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| TRMK > SEC Filings for TRMK > Form 10-K/A on 2-Jul-2009 | All Recent SEC Filings |
2-Jul-2009
Annual Report
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 Annual Report on Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify forward-looking statements by words such as "may," "hope," "will," "should," "expect," "plan," "anticipate," "intend," "believe," "estimate," "predict," "potential," "continue," "could," "future" or the negative of those terms or other words of similar meaning. You should read statements that contain these words carefully because they discuss our future expectations or state other "forward-looking" information. 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. You should be aware that the occurrence of the events described under Item 1A. Risk Factors, could have an adverse effect on our business, results of operations and financial condition. 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.
Risks that could cause actual results to differ materially from current expectations of Management 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 the current volatility in the credit and financial markets, changes in our ability to measure the fair value of assets in our portfolio, material changes in the level and/or volatility of market interest rates, the performance and demand for the products and services we offer, including the level and timing of withdrawals from our deposit accounts, the costs and effects of litigation and of unexpected or adverse outcomes in such litigation, our ability to attract noninterest-bearing deposits and other low-cost funds, competition in loan and deposit pricing, as well as the entry of new competitors into our markets through de novo expansion and acquisitions, economic conditions and monetary and other governmental actions designed to address the level and volatility of interest rates and the volatility of securities, currency and other markets, the enactment of legislation and changes in existing regulations, or enforcement practices, or the adoption of new regulations, changes in accounting standards and practices, including changes in the interpretation of existing standards, that effect our consolidated financial statements, changes in consumer spending, borrowings and savings habits, technological changes, changes in the financial performance or condition of Trustmark's borrowers, changes in Trustmark's 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, natural disasters, acts of war or terrorism 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.
EXECUTIVE OVERVIEW
The national economy, in 2008, faced numerous challenging macro-economic conditions. The economy was in recession and experienced rising unemployment, declining home values, extremely low liquidity in the debt markets and declining values and high volatility in the equity markets. As a result of these conditions, consumer confidence and spending decreased substantially and asset values declined. The capital and earnings levels of numerous financial institutions were negatively affected and a number of financial institutions failed or merged, in some cases with government involvement, with stronger financial institutions.
During 2008, Management monitored carefully the impact of illiquidity in the financial markets, declining values of securities and other assets, loan performance, default rates and other financial and macro-economic indicators, in order to navigate the challenging economic environment. Management implemented strategic decisions to reduce certain loan classifications, including construction, land development and other land loans, loans secured by 1-4 family residential properties and indirect auto loans. Throughout 2008, Trustmark and TNB's capital ratios exceeded the minimum levels required for it to be ranked well-capitalized, both prior to and after Trustmark's participation in the U.S. Treasury's TARP CPP.
During 2008, Management also monitored the trend of weakening residential real estate property values and increasing default rates, substantially all of which is in the Florida Panhandle region. Trustmark's other markets have experienced less of a decline in values and a marginal increase in default rates to date. The non-Florida markets in which Trustmark operates did not experience the dramatic rise in real estate values prior to the recession as was prevalent in Florida and other sections of the country. As a result, the impact of the recession on property values in Trustmark's other markets has been much less severe.
In 2008, Trustmark did not make significant changes to its loan underwriting standards. Trustmark's willingness to make loans to qualified applicants that meet its traditional, prudent lending standards has not changed. However, TNB has adjusted its concentration limits of commercial real estate loans, and closely adheres to its primary regulator's guidelines. As a result, TNB has been more restrictive in granting credit involving certain categories of real estate, particularly in Florida. Furthermore, in the current economic downturn, TNB makes fewer exceptions to its loan policy as compared to prior periods.
