DBRS Ratings on FirstMerit Corp. Unchanged after 2Q12 Results; Senior at A (low), Stable Trend

DBRS, Inc. (DBRS) has today commented that its ratings for FirstMerit Corporation (FirstMerit or the Company), including its A (low) Issuer & Senior Debt rating, are unchanged following the release of 2Q12 results. The trend on all ratings is Stable. The Company reported net income of $30.6 million for the quarter, up modestly from $30.3 million for 1Q12 and up from $29.8 million for 2Q11.

Despite a flat yield curve and the slow growth economic environment, FirstMerit’s resilient earnings reflect the Company’s solid balance sheet fundamentals and continued improvement in asset quality. Specifically, the slight increase in earnings reflected a 2.1% increase in total revenues, partially offset by a 4.7% increase in noninterest expense and a 7.8%, or $637,000 increase in provisions for noncovered loan losses.

Positively, QoQ revenue growth reflected broad based fee contributions from multiple sources, a resilient NIM and solid non-FDIC covered loan growth. Specifically, FirstMerit’s higher top line reflected a material 6.9% increase in noninterest income to $55.3 million and a modest 0.1% increase in net interest income to $118.9 million. Higher noninterest income was mostly attributable to an increase in other income (up 64.4%) and to a lesser degree, credit card fees (up 10.1%), trust income (up 1.8%) and deposit service charges (up 0.48%). DBRS notes that the large increase in other income mostly reflected a $2.6 million gain on covered loans paid in full. Somewhat offsetting, loan sales and servicing income contracted 23.1% to $5.1 million, due to a $2.6 million change in MSR valuation.

The modest QoQ increase in spread income (FTE) was attributable to a slight 0.4% increase in average earning assets and a one basis point narrowing of NIM to a still strong 3.77%. As with all banks, FirstMerit’s NIM remains pressured by the flat yield curve. The increase in average earning assets was attributable to a solid 2.0% increase in non-FDIC covered loans and a 0.2% increase in securities. DBRS notes that the Company concluded its securities repositioning strategy during the quarter, which included the purchase of approximately $32 million of municipal securities. Importantly, the Company reported solid loan growth, QoQ, across many non-FDIC covered loan types, including commercial loans (up 2.6%), home equity loans (up 1.7%) and residential mortgage loans (up 2.4%). Positively, new QoQ commercial loan production in the Company’s Chicago footprint was up 65% to $130 million. DBRS expects the Chicago franchise to be a focus of growth for the Company.

Higher QoQ noninterest expense (totaled $119 million) primarily reflected the impact of Firstmerit’s efficiency initiative, which had related charges of $8.9 million, mostly consisting of employee separation costs ($3.3 million) and professional services fees ($5.2 million). Excluding the charges, FirstMerit’s operating expenses declined $3.6 million sequentially, mostly reflecting $2 million in lower benefit accruals. Management anticipates third quarter expenses to range between $111 million to $112 million, inclusive of approximately $600,000 in one-time efficiency initiative expenses. Overall, the Company anticipates that the efficiency initiative will lower operating expenses to $110 million by 4Q12, which represents an approximately $2 million, or 1.3%, reduction in the expense run-rate.

Despite the difficult operating environment, nonperforming assets (NPAs) and net charge-offs (NCOs) continue to track positively. Specifically, NPAs (excluding acquired assets) decreased 10.1% to $61.1 million and represented 0.76% of loans at June 30, 2012, down from 0.87% at March 31, 2012. Meanwhile, NCOs (excluding acquired assets) contracted to 0.45% of average loans for 2Q12 from 0.63% for 1Q12. Finally, the Company’s reserve coverage remains sufficient, as its allowance for credit losses represented 235% of non-performing loans and 1.36% of period-end loans, at June 30, 2012.

FirstMerit maintains a strong funding profile that is underpinned by a high level of core deposits that more than amply fund its loans. During 2Q12, average deposits increased 0.7% and the mix improved, as noninterest bearing and savings & money market accounts increased, while time deposits declined. Rounding out the Company’s liquidity profile is a good quality securities portfolio, which represents 24% of total assets, and access to the Federal Home Loan Bank and Federal Reserve.

DBRS views FirstMerit’s capital as ample, providing solid loss absorption capacity as well as the opportunity for organic or acquisition related growth. The Company disclosed its estimated Basel III Tier 1 common ratio under the Federal Reserve’s NPR to be just below 11%, which is well above the minimum. At 2Q12, the Company’s tangible common equity ratio was a solid 8.01%.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating includes company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Mark Nolan
Approver: Roger Lister
Initial Rating Date: 3 February 2005
Most Recent Rating Update: 1 June 2012

For additional information on this rating, please refer to the linking document under Related Research.