Note 16 – Fair Value

Financial Instruments Measured at Fair Value

The methodologies Trustmark uses in determining the fair values are based primarily on the use of independent, market-based data to reflect a value that would be reasonably expected upon exchange of the position in an orderly transaction between market participants at the measurement date. The predominant portion of assets that are stated at fair value are of a nature that can be valued using prices or inputs that are readily observable through a variety of independent data providers. The providers selected by Trustmark for fair valuation data are widely recognized and accepted vendors whose evaluations support the pricing functions of financial institutions, investment and mutual funds, and portfolio managers. Trustmark has documented and evaluated the pricing methodologies used by the vendors and maintains internal processes that regularly test valuations for anomalies.

Trustmark utilizes an independent pricing service to advise it on the carrying value of the securities available for sale portfolio. As part of Trustmark’s procedures, the price provided from the service is evaluated for reasonableness given market changes. When a questionable price exists, Trustmark investigates further to determine if the price is valid. If needed, other market participants may be utilized to determine the correct fair value. Trustmark has also reviewed and confirmed its determinations in thorough discussions with the pricing source regarding their methods of price discovery.

Mortgage loan commitments are valued based on the securities prices of similar collateral, term, rate and delivery for which the loan is eligible to deliver in place of the particular security. Trustmark acquires a broad array of mortgage security prices that are supplied by a market data vendor, which in turn accumulates prices from a broad list of securities dealers. Prices are processed through a mortgage pipeline management system that accumulates and segregates all loan commitment and forward-sale transactions according to the similarity of various characteristics (maturity, term, rate, and collateral). Prices are matched to those positions that are deemed to be an eligible substitute or offset (i.e., “deliverable”) for a corresponding security observed in the market place.

Trustmark estimates fair value of MSR through the use of prevailing market participant assumptions and market participant valuation processes. This valuation is periodically tested and validated against other third-party firm valuations.

Trustmark obtains the fair value of interest rate swaps from a third-party pricing service that uses an industry standard discounted cash flow methodology. In addition, credit valuation adjustments are incorporated in the fair values to account for potential nonperformance risk. In adjusting the fair value of its interest rate swap contracts for the effect of nonperformance risk, Trustmark has considered any applicable credit enhancements such as collateral postings, thresholds, mutual puts, and guarantees. In conjunction with the FASB’s fair value measurement guidance, Trustmark made an accounting policy election to measure the credit risk of these derivative financial instruments, which are subject to master netting agreements, on a net basis by counterparty portfolio.

Trustmark has determined that the majority of the inputs used to value its interest rate swaps offered to qualified commercial borrowers fall within Level 2 of the fair value hierarchy, while the credit valuation adjustments associated with these derivatives utilize Level 3 inputs, such as estimates of current credit spreads. Trustmark has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its interest rate swaps and has determined that the credit valuation adjustment is not significant to the overall valuation of these derivatives. As a result, Trustmark classifies its interest rate swap valuations in Level 2 of the fair value hierarchy.

Trustmark also utilizes exchange-traded derivative instruments such as Treasury note futures contracts and option contracts to achieve a fair value return that offsets the changes in fair value of MSR attributable to interest rates. Fair values of these derivative instruments are determined from quoted prices in active markets for identical assets therefore allowing them to be classified within Level 1 of the fair value hierarchy. In addition, Trustmark utilizes derivative instruments such as interest rate lock commitments in its mortgage banking area which lack observable inputs for valuation purposes resulting in their inclusion in Level 3 of the fair value hierarchy.

At this time, Trustmark presents no fair values that are derived through internal modeling. Should positions requiring fair valuation arise that are not relevant to existing methodologies, Trustmark will make every reasonable effort to obtain market participant assumptions, or independent evaluation.

Financial Assets and Liabilities

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value ($ in thousands). There were no transfers between fair value levels for the six months ended June 30, 2014 and the year ended December 31, 2013.