During 2008, Management continued its practice of maintaining excess funding capacity to provide Trustmark with adequate liquidity for its ongoing operations. In this regard, Trustmark benefits from its strong deposit base, its investment portfolio and its access to funding from a variety of external funding sources. Among such sources, Trustmark's borrowings from the Federal Reserve's TAF program and its purchase of Federal funds in 2008 reduced its funding cost relative to other interest-bearing sources. During the fourth quarter of the 2008 fiscal year, Trustmark was able to add to its funding sources $200.0 million in short-term TAF borrowings. In addition, at December 31, 2008, Trustmark had $640 million of Federal funds purchased, $319 million, or 100%, more than the amount of Federal funds purchased at December 31, 2007.
TARP CAPITAL PURCHASE PROGRAM
Trustmark chose to participate in the TARP CPP in order to reinforce its strong capital position, advance the Treasury's efforts to facilitate additional lending in the markets where Trustmark operates, maintain its competitive advantage over its less well-capitalized competitors, support its foreclosure mitigation programs and support its general operations. Trustmark's decision to participate in the TARP CPP was also affected by discussions with its regulators, including the OCC, the Federal Reserve and the U.S. Treasury. Trustmark elected to participate in the TARP CPP as a healthy, well-capitalized bank.
As part of its participation in the TARP CPP, in addition to issuing 215,000 shares of Senior Preferred stock to the U.S. Treasury, Trustmark also issued to the U.S. Treasury a ten-year warrant (the Warrant) to purchase up to 1,647,931 shares of Trustmark's common stock, at an initial exercise price of $19.57 per share, subject to customary anti-dilution adjustments.
Cumulative dividends on the Senior Preferred stock will accrue on the liquidation preference at a rate of 5% per annum until February 15, 2014, and at a rate of 9% per annum thereafter, but will be paid only if, as, and when declared by Trustmark's Board of Directors. The Senior Preferred stock has no maturity date and ranks senior to the common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of Trustmark. The Senior Preferred stock is nonvoting, except in the event of a default in the payment of dividends for an aggregate of six or more quarters. The Senior Preferred stock constitutes Tier 1 capital for Trustmark.
Trustmark may redeem the Senior Preferred stock at par. Based upon recent legislation, it is not necessary for Trustmark to replace the Senior Preferred stock with Tier 1 (or other) capital as a condition to redemption. Any redemption is, however, subject to the consent of the U.S. Treasury, the Federal Reserve and the OCC.
The Senior Preferred stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. Trustmark registered the resale of the Senior Preferred stock, the Warrant, and the issuance of shares of common stock upon exercise of the Warrant (the "Warrant Shares") on December 12, 2008, in an automatic shelf registration statement filed with the U.S. Securities and Exchange Commission. Neither the Senior Preferred stock nor the Warrant are subject to any contractual restrictions on transfer, except that the U.S. Treasury may only transfer and/or exercise the Warrant with respect to an aggregate of one-half of the Warrant Shares prior to the earlier of (i) the date on which Trustmark has received aggregate gross proceeds of not less than $215.0 million from one or more Qualified Equity Offerings (as defined below) and (ii) December 31, 2009.
The Securities Purchase Agreement pursuant to which the U.S. Treasury purchased the Senior Preferred stock and the Warrant defines a "Qualified Equity Offering" as the sale and issuance for cash by Trustmark, to persons other than Trustmark or any Trustmark subsidiary, of shares of perpetual preferred stock, common stock or any combination of such stock, that, in each case, qualify as and may be included in Tier 1 capital of Trustmark at the time of issuance under the applicable risk-based capital guidelines of Trustmark's Federal banking regulator.
The Warrant has been exercisable since November 21, 2008, its date of issuance. In the event Trustmark completes one or more Qualified Equity Offerings on or prior to December 31, 2009 that result in Trustmark receiving aggregate gross proceeds of not less than $215.0 million, the number of the shares of common stock underlying the portion of the Warrant then held by the U.S. Treasury will be reduced by a number of shares equal to the product of (i) the number of shares of common stock initially covered by the Warrant (taking into account any adjustments pursuant to the terms of the Warrant), and (ii) 0.5.
