Note 17 – Derivative Financial Instruments

Trustmark maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. Trustmark’s interest rate risk management strategy involves modifying the repricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. Under the guidelines of FASB ASC Topic 815, “Derivatives and Hedging,” all derivative instruments are required to be recognized as either assets or liabilities and be carried at fair value on the balance sheet. The fair value of derivative positions outstanding is included in other assets and/or other liabilities in the accompanying consolidated balance sheets and in the net change in these financial statement line items in the accompanying consolidated statements of cash flows as well as included in noninterest income in the accompanying consolidated statements of income.

Derivatives Designated as Hedging Instruments

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 contracts consist of commitments to deliver mortgage loans, originated and/or purchased, in the secondary market at a future date. These derivative instruments are designated as fair value hedges under FASB ASC Topic 815. The ineffective portion of changes in the fair value of the forward contracts and changes in the fair value of the loans designated as loans held for sale are recorded in noninterest income in mortgage banking, net. Trustmark’s off-balance sheet obligations under these derivative instruments totaled $289.0 million at June 30, 2013, with a positive valuation adjustment of $10.1 million, compared to $310.3 million, with a negative valuation adjustment of $738 thousand as of December 31, 2012.

On April 4, 2013, Trustmark entered into an interest rate swap contract on junior subordinated debentures with a total notional amount of $60.0 million. The interest rate swap contract was designated as a derivative instrument in a cash flow hedge under FASB ASC Topic 815, with the objective of protecting the quarterly interest payments on Trustmark’s $60.0 million of junior subordinated debentures issued to Trustmark Preferred Capital Trust I throughout the five-year period beginning December 31, 2014 and ending December 31, 2019 from the risk of variability of those payments resulting from changes in the three-month LIBOR interest rate. Under the swap, Trustmark will pay a fixed interest rate of 1.66% and receive a variable interest rate based on three-month LIBOR on a total notional amount of $60.0 million, with quarterly settlements.

No ineffectiveness related to the interest rate derivative designated as a cash flow hedge was recognized in the consolidated statements of income during the three or six months ended June 30, 2013. The accumulated net after-tax gain related to effective cash flow hedges included in accumulated other comprehensive loss totaled $1.5 million at June 30, 2013. Trustmark does not expect to reclassify any amounts from accumulated other comprehensive loss to interest expense during the next 12 months since Trustmark’s derivative relating to its junior subordinated debentures does not become effective until December 31, 2014.

Derivatives not Designated as Hedging Instruments

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 fair value of MSR attributable to interest rates. These transactions are considered freestanding derivatives that do not otherwise qualify for hedge accounting. These exchange-traded derivative instruments are accounted for at fair value with changes in the fair value recorded in noninterest income in mortgage banking, net and are offset by changes in the fair value of MSR. The MSR fair value represents the present value of future cash flows, which among other things includes decay and the effect of changes in interest rates. Ineffectiveness of hedging the MSR fair value is measured by comparing the change in value of hedge instruments to the change in the fair value of the MSR asset attributable to changes in interest rates and other market driven changes in valuation inputs and assumptions. The impact of this strategy resulted in a net positive ineffectiveness of $121 thousand and $172 thousand for the three months ended June 30, 2013 and 2012, respectively. For the six months ended June 30, 2013, the impact was a net positive ineffectiveness of $1.4 million compared to a net negative ineffectiveness of $846 thousand for the six months ended June 30, 2012.

Trustmark also utilizes derivative instruments such as interest rate lock commitments in its mortgage banking area. 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 in 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 $157.9 million at June 30, 2013, with a positive valuation adjustment of $347 thousand, compared to $186.9 million, with a positive valuation adjustment of $2.3 million as of December 31, 2012.

Trustmark offers certain derivatives products directly to qualified commercial borrowers seeking to manage their interest rate risk. Trustmark economically hedges interest rate swap transactions executed with commercial borrowers by entering into offsetting interest rate swap transactions with third parties. Derivative 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 in 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 substantially offset. As of June 30, 2013, Trustmark had interest rate swaps with an aggregate notional amount of $369.7 million related to this program, compared to $321.3 million as of December 31, 2012.

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 derivative obligations.

As of June 30, 2013, the 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 was $745 thousand compared to $5.4 million as of December 31, 2012. As of June 30, 2013, Trustmark had posted collateral with a market value of $1.3 million against its obligations because of negotiated thresholds and minimum transfer amounts under these agreements. If Trustmark had breached any of these triggering provisions at June 30, 2013, 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. As of June 30, 2013, Trustmark had entered into three risk participation agreements as a beneficiary with an aggregate notional amount of $19.9 million, compared to two risk participation agreements with an aggregate notional amount of $10.1 million at December 31, 2012. The fair values of these risk participation agreements were immaterial at June 30, 2013.

Tabular Disclosures

The following tables disclose the fair value of derivative instruments in Trustmark’s balance sheets as well as the effect of these derivative instruments on Trustmark’s results of operations for the periods presented ($ in thousands):

	June 30,			December 31,
	2013			2012
Derivatives in hedging relationships
Interest rate contracts:
Interest rate swaps included in other assets	$	2,354		$	-
Forward contracts included in other liabilities		(10,129	)		738

Derivatives not designated as hedging instruments
Interest rate contracts:
Futures contracts included in other assets	$	(2,358	)	$	(482	)
Exchange traded purchased options included in other assets		259			42
OTC written options (rate locks) included in other assets		347			2,284
Interest rate swaps included in other assets		3,988			5,241
Credit risk participation agreements included in other assets		25			22
Exchange traded written options included in other liabilities		633			545
Interest rate swaps included in other liabilities		3,560			5,329

	Three Months Ended June 30,						Six Months Ended June 30,
	2013			2012			2013			2012
Derivatives in hedging relationships
Amount of gain (loss) recognized in mortgage banking, net	$	10,933		$	(3,460	)	$	10,867		$	(1,067	)

Derivatives not designated as hedging instruments
Amount of (loss) gain recognized in mortgage banking, net	$	(7,935	)	$	8,496		$	(8,149	)	$	7,030
Amount of gain (loss) recognized in bankcard and other fees		421			(195	)		395			(160	)

The following table discloses the amount included in other comprehensive (loss) income for derivative instruments designated as cash flow hedges for the periods presented ($ in thousands):

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Derivatives in cash flow hedging relationship
Amount of gain recognized in other comprehensive (loss) income	$	1,454	$	-	$	1,454	$	-

Certain financial instruments, including resell and repurchase agreements, securities lending arrangements and derivatives, may be eligible for offset in the consolidated balance sheet and/or subject to master netting arrangements or similar agreements. Information about financial instruments that are eligible for offset in the consolidated balance sheets as of June 30, 2013 and December 31, 2012 is presented in the following tables ($ in thousands):

Offsetting of Derivative Assets

As of June 30, 2013

							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	$	6,342	$	-	$	6,342	$	(1,114	)	$	(1,810	)	$	3,418

Offsetting of Derivative Liabilities

As of June 30, 2013

							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	$	3,560	$	-	$	3,560	$	(1,114	)	$	-	$	2,446

Offsetting of Derivative Assets

As of December 31, 2012

							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	$	5,241	$	-	$	5,241	$	-	$	-	$	5,241

Offsetting of Derivative Liabilities

As of December 31, 2012

							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	$	5,329	$	-	$	5,329	$	-	$	(594	)	$	4,735