	June 30, 2014
	Total		Level 1			Level 2		Level 3
U.S. Treasury securities	$	100	$	-		$	100	$	-
U.S. Government agency obligations		158,337		-			158,337		-
Obligations of states and political subdivisions		171,229		-			171,229		-
Mortgage-backed securities		2,011,623		-			2,011,623		-
Asset-backed securities and structured financial products		35,142		-			35,142		-
Securities available for sale		2,376,431		-			2,376,431		-
Loans held for sale		142,103		-			142,103		-
Mortgage servicing rights		65,049		-			-		65,049
Other assets - derivatives		6,036		(491	)		4,318		2,209
Other liabilities - derivatives		6,203		500			5,703		-

	December 31, 2013
	Total		Level 1			Level 2		Level 3
U.S. Treasury securities	$	502	$	-		$	502	$	-
U.S. Government agency obligations		169,472		-			169,472		-
Obligations of states and political subdivisions		171,738		-			171,738		-
Mortgage-backed securities		1,788,505		-			1,788,505		-
Asset-backed securities and structured financial products		63,937		-			63,937		-
Securities available for sale		2,194,154		-			2,194,154		-
Loans held for sale		149,169		-			149,169		-
Mortgage servicing rights		67,834		-			-		67,834
Other assets - derivatives		4,994		(2,579	)		7,447		126
Other liabilities - derivatives		3,298		581			2,717		-

The changes in Level 3 assets measured at fair value on a recurring basis for the periods ended June 30, 2014 and 2013 are summarized as follows ($ in thousands):

	MSR			Other Assets - Derivatives
Balance, January 1, 2014	$	67,834		$	126
Total net (losses) gains included in Mortgage banking, net (1)		(7,964	)		2,493
Additions		5,179			-
Sales		-			(410	)
Balance, June 30, 2014	$	65,049		$	2,209

The amount of total losses for the period included in earnings that are attributable to the change in unrealized gains or losses still held at June 30, 2014	$	(3,761	)	$	(594	)

Balance, January 1, 2013	$	47,341		$	2,284
Total net gains included in net income (1)		2,378			4,709
Additions		10,661			-
Sales		-			(6,646	)
Balance, June 30, 2013	$	60,380		$	347

The amount of total gains (losses) for the period included in earnings that are attributable to the change in unrealized gains or losses still held at June 30, 2013	$	7,594		$	(60	)

(1)	Total net (losses) gains included in net income relating to MSR includes changes in fair value due to market changes and due to runoff.

Trustmark may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. Assets at June 30, 2014, which have been measured at fair value on a nonrecurring basis, include impaired LHFI. Loans for which it is probable Trustmark will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement are considered impaired. Impaired LHFI have been determined to be collateral dependent and assessed using a fair value approach. Specific allowances for impaired LHFI are based on comparisons of the recorded carrying values of the loans to the present value of the estimated cash flows of these loans at each loan’s original effective interest rate, the fair value of the collateral or the observable market prices of the loans. Fair value estimates begin with appraised values based on the current market value or as-is value of the property being appraised, normally from recently received and reviewed appraisals. Appraisals are obtained from state-certified appraisers and are based on certain assumptions, which may include construction or development status and the highest and best use of the property. These appraisals are reviewed by Trustmark’s Appraisal Review Department to ensure they are acceptable. Appraised values are adjusted down for costs associated with asset disposal. At June 30, 2014, Trustmark had outstanding balances of $30.5 million in impaired LHFI that were specifically identified for evaluation and written down to fair value of the underlying collateral less cost to sell based on the fair value of the collateral or other unobservable input compared to $31.6 million at December 31, 2013. These specifically evaluated impaired LHFI are classified as Level 3 in the fair value hierarchy. Impaired LHFI are periodically reviewed and evaluated for additional impairment and adjusted accordingly based on the same factors identified above.

Please refer to Note 2 – Business Combinations, for financial assets and liabilities acquired, which were measured at fair value on a nonrecurring basis in accordance with GAAP.

Nonfinancial Assets and Liabilities

Certain nonfinancial assets measured at fair value on a nonrecurring basis include foreclosed assets (upon initial recognition or subsequent impairment), nonfinancial assets and nonfinancial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other nonfinancial long-lived assets measured at fair value for impairment assessment.