Copies of the Securities Purchase Agreement, the Warrant, the Certificate of Designations for the Senior Preferred stock and the form of Senior Preferred stock certificate are included as exhibits to this report. The foregoing summary of these documents is qualified in its entirety by reference thereto.
Use of Capital
The TARP CPP funds have not been segregated from Trustmark's other funds, and thus those funds cannot be directly traced through Trustmark's balance sheet.
Based on analysis of the market conditions at the time of issuance, Trustmark determined that the proceeds of the U.S. Treasury investment in its Senior Preferred stock initially would be best deployed in U.S. Government Agency mortgage-backed securities (MBS) until loan demand improved. Trustmark retained $10 million of the proceeds to provide for the 2009 dividend payments on the Senior Preferred stock and invested the remaining $205 million in TNB. In turn, TNB invested the $205 million of the proceeds, along with other funds obtained to leverage the TARP CPP investment, in MBS, pending deployment in more permanent uses. With these investments, Trustmark provided incremental liquidity to the residential mortgage markets and at the same time obtained products that generate cash flow. Trustmark is holding the MBS assets on its balance sheet as available for sale. Trustmark intends to utilize its cash flows, including those derived from its MBS investments and the proceeds of any sale or disposition of its MBS investments, to fund commercial and residential loans that meet Trustmark's long-standing prudent lending standards as the demand for high-quality loans rises in the markets it serves, as well as to advance foreclosure mitigation efforts and otherwise support its business.
Trustmark is committed to making credit available to the markets it serves and fulfilling the needs of its customers. To insure that all lending growth opportunities were addressed, Trustmark restructured its Senior Loan Committee to form two new committees, composed of senior and executive management: the Commercial Loan Committee and the Real Estate Loan Committee. Additionally, senior executives were placed in lending roles specializing in particular loan products to address the needs of existing and prospective clients. In certain sectors, such as commercial lending, loan demand has diminished consistent with the overall economy as customers have taken a conservative direction and postponed investments. Conversely, residential mortgage activity increased in December 2008 and into the first fiscal quarter of 2009 in response to favorable interest rates and new Government Agency programs; nearly three quarters of this activity was in the form of refinancings, with the balance consisting of new purchases. While the TARP CPP funds have not been segregated, and this increased lending is not directly traceable in a dollar-for-dollar manner to the TARP CPP, the strengthening of Trustmark's balance sheet by the TARP CPP investment has directly facilitated increased lending activity.
In addition, Trustmark has initiated programs and dedicated additional resources and staff to seek to mitigate foreclosure of primary residences on borrowers that are subject to adverse financial conditions in the current economic environment. Loss mitigation counselors and additional support staff have been added to accommodate loss mitigation activity. Trustmark has utilized personnel in its collections department and has conducted regular training of its personnel on foreclosure mitigation in order to respond to this need. In some cases, Trustmark may make special payment arrangements with such borrowers. Likewise, Trustmark is following the Fannie Mae, Freddie Mac and GNMA guidelines for foreclosure moratoriums in its portfolio of loans serviced for others.
Loan modifications made to date have mostly occurred on loans serviced for outside investors. To date, there have been comparatively less need for, or use of, available loan modification programs on Trustmark's primary residence mortgage portfolio. This is a function of Trustmark's preference for shorter average loan terms and the aging of its portfolio, as well as adherence to its prudent lending standards. However, Trustmark is preparing for a potential increase in demand for loan modification on internal loans covering primary residences, and intends to carry out specific programs as needed. As for new loan originations, Trustmark follows, in substantially all situations, the underwriting standards of the government agencies. As those agencies have revised standards on new originations, so has Trustmark.
