Derivatives Designated as Hedging Instruments

FASB ASC Topic 815, Derivatives and Hedging (ASC 815), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.

When entering into a hedge transaction, Trustmark formally documents the relationship between the hedging instrument and the hedged item, as well as the risk management objective and strategy for undertaking the hedge transaction, which includes designating the derivative instrument as a fair value or cash flow hedge to a specific asset or liability on the balance sheet or to specific forecasted transactions and the risk being hedged, along with a formal assessment at the inception of the hedge as to the effectiveness of the derivative instrument in offsetting changes in fair values or cash flows of the hedged item. Trustmark continues to assess hedge effectiveness on an ongoing basis using either a qualitative or a quantitative assessment (regression analysis).

As required by ASC 815, Trustmark records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether Trustmark has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. For cash flow hedges, changes in the fair value of the derivative instrument are recorded in accumulated other

comprehensive income (loss) and subsequently reclassified to net income in the same period that the hedged transaction impacts net income. Upon discontinuation of hedge accounting for cash flow hedges, any amounts in accumulated other comprehensive income (loss) related to that relationship affects earnings at the same time and in the same manner in which the hedged transaction affects earnings. If it becomes probable that the forecasted transaction will not occur, any related amounts in accumulated other comprehensive income (loss) are reclassified to earnings immediately.

During the third quarter of 2022, Trustmark initiated a cash flow hedging program. Trustmark's objectives in initiating this hedging program are to add stability to interest income and to manage its exposure to interest rate movements. Interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for Trustmark making variable-rate payments over the life of the agreements without exchange of the underlying notional amount. Trustmark uses such derivatives to hedge the variable cash flows associated with existing and anticipated variable-rate loan assets. At September 30, 2022, the aggregate notional value of Trustmark's interest rate swaps designated as cash flow hedges totaled $675.0 million.

Trustmark records any gains or losses on these cash flow hedges in accumulated other comprehensive income (loss). As interest payments are received on Trustmark's variable-rate assets, amounts reported in accumulated other comprehensive income (loss) are reclassified into interest and fees on LHFS and LHFI in the accompanying consolidated statements of income during the same period. During the next twelve months, Trustmark estimates that $7.8 million will be reclassified as a reduction to interest and fees on LHFS and LHFI. This amount could differ due to changes in interest rates, hedge de-designations or the addition of other hedges.

Trustmark utilizes a portfolio of exchange-traded derivative instruments, such as Treasury note futures contracts and option contracts, to achieve a fair value return that economically hedges changes in the fair value of the MSR attributable to interest rates. These transactions are considered freestanding derivatives that do not otherwise qualify for hedge accounting. The total notional amount of these derivative instruments was $260.0 million at September 30, 2022 compared to $409.5 million at December 31, 2021. Changes in the fair value of these exchange-traded derivative instruments are recorded as noninterest income in mortgage banking, net and are offset by changes in the fair value of the MSR. The impact of this strategy resulted in a net negative ineffectiveness of $928 thousand and a net positive ineffectiveness $144 thousand for the three months ended September 30, 2022 and 2021, respectively. For the nine months ended September 30, 2022 and 2021, the impact was a net negative ineffectiveness of $554 thousand and a net positive ineffectiveness of $1.7 million, respectively.

As part of Trustmark’s risk management strategy in the mortgage banking area, derivative instruments such as forward sales contracts are utilized. Trustmark’s obligations under forward sales contracts consist of commitments to deliver mortgage loans, originated and/or purchased, in the secondary market at a future date. Changes in the fair value of these derivative instruments are recorded as noninterest income in mortgage banking, net and are offset by changes in the fair value of LHFS. Trustmark’s off-balance sheet obligations under these derivative instruments totaled $140.5 million at September 30, 2022, with a positive valuation adjustment of $5.5 million, compared to $236.0 million, with a negative valuation adjustment of $81 thousand, at December 31, 2021.

Trustmark also utilizes derivative instruments such as interest rate lock commitments in its mortgage banking area. Interest rate lock commitments are residential mortgage loan commitments with customers, which guarantee a specified interest rate for a specified time period. Changes in the fair value of these derivative instruments are recorded as noninterest income in mortgage banking, net and are offset by the changes in the fair value of forward sales contracts. Trustmark’s off-balance sheet obligations under these derivative instruments totaled $85.5 million at September 30, 2022, with a negative valuation adjustment of $868 thousand, compared to $142.6 million, with a positive valuation adjustment of $1.9 million, at December 31, 2021.

Trustmark offers certain derivatives products directly to qualified commercial lending clients seeking to manage their interest rate risk. Trustmark economically hedges interest rate swap transactions executed with commercial lending clients by entering into offsetting interest rate swap transactions with institutional derivatives market participants. Derivatives transactions executed as part of this program are not designated as qualifying hedging relationships and are, therefore, carried at fair value with the change in fair value recorded as noninterest income in bank card and other fees. Because these derivatives have mirror-image contractual terms, in addition to collateral provisions which mitigate the impact of non-performance risk, the changes in fair value are expected to substantially offset. The Chicago Mercantile Exchange rules legally characterize variation margin collateral payments made or received for centrally cleared interest rate swaps as settlements rather than collateral. As a result, centrally cleared interest rate swaps included in other assets and other liabilities are presented on a net basis in the accompanying consolidated balance sheets. At September 30, 2022, Trustmark had interest rate swaps with an aggregate notional amount of $1.491 billion related to this program, compared to $1.225 billion at December 31, 2021.

