Trustmark Corp (TRMK) 2009 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Trustmark Corporation's second quarter earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation this morning, there will be a question-and-answer session. (Operator Instructions). As a reminder, this call is being recorded.

It is now my pleasure to introduce Joey Rein, Director of Investor Relations at Trustmark.

Good morning and thank you. I would like to remind everyone that a copy of our second quarter earnings release, along with supporting financial information, is available on the Investor Relations section of our website at Trustmark.com by clicking on the News Releases tab.

During the course of our call this morning, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We would like to caution you that these forward-looking statements may differ materially from actual results due to a number of risks and uncertainties which are outlined in our release and our other filings with the Securities and Exchange Commission.

At this time I'd like to introduce Richard Hickson, our Chairman and CEO of Trustmark Corporation.

Good morning. Thank you for joining us. I have with me this morning Jerry Host, our Chief Operating Officer, Louis Greer, our Chief Financial Officer, plus other executive officers of the Company which will be pleased to answer any questions that you might have after my comments.

Trustmark reported net income available to common shareholders of $13.4 million or $0.23 during the quarter, including a special assessment which reduced net income by 2.7 million or $0.05 per share. Our quarterly results reflected a very robust net interest margin, disciplined management of core non-interest expense, continued extensive examinations and reappraisals of credit in the Florida Panhandle.

Bottom line, Trustmark produced solid core earnings and a very, very strong capital position, a strong, fluid balance sheet and has the financial flexibility to succeed in an ever-changing marketplace.

I might take you to Page 6 of our stat sheet. My first comments will revolve around credit quality and there, you will be able to follow on a five-quarter trend which I believe will make it easier for you to follow and evaluate my comments.

As I commented, we continued to conduct an extensive evaluation of the corporation's Florida loan portfolio covering 92% of the portfolio. Our Corporate Loan Review Group and our Florida Special Asset Team conducted almost quarter-long looks which did cover 92% of the portfolio. We received updated financials and about 160 updated property appraisals.

The fact that you receive financial statements generally toward the end of first quarter or beginning of second quarter from the vast majority of your commercial customers, and the uniqueness of the slowness in the Florida Panhandle during the winter, has led us to believe that this is a best time to do this process because we're getting at the financials as soon as they're available.

We're doing our global cash flows. We are reappraising essentially the entire bulk of the portfolio in the March, April, May timeframe after we can see what the deterioration might have been during the off season. So even though it bulks up our reserving and write-offs, as you will compare to the year before in the second quarter, it's by far the best time to do it.

We charged off $21.2 million in Florida loans. Of this $21 million, $16.5 million was provisioned in prior periods. Over the last 18 months, Florida construction and land development portfolio was reduced by $141 million or approximately 36% to $245 million. In Florida, non-impaired construction and development loans totaled $204 million at the end of the quarter with approximately 26 million in reserves or 12.6%.

Non-performing assets increased $11.5 million for the corporation as a whole to 188 million or 2.72%. This was principally one loan, a commercial real estate loan, made out of our Jackson real estate department. It actually resides in Memphis. It's an old customer who had problems with a condominium project. It was actually reserved for as a classified loan in a previous quarter. Therefore, it had no significant impact on our reserving for the quarter.

We had minimal losses in other geographic areas or lines of business. If you take a look, the Florida non-accrual loans actually moderated somewhat and were down $11 million. Mississippi was up 10 on the specific loan that I have mentioned, and any other change in Tennessee and Texas was minimal.

Under other real estate, we were able to move a couple of properties, principally one significant vertical property of some very attractive properties in [Sandestin] into ORE and we're having a lot interest in them. They're now placed on the market with a proper price. We feel we're fully reserved for it. It [came in] and just gone through recent appraisals.

In Mississippi, that was principally one condo project in Biloxi where we had 12 units in a larger condominium. They're now on the market. They went through appraisal. We don't see a loss there. We actually think we should see this quarter a drop down in the ORE related to these two particular properties.

I would like to make a comment on the dynamics of the loan-loss reserve. Out of our total chargeoffs, $17.9 million in the corporation was provisioned for in prior periods, and we went through a fairly significant appraisal and reappraisal process which was successful. So we actually provisioned $19.3 million more than net chargeoffs in the quarter and if you have any questions on that later, Barry Harvey will address them.