Effects of TARP CPP Participation
Pursuant to the terms of the Securities Purchase Agreement, Trustmark registered for resale the Senior Preferred stock, the Warrant to purchase 1,647,931 shares of its common stock and the shares of common stock underlying the Warrant, in an automatic shelf registration statement filed with the Securities and Exchange Commission on December 12, 2008. Pursuant to the terms of the Securities Purchase Agreement, prior to November 21, 2011, unless Trustmark has redeemed the Senior Preferred stock or the U.S. Treasury has transferred the Senior Preferred stock to a third party, Trustmark may not, without the consent of the U.S. Treasury, (i) declare or pay any dividend or make any distribution on its common stock (other than regular quarterly cash dividends of not more than $0.23 per share of common stock) or (ii) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other limited circumstances specified in the Securities Purchase Agreement.
The Warrant is immediately exercisable, and if exercised, Trustmark's common shareholders, would be diluted by the issuance of up to 1,647,931 additional shares of common stock.
The Certificate of Designations of the Senior Preferred provides that, in the event Trustmark defaults on the payment of dividends due on the Senior Preferred for an aggregate of six quarters or more, the Board of Directors of Trustmark shall be automatically increased by two positions, and the holders of the Senior Preferred shall have the right to elect two directors to fill those positions. There was no need for Trustmark to amend its bylaws to increase the maximum size of the board of directors in order to be able to accommodate an election of those two directors. However, Trustmark's bylaws were amended, effective November 21, 2008, to permit the expansion of the board of directors under such circumstances by means of an automatic process, consistent with the provisions of the Certificate of Designations of the Senior Preferred. Trustmark did not have any other senior class of securities outstanding at the time it entered into the Securities Purchase Agreement.
With respect to Trustmark's day-to-day operations, participation in the TARP CPP has heightened the focus on originating new loans that meet TNB's prudent lending standards. In addition, Trustmark is following the Fannie Mae, Freddie Mac and GNMA guidelines for foreclosure moratoriums in TNB's portfolio of loans serviced for others.
Participation in the TARP CPP strengthened Trustmark's capital ratios. For example, at September 30, 2008 (prior to the TARP CPP transaction), TNB's ratios of Total Capital to Risk Weighted Assets, Tier 1 Capital to Risk Weighted Assets and Tier 1 Capital to Average Assets were 11.50%, 9.61% and 7.93%, respectively, and at December 31, 2008 (following the November 21, 2008 TARP CPP transaction) TNB's ratios of Total Capital to Risk Weighted Assets, Tier 1 Capital to Risk Weighted Assets and Tier 1 Capital to Average Assets were 14.52%, 12.63% and 10.13%, respectively. However, it should be noted that, prior to Trustmark's participation in the TARP CPP, both it and TNB were well-capitalized. At September 30, 2008, each of TNB's ratios of Total Capital to Risk Weighted Assets, Tier 1 Capital to Risk Weighted Assets and Tier 1 Capital to Average Assets exceeded the respective ratios of 10.00%, 6.00% and 5.00%, which are the minimum ratios of regulatory capital required to be well-capitalized. Furthermore, Trustmark estimates that had it not participated in the TARP CPP, its ratios of Total Capital to Risk Weighted Assets, Tier 1 Capital to Risk Weighted Assets and Tier 1 Capital to Average Assets at December 31, 2008 would have been 11.98%, 10.04% and 8.04%, respectively.
Trustmark's participation in the TARP CPP has affected the income available to common shareholders in two ways: (1) Trustmark agreed in the Securities Purchase Agreement to not pay any dividend on the common stock prior to November 21, 2011 other than regular quarterly cash dividends of not more than $0.23 per share of common stock, and (2) the dividend payments which are due on the Senior Preferred have the effect of reducing the net income otherwise available to the common stockholders. The terms of the Stock Purchase Agreement prohibit repurchases of common stock (although there was no intent, at the time of the issuance of the Preferred Stock, for Trustmark to buy back or otherwise repurchase any of its common stock).