Trustmark has agreements with its financial institution counterparties that contain provisions where if Trustmark defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Trustmark could also be declared in default on its derivatives obligations.

At September 30, 2022, there was no termination value of interest rate swaps in a liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements compared to a termination value of $655 thousand at December 31, 2021. At September 30, 2022 and December 31, 2021, Trustmark had posted collateral of $40 thousand and $850 thousand, respectively, against its obligations because of negotiated thresholds and minimum transfer amounts under these agreements. If Trustmark had breached any of these triggering provisions at September 30, 2022, it could have been required to settle its obligations under the agreements at the termination value.

Credit risk participation agreements arise when Trustmark contracts with other financial institutions, as a guarantor or beneficiary, to share credit risk associated with certain interest rate swaps. These agreements provide for reimbursement of losses resulting from a third-party default on the underlying swap. At September 30, 2022, Trustmark had entered into five risk participation agreements as a beneficiary with an aggregate notional amount of $50.6 million compared to six risk participation agreements as a beneficiary with an aggregate notional amount of $52.0 million at December 31, 2021. At September 30, 2022, Trustmark had entered into twenty-eight risk participation agreements as a guarantor with an aggregate notional amount of $225.6 million compared to twenty-four risk participation agreements as a guarantor with an aggregate notional amount of $173.5 million at December 31, 2021. The aggregate fair values of these risk participation agreements were immaterial at both September 30, 2022 and December 31, 2021.

The following tables disclose the fair value of derivative instruments in Trustmark’s consolidated balance sheets at September 30, 2022 and December 31, 2021 as well as the effect of these derivative instruments on Trustmark’s results of operations for the periods presented ($ in thousands):


	September 30, 2022			December 31, 2021
Derivatives in hedging relationships:
Interest rate contracts:
Interest rate swaps included in other liabilities (1)	$	933		$	—

Derivatives not designated as hedging instruments:
Interest rate contracts:
Exchange traded purchased options included in other assets	$	16		$	438
OTC written options (rate locks) included in other assets		(868	)		1,859
Futures contracts included in other assets		—			2,356
Interest rate swaps included in other assets (1)		9,870			20,115
Credit risk participation agreements included in other assets		9			41
Futures contracts included in other liabilities		6,370			—
Forward contracts included in other liabilities		(5,550	)		81
Exchange traded written options included in other liabilities		1,629			414
Interest rate swaps included in other liabilities (1)		49,260			4,144
Credit risk participation agreements included in other liabilities		10			38

(1)

In accordance with GAAP, the variation margin collateral payments made or received for interest rate swaps that are centrally cleared are legally characterized as settled. As a result, the centrally cleared interest rate swaps included in other assets and other liabilities are presented on a net basis in the accompanying consolidated balance sheets.


	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022			2021
Derivatives in hedging relationships:
Amount of gain (loss) reclassified from accumulated other comprehensive income (loss) and recognized in interest and fees on LHFS & LHFI	$	643		$	—		$	643		$	—

Derivatives not designated as hedging instruments:
Amount of gain (loss) recognized in mortgage banking, net	$	(8,405	)	$	(1,612	)	$	(39,181	)	$	(12,424	)
Amount of gain (loss) recognized in bank card and other fees		63			217			385			1,152

Trustmark’s interest rate swap derivative instruments are subject to master netting agreements, and therefore, eligible for offsetting in the consolidated balance sheets. Trustmark has elected to not offset any derivative instruments in its consolidated balance sheets. Information about financial instruments that are eligible for offset in the consolidated balance sheets as of September 30, 2022 and December 31, 2021 is presented in the following tables ($ in thousands):


Offsetting of Derivative Assets
As of September 30, 2022
							Gross Amounts Not Offset in the Statement of Financial Position
	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Statement of Financial Position		Net Amounts of Assets presented in the Statement of Financial Position		Financial Instruments		Cash Collateral Received			Net Amount
Derivatives	$	9,870	$	—	$	9,870	$	—	$	(3,070	)	$	6,800


Offsetting of Derivative Liabilities
As of September 30, 2022
							Gross Amounts Not Offset in the Statement of Financial Position
	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Statement of Financial Position		Net Amounts of Liabilities presented in the Statement of Financial Position		Financial Instruments		Cash Collateral Posted			Net Amount
Derivatives	$	50,193	$	—	$	50,193	$	—	$	(40	)	$	50,153


Offsetting of Derivative Assets
As of December 31, 2021
							Gross Amounts Not Offset in the Statement of Financial Position
	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Statement of Financial Position		Net Amounts of Assets presented in the Statement of Financial Position		Financial Instruments			Cash Collateral Received		Net Amount
Derivatives	$	20,115	$	—	$	20,115	$	(55	)	$	—	$	20,060


Offsetting of Derivative Liabilities
As of December 31, 2021
							Gross Amounts Not Offset in the Statement of Financial Position
	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Statement of Financial Position		Net Amounts of Liabilities presented in the Statement of Financial Position		Financial Instruments			Cash Collateral Posted			Net Amount
Derivatives	$	4,144	$	—	$	4,144	$	(55	)	$	(850	)	$	3,239