Taking a look at Florida credit quality specifically, I might take you to Page 8 of our stat sheet. On a linked-quarter basis, we actually saw a $31 million drop in construction and land development loans to 245 million. Total construction loans, less impaired, is now at the 200 million mark. We are reserving approximately $26 million against that construction portfolio or 12.6%. Our total Florida portfolio was down about $35 million and our reserve is a strong 6% against Florida.

We don't think Florida is over with. We see some activity on vertical properties, but no activity of any significance on lots or land. It may be bottoming. We can't give you any number with any exactness from this large group of 160 appraisals, and if we average the entire process together, it was down 21% from the prior appraisal.

There were hardly any properties that that was a first appraisal on, so for the market as a whole -- but I will tell you that there were pieces of land and lots that were down significantly more, and pieces of land and lots that were down less than that, but I think that's a good fair number overall to look at.

Our total provision for loan losses totaled 26.8 million. We presently have about 102 million at our loan-loss reserve. That is a reserve of 2.01% of our total commercial portfolio of a little over $4 billion and 73 basis points on consumer loans and home mortgages.

I'd like to let you know that we are -- if you can be -- pleased with what we're seeing in our consumer portfolios. The issues in our 800 million old balance sheet home mortgage portfolio are negligible. Modifications numbers, you can count them almost on two hands. We are grading them, moving them to non-accrual, writing them down.

We're not seeing any significant deterioration in our direct portfolio in Mississippi. As you know, most of it is centered -- are HELOCs in this Mississippi market. Mississippi has been sort of in the middle of the pack on unemployment, particularly on the indirect auto portfolio. It's coming off as expected. Losses have begun to moderate. Net loss is probably in the range of 500,000 a month now, down significantly. Barry Harvey will answer any questions that you have later on that.

You will notice on Page 7 of our stat sheet, down at the bottom, that during the quarter, we refined our allowance for loan-loss methodology for commercial loans. We are very excited about this, if you can be excited about something like that. This is the end of an 18-month very rigorous process.

We have worked very closely with our primary regulator and our outside accountants, under no duress, but asking their advice to make sure that we have taken Trustmark directly in line with the methodology requested in the inter-agency allowance for loan losses. This is done by classifying into 13 separate homogeneous loan types, taking into consideration the uniqueness of our markets.

And as you know, there is a broad difference between the core Mississippi market, the Florida real estate market and the stable, unballooned values in the Houston real estate market. If you have further questions on this, Barry Harvey will be happy to address them for you.

We feel this is a very positive -- it [cleans] the risk by category. It's looking at trends. It's putting the reserves where we really need them, and it's put the onus on us if we've had a certain breed of dog with a (inaudible) brown spots behind his left ear. If another one comes along, and we had a problem with it, it's going to have a real big reserve on it. It's going to be very difficult to make a Florida land loan in the future, or a Florida lot loan, if you look at the level of reserving that's required on (inaudible).

I do not feel we are under-reserved in Mississippi. I explained to you that we put a lot of reserves in and that the increase in non-performing in Mississippi was one credit that was reserved for prior. The loan that -- of condos that moved in Biloxi into ORE where that went up in Mississippi went through rigorous appraisal and test on the market, and a couple have been sold, validating our price.

Let me leave credit quality and move to capital strength. Tangible common equity increased again to 683 million. It's now at a very comfortable 7.34%. Total risk-based capital went up to 15.45; total risk-based capital, excluding the senior preferred of 215 million, was at 12.44%.

We're still giving the TARP very thoughtful evaluation and we'll address TARP when we feel it's appropriate, when we have seen enough moderation relative to the analysis of our portfolio. We have made a decision that we don't think it's good to speculate on when we might address the TARP issue. We'll tell you immediately when we do.

On our balance sheet, loans held for investment decreased by $70 million. 40 million of this was reduced exposure to construction, land and development. Reduction in our consumer portfolio of approximately $80 million was principally due to our decision in late '07 to exit the indirect auto business. As I mentioned, that's coming off well.

A highlight for us in the quarter was that mortgage banking production totaled $583 million. Year-to-date, 1.2 billion are up 56% from year-earlier figures. I might comment on year-earlier, our construction land development portfolio is down approximately $200 million from June a year ago or 17%. That's very positive for us and putting us in a position of being able to finance good vertical projects going forward.

On the deposit side, they remain very stable. That is a very closely managed number for us. Declines in interest-bearing deposits were offset by growth in non-interest-bearing deposits. Non-interest checking was up $46 million linked quarter. Non-interest-bearing deposits are approximately 22% of deposits for Trustmark.