Other real estate, excluding covered other real estate, includes assets that have been acquired in satisfaction of debt through foreclosure and is recorded at the lower of cost or estimated fair value less the estimated cost of disposition. Fair value is based on independent appraisals and other relevant factors. In the determination of fair value subsequent to foreclosure, Management also considers other factors or recent developments, such as changes in market conditions from the time of valuation and anticipated sales values considering plans for disposition, which could result in an adjustment to lower the collateral value estimates indicated in the appraisals. At June 30, 2014, Trustmark's geographic other real estate distribution was concentrated primarily in its five key market regions: Alabama, Florida, Mississippi, Tennessee and Texas. The ultimate recovery of a substantial portion of the carrying amount of other real estate, excluding covered other real estate, is susceptible to changes in market conditions in these areas. Periodic revaluations are classified as Level 3 in the fair value hierarchy since assumptions are used that may not be observable in the market.

Certain foreclosed assets, upon initial recognition, are remeasured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed asset. The fair value of a foreclosed asset, upon initial recognition, is estimated using Level 3 inputs based on adjusted observable market data. Foreclosed assets measured at fair value upon initial recognition totaled $24.6 million (utilizing Level 3 valuation inputs) during the six months ended June 30, 2014 compared with $60.5 million for the same period in 2013. Foreclosed assets measured at fair value upon initial recognition for the six months ended June 30, 2013 included $40.1 million of other real estate acquired from BancTrust. In connection with the measurement and initial recognition of the foregoing foreclosed assets, Trustmark recognized charge-offs of the allowance for loan losses totaling $6.7 million and $2.7 million for the first six months of 2014 and 2013, respectively. Other than foreclosed assets measured at fair value upon initial recognition, $25.9 million of foreclosed assets were remeasured during the first six months of 2014, requiring write-downs of $3.3 million to reach their current fair values compared to $28.3 million of foreclosed assets that were remeasured during the first six months of 2013, requiring write-downs of $4.4 million.

Fair Value of Financial Instruments

FASB ASC Topic 825, “Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. A detailed description of the valuation methodologies used in estimating the fair value of financial instruments can be found in Note 19 – Fair Value included in Item 8 of Trustmark’s Form 10-K Annual Report for the year ended December 31, 2013.

The carrying amounts and estimated fair values of financial instruments at June 30, 2014 and December 31, 2013, are as follows ($ in thousands):

	June 30, 2014				December 31, 2013
	Carrying		Estimated		Carrying		Estimated
	Value		Fair Value		Value		Fair Value
Financial Assets:
Level 2 Inputs:
Cash and short-term investments	$	327,960	$	327,960	$	353,014	$	353,014
Securities held to maturity		1,156,790		1,162,871		1,168,728		1,150,833
Level 3 Inputs:
Net LHFI		6,120,352		6,158,557		5,732,433		5,787,408
Net acquired loans		635,360		635,360		794,570		794,570
FDIC indemnification asset		10,866		10,866		14,347		14,347

Financial Liabilities:
Level 2 Inputs:
Deposits		9,860,366		9,865,144		9,859,902		9,866,118
Short-term liabilities		620,543		620,543		317,972		317,972
Long-term FHLB advances		8,236		8,254		8,458		8,474
Subordinated notes		49,920		53,759		49,904		53,387
Junior subordinated debt securities		61,856		43,299		61,856		40,206

In cases where quoted market prices are not available, fair values are generally based on estimates using present value techniques. Trustmark’s premise in present value techniques is to represent the fair values on a basis of replacement value of the existing instrument given observed market rates on the measurement date. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates for those assets or liabilities cannot be necessarily substantiated by comparison to independent markets and, in many cases, may not be realizable in immediate settlement of the instruments. The estimated fair value of financial instruments with immediate and shorter-term maturities (generally 90 days or less) is assumed to be the same as the recorded book value. All nonfinancial instruments, by definition, have been excluded from these disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of Trustmark.

The fair values of net LHFI are estimated for portfolios of loans with similar financial characteristics. For variable rate LHFI that reprice frequently with no significant change in credit risk, fair values are based on carrying values. The fair values of certain mortgage LHFI, such as 1-4 family residential properties, are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair values of other types of LHFI are estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The processes for estimating the fair value of net LHFI described above does not represent an exit price under FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” and such an exit price could potentially produce a different fair value estimate at June 30, 2014 and December 31, 2013.