Trustmark has complied and will continue to comply with the executive compensation and corporate governance requirements of each of (i) the Emergency Economic Stabilization Act (EESA) of 2008, (ii) the Treasury Department guidance thereunder issued on October 20, 2008, (iii) the American Recovery and Reinvestment Act of 2009 (ARRA), which was signed into law on February 17, 2009 and (iv) any subsequent legislation, regulations or guidance for so long as the Senior Preferred stock or any other security acquired under the Securities Purchase Agreement is held by the U.S. Treasury.
On November 11, 2008, Trustmark's Board of Directors approved a resolution to adopt an omnibus amendment to all compensation plans. This amendment, which conforms all of Trustmark's benefit plans to the EESA and which applies to any senior executive officer (SEO) thereunder, includes the following:
· Clawback Provision
· Golden Parachute Limitation
· Signed Consent by all SEOs
As required by the EESA and ARRA, Trustmark will further limit the Section 162(m) tax deduction for executive compensation to $500,000 per year for any SEO for so long as the Senior Preferred stock or any other security acquired under the Securities Purchase Agreement is held by the U.S. Treasury.
An executive compensation risk assessment was performed by Trustmark's senior risk officers within 90 days of Treasury's purchase of the Senior Preferred stock and the Warrant. Based on the materials reviewed and discussions with subject matter experts, Trustmark's senior risk officers concluded that the executive compensation and incentive program as then in effect did not encourage the SEOs to take unnecessary and excessive risks. The findings of this risk assessment were presented to the Human Resources Committee of Trustmark's Board of Directors on January 14, 2009. The final Executive Compensation Risk Assessment Conclusion Memorandum was provided to this committee on February 18, 2009. A certification statement has been included within the Human Resources Committee Report of the Trustmark 2009 Proxy Statement. This risk assessment process will occur each year in which the Senior Preferred stock or any other security acquired under the Securities Purchase Agreement is held by the U.S. Treasury. In addition, the Human Resources Committee, which is composed entirely of independent directors, will discuss Trustmark's compensation arrangements in light of such a risk assessment at least semi-annually for so long as the Senior Preferred stock or any other security acquired under the Securities Purchase Agreement is held by the U.S. Treasury.
Trustmark's 2009 Proxy Statement permitted a nonbinding shareholder vote to provide advisory approval of the compensation of Trustmark's executives.
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. These critical accounting policies are described in detail below.
For additional information regarding the accounting policies discussed below, please see the notes to Trustmark's Consolidated Financial Statements set forth in Item 8 - Financial Statements and Supplementary Data.
Allowance for Loan Losses
The allowance for loan losses is established through provisions for estimated loan losses charged against net income. The allowance for loan losses is maintained at a level believed adequate by management, based on estimated probable losses within the existing loan portfolio. Each such evaluation is inherently subjective, as it requires a range of estimates, assumptions and judgments as to the facts and circumstances of the particular situation, including the amounts and timings of future cash flows expected to be received on impaired loans that may be susceptible to significant change.
Trustmark's allowance for probable 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 on other regulatory guidance. The allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan," based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with SFAS No. 5, "Accounting for Contingencies," based on historical loan loss experience for similar loans with similar characteristics and trends; and (iii) qualitative risk valuation allowances determined in accordance with SFAS No. 5 based on general economic conditions and other qualitative risk factors, both internal and external, to Trustmark. Each of these elements calls for estimates, assumptions and judgments, as described below.
Loans-Specific Valuation Allowances
Valuation allowances for probable losses on specific commercial loans are based on an ongoing analysis and evaluation of classified loans. Loans are classified based on Trustmark's internal credit risk grading process that evaluates, among other things: (i) the obligor's ability and willingness to repay; (ii) the value of any underlying collateral; (iii) the ability of any guarantor to perform its payment obligation, and (iv) the economic environment and industry in which the borrower operates. Once a loan is classified, it is subject to periodic review to determine whether or not the loan is impaired. If determined to be impaired, the loan is evaluated using one of the valuation criteria permitted under SFAS No. 114. The amount of impairment, if any, becomes a specific allocated portion of the allowance for loan losses and segregated from any pool of loans. Specific . . .
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