I might take you to Page 5 of our stat sheet so that you can look with me at a five-quarter run rate on revenues. We are so happy when we look back over the last eight quarters at pretax, pre-provision income for this Company. The lowest was 48 million and the highest was 57 million and it's [hit] on an up trend. Relative to the net interest margin, and why it's expanded, capital strength, branding in our marketplaces and strong liquidity have enabled us to lower the deposit cost at our Company significantly and optimize funding cost.

Our officer staff has been super in very disciplined loan pricing, in introducing [force] in the vast majority of loans that have come up for renewal for new loans and has had a very positive impact.

The net interest margin of 90.8 million, in our opinion, validates the core revenue strength of Trustmark. The net interest margin actually expanded a couple of basis points to 420. On non-interest income of about 41 million, there was a decline of around 2 million relative to the first quarter.

Mortgage banking was down significantly, about $8 million from the prior quarter. Primarily this was due to mortgage servicings (inaudible) hedge and effectiveness of about 4.6 million pretax. Buddy Wood will answer any questions on that as to whether we think that's one time.

I will tell you that Louis Greer told me this morning, and we were talking about it yesterday in our Audit Finance Committee -- if you look at our hedging [sensing] section, which I believe has been the end of '06, we're about pretax $10 million. If we had not hedged, we would have --

We would have been -- our MSR would have lost 27 million.

Had we not hedged, it would have been down $27 million. So these are highly unusual times with government intervention into Treasury rates and home mortgage rates and the spreads have been particularly volatile.

Buddy Wood will comment, but it's not unusual for volatility to be a couple of million dollars in a month until it settles in and we reach whatever the new level is going to be. It's not of significance when you look at the overall revenues of the corporation, and particularly if you look at the success in our hedging program.

And no, it's not time to stop hedging. Even though you might think interest rates are going to go up, they can go the other way, so we choose to limit it. The interest rate risk is hedged. It's the volatility in the spreads between the primary mortgage and the Treasury.

Service charges increased around $700,000. General banking increased about the same amount. Our insurance revenues are relatively unchanged from the prior quarter. For the Florida markets, in insurance agency business, it's cyclical. It's in a down cycle right now, particularly a lot of pressure on flood insurance for condominium associations where we are a significant player in that market.

Wealth management was stable with last quarter, but obviously down from a year ago. In talking with our Wealth Management executives, most of this decline can be taken back to our spreads in our money market mutual funds, which we feel is not permanent and will replace itself once interest rates start back up.

As you know, we bought an awful lot of securities last fall at a very opportune time. We're making a great margin on those securities. They're clear of credit risk from our perspective. We do have a $50-plus-million profit there. Our Chief Investment Officer decided that there were some profits in there that he thought would move away with some very short-term maturities and he elected to take those profits. There was no tie of thought between the FDIC special assessment, the (inaudible) loss or the profits. We may take more bond profits. It's going to depend on our [ALCA] model and what our group feels about prepayments.

On expense management, they increased $4.6 million to $79 million. Our FDIC pretax cost was $9.5 million more than it was a year-ago quarter. That's a significant increase. We feel that's a definite inconvenience and burden on those financial institutions that are out making loans and taking deposits, intending to make their economies grow.

I will say we realize, as more institutions fail and the FDIC takes them over, we're expecting this to continue. We're modeling going forward with assessments in there. We don't know what they'll be, so were modeling what they were this quarter. If they're more than that or less than that, so be it.

Salaries and employee benefits decreased on a linked quarter about 2.4 million. These are freezing the benefit accruals right in there, our defined benefit plan. As you know, we froze it. We have a good solid 401K that matches up to 6%. We've actually reduced headcount 75 FTE year-over-year. We have less people than we did in the middle of '06 when we bought Republic Bank. We are particularly pleased with our management. We've done most of this through attrition. We're still under a hiring freeze in general and it takes a fairly strong justification to increase a filled job.

One of the things I do want to talk about that I think is very important for the Company is we finished the pilot and begun implementation on our new sales and service delivery platform. It's been in our call center, I guess, six months. It has cut our call time by quite a number of seconds. It takes everything in the Company about a customer and brings it to a screen in a very readable, useable fashion, where you would go out to the call center and those that could do a good job looked more or less like they were playing a piano, going from screen to screen, and now sit there, lean back in their seats, really enjoying the process. We've seen some headcount reduction there.

