3m; bank-card fees and wealth-management income increased.
• Q2 provision was a net recapture of $6.4m, compared with $2.3m of provision in Q2 2012. First-half provision was a net recapture of $9.2m, versus $5.4m of provision in the prior-year period. First-half net loan recoveries were $1.9m, versus $8.7m of net charge-offs.
• At June 30, assets were $11.86bn, deposits $9.82bn and shareholders’ equity $1.33bn. Total assets and deposits increased substantially from year-end 2012, principally due to BancTrust.
• Cash and cash equivalents were $301.5m at June 30, up $70.0m from year-end. First-half operating cash flow was $105.5m, investing cash flow was negative $216.2m and financing cash flow was positive $180.8m.
• Interest-bearing debt and short-term funding included $430.7m of short-term liabilities, $8.7m of long-term FHLB advances, $49.9m of subordinated notes and $61.9m of junior subordinated debt. Deposits remained the primary funding source. Management said liquidity and capital resources were sufficient for known operating needs.
• Trustmark National Bank was well-capitalized at June 30: total risk-based capital 13.52%, Tier 1 risk-based capital 12.20% and Tier 1 leverage 8.47%. The parent’s corresponding ratios were 13.89%, 12.55% and 8.71%.

Material changes and notable items

• BancTrust added $29.3m of revenue and approximately $8.0m of net income through June 30, excluding non-routine transaction expenses. Trustmark recorded about $9.4m of BancTrust merger expenses in the first half. BancTrust contributed approximately $1.027bn to year-to-date average earning-asset growth.
• Net interest income increased, but margin declined as fixed-rate assets repriced downward and the portfolio shifted toward lower-yielding securities. Lower deposit costs and acquired-loan income partly offset these pressures.
• Nonperforming assets, excluding acquired loans and covered other real estate, were $192.0m, up $31.5m, or 19.6%, from year-end; the increase largely reflected acquired other real estate. Nonaccrual loans declined to $74.3m from $82.4m. Management reported year-over-year decreases in classified and criticized LHFI of 16.9% and 20.8%, respectively.
• Other real estate excluding covered assets rose to $117.7m from $78.2m, including $44.8m associated with BancTrust. Excluding BancTrust-related assets, it declined $5.3m from year-end.
• Available-for-sale securities increased to $3.51bn, but rising rates drove a substantial fair-value decline: net unrealized gains fell to $2.5m from $72.8m at year-end, and accumulated other comprehensive income moved from positive $3.4m to negative $36.1m. Management attributed unrealized losses primarily to market rates, not credit quality, and reported no other-than-temporary impairments.
• First-half mortgage-loan servicing putback expense declined to $0.9m from $7.1m in 2012; the reserve was $5.9m. A $4.0m pretax charge was recorded for the proposed settlement of overdraft-fee class actions, subject to court approval and other conditions.

Outlook, risks and contingencies

• Management described the economic outlook as uncertain despite moderate improvement, citing continuing pressure on local-market asset growth, credit quality and earnings. It gave no specific earnings or margin guidance.
• Management estimated that debit-card interchange rules could reduce annual noninterest income by approximately $7m–$10m once Trustmark becomes subject to the standards, expected July 1, 2014. A court decision had remanded the applicable rule to the Federal Reserve, leaving the eventual effect uncertain.
• New regulatory capital rules were expected to apply beginning January 1, 2015; management was evaluating their impact and expected higher capital requirements. Trustmark also expected to become subject to company-run stress tests in fall 2014 after exceeding $10bn in assets.
• Interest-rate sensitivity modeling estimated annual net interest income declines of 0.7% under a 200-basis-point rise and 4.3% under a 100-basis-point decline, based on the latest available May 2013 analysis. Management cautioned that modeled outcomes are not assurances of actual results.
• Key risks include loan defaults and collateral values, regional economic conditions, interest-rate and securities-market volatility, deposit behavior, mortgage servicing representations and warranties, litigation, regulatory changes and integration of acquisitions. Two Stanford-related lawsuits and other claims remained pending; management said losses were not probable and could not be reasonably estimated. The overdraft settlement was not final.

Investor verification points

• Separate BancTrust’s contribution and merger costs from recurring operating trends; review subsequent integration results and finalized purchase accounting.
• Track the rise in nonperforming assets and other real estate, credit migration, reserve adequacy and whether recoveries and provision recaptures persist.
• Assess the effect of interest rates on securities fair values, accumulated other comprehensive loss, net interest margin and mortgage servicing rights.
• Confirm court approval and final terms of the proposed $4m overdraft settlement, and monitor the Stanford cases and mortgage putback exposure.
• Verify the implementation and financial impact of interchange and regulatory capital rules, and monitor capital ratios as acquired assets are integrated.
• Evaluate deposit mix, liquidity capacity and borrowing needs; the filing reports significant available borrowing capacity but no guarantee of future conditions.