We've been piloting it in a few Jackson branches. It's now moving out through Jackson. It will move out through the remainder of the corporation before year end. It's really going to increase our productivity. We think we'll see some increase in revenues. The consultants, this is [ARGO], they will tell you certain percentages, but we'll wait and see what happens.

Our strategic direction is to manage credit and balance sheet risk in the future, as we watch the economy hopefully begin to moderate. We'll continue development of our Houston franchise. We're seeing loan growth in Houston, solid healthcare and major loan to a church and industrial.

We don't have any particular comments about the energy business. We do not have a heavy exposure in the energy business. You're getting that information from people who have heavy exposure and are actually doing production lending. Ours is to more solid companies.

We continue to vigorously defend our leadership position in major Mississippi markets with aggressive business development, calling on our customers and prospects, and we continue to prudently manage equity.

Thank you for listening to me. We'll be happy to attempt to answer any questions that you might have.

(Operator Instructions). And our first question today comes from Steven Alexopoulos of JP Morgan.

Hi, everyone.

Hi, there.

One to start -- looking at the 750 million of the construction and development loans that are outside of Florida, can you talk about what percent of those are criticized and what are the specific reserves on that part of the book?

Well, I think that's getting more granular than we want to. I will tell you that the reason for being -- I would not want you to try to assess when you look at our exposure of, say, 100 million of home building in the Jackson MSA or certain Mississippi markets where there has been no inflation of land prices and no inflation of home prices. So I think you would jump to conclusions and comparisons.

It is not significant. The building is -- the construction portfolio is not concentrated. It's spread fairly equally between overall Florida, Mississippi and Texas, and we feel that the deterioration has been more in line, or pretty much directly in line, with what you would expect with a quality portfolio in Houston and a superb quality portfolio in Mississippi.

Okay. Maybe could you talk about the driver of the reversing the provision expense? It looks like it happened in all the markets outside of Florida in the quarter.

I addressed that we provisioned 19.3 million more to chargeoffs. A lot of that is driven by the fact that the vast majority of our writedowns and chargeoffs from the quarter were the reappraisals and for real estate that had been previously provisioned.

Now, I think this would be a good time because we'd hoping you would ask. I'm going to ask Barry Harvey to talk about our revised loan loss methodology while we're pleased about it, and the impact it has on us now and the impact it will have on us going forward, if I may. I think that'll address your question. Barry?

Sure, I'd be glad to answer it. Just backing up a little bit, as Richard indicated, the objective here for taking the commercial portion of our loan portfolio and really enhancing the loan-loss reserve methodology we had, the objective there was to better comply with the inter-agency guidelines regarding the allowance for loan-loss reserves, and strictly to better segment the portfolio based upon the risk characteristics that are presented.

So what we did, as Richard indicated earlier, we took our commercial portfolio, segmented it into groups with common risk characteristics, and taking into account the uniqueness of some of our markets. So if you can envision it, we ended up with 13 loan portfolios within our commercial loan portfolio.

And by doing so, it allowed us to place the reserves on the loans that represented the highest risk. And that's not just as it relates to our Florida portfolio, but even in the CRE areas outside of Florida, we ended up allocating more reserve than we -- than our previous methodology allowed.

So the real answer to your question regarding the negative provisioning is as simple as our new methodology indicated that we needed more reserves in our Florida CRE portfolio. We also needed more reserves in some of our non-Florida CRE portfolio. And then we had other types of lending that, based on our historical losses, and based upon the current environment, would not evidence that they needed the reserve level we previously had.

So I think what we've done a much better job of is distributing the reserve to the areas that need -- that represent the most risk and need more reserving and that's not only true today, as it sits as of 6:30, but all future bookings will also receive a lesser or a higher reserve level based upon the inherent risk that that type of lending presents. So that's what ended up leading to a negative provisioning was the shifting of the existing reserves to the appropriate areas, although that negative provisioning was $1 million, not a significant --

It was very immaterial.

Yes.

Okay. That's very helpful. Maybe just one final question --

Sure.

Florida C&D loans were on non-accrual, I guess were down 15 million sequentially. Can you reconcile that change? How much went to OREO, what was charged off, what were just normal paydowns and what were the inflows into non-accrual?

We would be happy to do that. I'm not sure it's going to enlighten you beyond the fact that the Florida portfolio is still in a tough period of time, that we have essentially worked through it and we're sort of at the bottom of the barrel on anything with any size to it. But I'm going to ask either Bob Hardison or Barry Harvey because we have all of these numbers to tell you how much went in non-accrual in Florida in the quarter and how much was charged off and how much moved to ORE.

Okay.

It wasn't a big number anywhere, but we'll give it to you.

Okay. And I'll begin and let Bob jump in and really try to address it more from -- as it relates to the impaired loans, which is really what had the greatest impact. And we had moving into ORE from the impaired category approximately $11 million worth of loans that transferred into ORE that were Florida related.

As far as the non-accruals go themselves, the balance has actually, in the Florida portfolio, decreased about $11.6 million and that was really a combination of about 16 million worth of new non-accruals, some paydowns of about 1.9 million, of course, chargeoffs of about 15.6. And then, as it turned out, 6.8 million actually moved into ORE. So the combination of those small amounts of increase and the outflows going into both chargeoff -- coming to chargeoff, also moving into ORE and then the paydowns of about 1.9 million led to the change in the Florida balance.

I want to make one comment on that because I think it tells you where we are with the portfolio also. We do a report where we take the largest 20 non-accrual relationships, including impaired loans in Florida each month. And when we take a look at that, the smallest, our number 20, was $1.052 million and it drops down into 2, 300,000 at a pop pretty quickly after that.

But those 20 loans, the original loan amount less any paydown by the customer, cumulatively, those 20 loans totaled $89 million. We have either written down or have reserved and the vast majority of these top 20 have been written down and impaired, all but two or three, almost $41 million or 46%.

So the amount carried is 54% of the original loan amount. We pretty well worked the bulk of this down. These were most of the land credits, the large lot credits, the large development credits. I cannot emphasize to you enough how vigorous the real estate exam was in Florida by our loan review group, our workout group. And as you know, we are regulated -- our primary regulator, I would say, has a reputation of understanding credit pretty well.

And then we also did rigorous reviews of our real estate portfolio in Mississippi, our residential lending department here in Jackson, which more or less supervises all residential lending in Tennessee and the State of Mississippi, our commercial real estate department here, and spent a significant amount of time with a hard look at our Jackson commercial C&I portfolios. And we have had in the past a few solid family-owned companies that maybe made hardwood floors or bricks or cabinets and those have been criticized, classified and provisioned for in previous quarters.

We have seen a small amount of deterioration in some very solid real estate developers in Mississippi, but their properties don't have any inflation. They're still moving properties. It's just slowed, as you would expect. They've been reserved for along our methodology, and I'm not expecting losses in a lot of our migration in this stable Mississippi market that we might have experienced before. Barry, any comments (inaudible) on that?

No, I'd agree with that.

Thanks for all the color, guys; appreciate it.

And our next question comes from Albert Savastano of Fox-Pitt Kelton.

Hi, guys. This is actually Bill Young. I just have one question for you. Could you give a little color around the increasing criticized loans for the threshold and CRE and consumer portfolio in Florida?

Well, everybody, including me, looked at 92% of the total loan portfolio in Florida. We go back and literally have new financials and do cash flows and global cash flows literally on every customer of any size at all. We have reappraised the market and I think what you're seeing is a normal migration of four or five months of the winter with no activity down there and that's where I would describe it.

You know, the last loans we made in Florida, there's almost a next generation in the Company. It's way back in 2005, so I can't tell you how many times that Mr. Host or I had visited almost every piece of real estate that we have leaned on in the Panhandle of Florida over the last three or four years.

So we go by the appraisals. If we think the appraisals are for some reason too high or too low, we send it back to another appraiser, because we have to live with the appraisals. And we really know our customers and know our loans.

So we have a very independent process, credit review, reports to the Board, to the Audit Finance Committee, and basically a credit -- they're going to downgrade it, they're going to upgrade it, agree or disagree with the officer. And if the officer missed it, they're going to slap him on the hand. If they come forward with problems, they're going to pat him on the back and it's just a good process and it's proved fairly accurate today.

I hope that gives you some sense at a higher level of what we're doing. [I have] to wear out the files. They're going to have all be imaged, the covers, we've been in them so much.

Right. I was just kind of maybe looking for maybe some just general sense of color in what's kind of happening in the Florida portfolio outside of residential real estate.

Okay. Well, that's a good question. We're making new loans and they're paying down and our commercial income producing real estate that relates more to everybody going to the beach, good, solid shopping centers in Fort Walton and other places seen to be holding their own.

I visited with a major (inaudible) a couple of weeks ago in Florida that is heavily involved in the retail business down there, heavily involved with one of the largest projects, and they're flat. And rents are down, but volume is there and we just haven't seen any real deterioration of significance.

We'll see some become criticized, but it's very difficult not to say that most anything down there now doesn't have some sort of potential problem to it, if it has any size. So I would say we are being pretty tough right now on our interpretation of watch, especially mention sub-standard. If anything, we're trying to err on the conservative side and I would say that in the exams and our discussions with our regulators, we've had none or very minimal disagreement with our ideas of grading credits.

[This is] Jerry. Let me add just a little bit to that, Richard. There's -- as you know, there's three primary segments to the economy in the Panhandle generally speaking -- the real estate business, which has been covered thoroughly, and we feel like we have examined it and have addressed it every way that we can.

The second is tourism and the support businesses to tourism. And as Richard mentioned earlier, there has been an enticement to get more tourists there by condo owners, by the tourism industry, by reducing some of the rents. So volumes are very good. The activity associated with the support businesses that we lend to is very good and we stay on top of that.

The third segment is the military segment and as most of you know, there has been a renewed commitment to military projects within that region, which result in housing opportunities. It results in military support businesses continuing to grow and to add people.

So there are two of three segments that are still doing very well in the Florida market, but obviously, the most dominant one at this point, the one we talk about most, is the real estate business, which we feel like we have adequately addressed.

You know, things are tough in Atlanta and Birmingham and Memphis and St. Louis and Dallas. These people are driving to the beach on vacation this year. It's very crowded down there and the weather's been very good. So I think that's helped, but time will continue to weigh until we see some recovery.

Okay, great. Thanks for the color, guys.

And we'll take our next question comes from [Brent Morse] of FTN Equity Capital.

Good morning, Bill.

Hi.

I was just wondering if you could give us a little more color on the 21 million of writedowns? How is it distributed throughout the Florida portfolio?

Wow. You mean like construction?

Well, yes, like within the lots or the development or the -- like how did it kind of split up between those different sections?

Let me answer it in this way first. On a linked quarter, our lot exposure went down $5 million; our development exposure went down $8 million; our unimproved land went down 5.7 million; one to four family, 8.5 million; under construction, 3.4 -- so a $30 million drop in the construction portfolio.

I think while I said that, Barry Harvey or Bob Hardison have had a chance to look in their notes and they'll give you specific chargeoffs, but it was principally writedowns of impairments.

That's correct, Richard. The impairment writedowns, whether it be new impaired loss that was written down or existing impaired loans that were revalued during the period represented 17.4 million of the $21 million worth of chargeoffs. So these were loans that were known to us that we revalued and had a need to write down due to further decline in valuation. The difference is going to come more from -- some from the consumer side and then some from the smaller commercial credits that were not of a level that would need to be impaired based upon our definitions.

It's a little -- we have an established policy within the Company that we're following that if a loan is criticized that is in the construction category, and it changes and construction is completed, we're not switching it in the categories because we're trying to be able to look back at where we were, all in that $240 million or $200 million non-impaired. So the difference between a development loan and a lot loan and a one to four family construction could blur a little bit, and that's why I think that you could just say, it's an all construction and it's principally lots and land --

All right, perfect. Thank you.

-- [out of] the writedowns.

(Operator Instructions). And our next question comes from Erin Jacobson of KBW.

Good morning, gentlemen.

Good morning, Erin.

I was just looking at the expenses and trying to get to a run rate. I know that there's the FDIC special assessment in there, of course, but I was wondering if you could talk about the strategic capital initiative, and also if any of that is sort of temporary and might come back, or if we can expect those reductions to be ongoing?

We're having a little interruption in your voice. Can you repeat that question again or Joey, did you get it? Can you repeat it for the remainder of us, see if we have the --

I think Erin, your question concerned run rate for expenses going forward and details of the human initiatives that were human -- human resource management initiatives that are underway.

That's right. And if any of those expense reductions are temporary or if they're ongoing.

I don't see anything temporary about them.

Specifically one item --

(Inaudible) came about through image technology. We have completely now eliminated the proof department. There is not one at Trustmark. There was a headcount reduction in our call centers from our new delivery platform. We have not seen the reduction in our retail bank from this implementation yet. Our retail reduction is ongoing, always using a very sophisticated tele-model. We've had no real reduction in any compliance area in the bank at all and we've actually added rather significant headcount over the last couple of quarters in our collection departments.

We did see a reduction of around 22 people late last year and early this year when we finally shut down our indirect auto and that's permanent. We have -- principally Mr. Host has made decisions about management structures and reporting in a number of departments where he felt we could manage as or more effectively. So I would say it's not temporary.

We have a goal right now that's a little bit higher than at 75 and he's fairly committed to it and he reinforced that commitment to the Board yesterday. So I'm expecting to see continued reductions in headcount, although unless there's some drastic change in our revenue stream, I don't see any big jolts in there.

Okay. Thank you very much. And then also, if you could speak to your mortgage pipeline.

Well, it's not as big as it was 60 days ago. I'm going to let Jerry Host to comment on the specifics of why it's where it is today and what his expectations are.

Thank you, Richard. Because of the change of interest rates, we have seen a reduction in the mortgage pipeline this last month. We do not anticipate we would see levels where they were for the first six months, but we still believe that they would be ahead of our levels for last month.

Profitability remains good in the mortgage company as it relates to our fee revenues, our origination revenues and our secondary marketing revenues. The blip we had in the second quarter was a result of the change of value of the MSR hitch. So that says we all know it's something that's very volatile.

We are managing the size of our MSR portfolio. We're also managing the volumes that we hold on balance sheets of one to four family. So we see those. As I said, we see overall volumes less than the first half of the year, but we believe they'll exceed the second half of 2008.

Okay. Thank you very much.

Sure.

We'll take our next question from Andy Stapp of B. Riley & Company.

Hi, guys.

Hi, Andy.

I wonder if you could go over how you hedge the mortgage servicing rights, just give an overview of that.

We would be happy to do so. I asked Buddy Wood if he would comment on that and what happened in the quarter and do we think it's going to happen again and why it happened and what we're doing to address it. Buddy?

Okay. I'll start with just a brief comment on the hedge itself. It's a 10-year treasury futures hedge and because there is a basis risk between the 10-year treasury and the underlying mortgage rate of our MSR, we either use -- we either short or go long the 10-year options as well in order to fine-tune those. So the structure is using the 10-year which is a longstanding correlation to the mortgage business, as you know.

To take that a step further as it relates to the quarter, what we had was one month really that caused the negative ineffectiveness and that was in April. In May and in June, we saw a positive 1 million one month and a negative 1 million the next month. So that's well within our just normal volatility that occurs in the month of April because of the fed's very active involvement with both mortgage-backed securities, but even more so, with government buying for the fed account. As you know, they surprised the market on three days during the month of April and it caused some significant swings which were about $4 million and that just carried through as we went forward.

When we look at the -- and listen to the Chairman Bernanke's recent comments and his recognition of how much influence he has had on a number of securities-related activity, and the comments that he's made in the past couple of weeks, it's very clear that he plans to be as open with the markets and not give false inclinations about behavior of the portfolios.

So our confidence is that we will have a much tighter relationship between our instruments that we had on those three days and that they'll be well within the plus-or-minus $1 million range around zero that we engage with our hedging partner and with our own activity.

Okay. Just a follow-up question on your gains on sales or loans and the [timing and recognition] of that, would a good run rate be somewhere in between your Q1 and Q2 levels for Q3?

Yes, I think I'm going to let Jerry and Louis comment on that because --

I think that's a bit forward in terms of us giving any direction. Our approach to taking -- recognizing gains off of the securities portfolio is very much a function of opportunities that exist in the market and restructuring the portfolio.

As you know, we want to take advantage of some anomalies that may exist on the short end of the portfolio because of the curve which we have done, but it's after thorough analysis of specific securities that we feel have characteristics that have unusual values that we can take advantage of. So I don't want to give any kind of forward indication because it is very specific and unique to our portfolio.

Well, what I was talking about was gain on sale of loans. You had 8.9 million in the second quarter --

That's what I [thought]. That was an unusual situation where again, we were able to use our capital and stability and liquidity to get in there and [elbow] these three big players right now and we were able to do that. I don't view that as ongoing or likely to reoccur at that level. Usually, Jerry, it's about $5 million a year on average.

(Inaudible) I think it's a function of the difference between the FNCL rate and market rates because there are fewer players out there to have created opportunities for us to price the mortgage loans at a level that, as we go to market and sell these pools of securities, we've had some opportunity.

So I guess the answer to your question is the opportunity is currently still there. At that point in time that we see that spread narrow, you might anticipate that our opportunity will be somewhat reduced.

Jerry, would you, or Louis, one, comment on the tie of that category to the 133 re-evaluation of the pipeline?

Be glad to, Richard. Our 133, as Richard mentioned, is doing the fair value of loans held for sale, as well as rate lots and rate commitments. They're included in the mortgage banking other net line. And as Jerry has mentioned, the first two quarters of the year were historically the highest volumes in the history of Trustmark. They have produced significant gains. Well, if those volumes declined, certainly, there will be a reduction in cost of the gains, as well as a change in the 133. So it should normalize as rates stabilize.

Okay.

They weren't gambling or anything.

No, I understand that.

That was about the third question I asked and the third question the Audit Committee asked too.

(Inaudible) volumes.

Okay. And if you back out the special FDIC assessment, other non-interest expenses were up about 2.5 million. Did that have to do with the loan review that you've conducted during the quarter or --

Principally, ORE --

Okay.

-- and foreclosure and legal expenses related to it. Other expenses like technology were up like $400,000 and something else. You know, essentially, it's all FDIC and ORE and we can feel it too. We hadn't had raises in a long time and particularly the administrative group of top 200 officers.

And we're not expecting any significant changes there until the economy moderates -- no big technology [stands] going on. Pretty well [saw] now in our run rate the cost of our new retail deposit teller and sales system. So I think it's going to be whatever it costs in the ORE and it's all been appraised and written down to what we think cost of sale that it will bear.

Okay. And then there was -- was it elevated because of your more intensive review this quarter?

It was elevated principally because of Memphis lots and houses that we took into ORE last year --

Right.

-- that didn't move and that was around $700,000 or so, and maybe of our 22 million or whatever it was ORE portfolio, we got new appraisals on all of it. And the writedown was about $1 million there. So when you look at it, I think it was about 1.7 million of all existing ORE, which was pretty good relative to that. And literally everything got appraised in there.

Richard, I might comment on expenses that you (inaudible), the FDIC and the foreclosures which up on a linked quarter, about three -- linked quarter core expenses are down almost $2 million. On a year-to-date, I think they're slightly up less than 1% when you back down the FDIC and ORE for 200,000 for a linked quarter. So core expenses are well managed and down for a linked quarter, slightly up on a year-over-year basis.

Yes, I had an [efficiency] ratio of -- we've always run a lower efficiency ratio.

Right, okay. And would you happen to have the 39 to 80 -- 30 to 89-day delinquencies at quarter end?

Yes, it decreased $3.1 million down to 6.9 million, nothing in particular in there.

Okay. And would you also have the aggregate balance of the watch list, both at March 31 and June 30?

No, I don't.

Okay. And could you provide some color on opportunities for further margin expansion?

I think about 420 is about up there where there's not much air to breathe.

Okay. All right. Sounds good. Thank you.

And we'll take our final question from William Griffin of Synergy.

Good morning, gentlemen --

Good morning.

-- or good afternoon, I guess now. Actually, most of my questions have been addressed. Just a clarification -- your new commercial loan methodology, you mentioned that resulted in an additional reserve of about a million. Is that correct?

Above chargeoffs, we reserved about 1.4 million in the quarter. The process that we were trying to get across is the dynamics, which all of you well understand, that the vast majority of what we charged off in the quarter had been provisioned in previous quarters against specific credits. So our actual provision above chargeoffs was about $19 million.

That's correct.

And it's the dynamics and we'll see that going forward more and more as migration slows and these credits, where we're reserving for specific losses, work themselves through.

Okay. All right. Well, thanks very much.

Thank you very much.

I want to thank you for joining us today, a lengthy, but what we hope was productive call for you. We covered all fronts on the Company. I would like you to pay close attention to our five-quarter trends, to the stability of our margin, to the control of interest expenses, to the fact that the second quarter has become traditional (inaudible) for us because of the uniqueness of the Panhandle for a complete reappraisal.

I would take you to our provisioning levels of the third and fourth quarter of last year and look closely at them. I am not expecting to see anything particularly deteriorate in our margins over the next couple of quarters. We are a smidgen positively [gapped], so if they decide to move interest rates up, we are having absolutely good success in taking advantage of our capital strength and our liquidity.

Our capital continues to grow. Every month, the risk in the Company decreases with the payoff of construction and indirect auto. We have a very aggressive business development program going on. We're out; we're calling on prospects; we're calling on customers and doing business. We're looking for good loans.

Thank you for joining us.

And that does conclude today's conference, ladies and gentlemen. We appreciate everyone's participation today. Have a wonderful day.