DBRS Confirms FirstMerit Corp at A (Low), Changes Trend to Negative after Citizen’s Announcement

DBRS, Inc. (DBRS) has today confirmed the ratings of FirstMerit Corporation (FirstMerit or the Company) and its rated bank subsidiary, FirstMerit Bank, N.A, including FirstMerit’s Issuer & Senior Debt rating of A (low), following the announcement of its plan to acquire Citizens Republic Bancorp, Inc. (Citizens). At the same time, DBRS has changed the trend on all ratings to Negative from Stable, except for the short-term instruments rating for FirstMerit Bank, N.A, which was confirmed. On September 13, 2012, FirstMerit announced that it had agreed to acquire Citizens in an all stock transaction valued at approximately $912 million. As part of the transaction, FirstMerit expects to repay Citizens’ $345 million of TARP preferred stock, including $45 million of deferred dividends. The transaction is expected to close during 2Q13 subject to standard regulatory and shareholder approvals.

The change in trend to negative reflects several concerns the first of which is DBRS’s view of the significant integration and execution risk embedded in the transaction which will be FirstMerit’s largest to date at 66% of its asset size. Partially offsetting this concern is FirstMerit’s success at integrating past acquisitions as well as the fact that both companies operate on similar primary operating platforms. Secondly, FirstMerit’s capital position will contract after the close of the deal, pressuring the Company’s loss absorption capacity and to a degree its financial flexibility. Thirdly, FirstMerit will be operating a far larger banking platform estimated at $24.3 billion in assets, over an expanded footprint, which will result in a higher level of operating risk and require more skill to manage. Finally, DBRS notes that, FirstMerit must successfully execute $250 million of subordinated debt and $100 million of preferred stock offerings to prepay Citizens’ TARP preferreds.

DBRS notes that negative ratings pressure could result from a troubled integration/conversion, material customer disruption, inability to restore capital levels and degradation in earnings capacity. Conversely, a successful integration/conversion, improved capital position, enhanced core earnings generation and sound asset quality could return the trend to Stable over time.

The confirmation of FirstMerit’s ratings reflects DBRS’s view that the combination is a good strategic fit, creating a much larger regional banking franchise underpinned by deeply rooted banking operations with a good deposit generating capacity. The confirmation is also underpinned by FirstMerit’s solid credit culture, resilient earnings power and solid funding position.

Although FirstMerit is acquiring a bank with strained fundamentals; due to asset quality issues driven by the recent recession, Citizens credit quality is much improved in DBRS’s view, as the company has significantly reduced levels of troubled loans. Although credit risks remain within Citizens’ loan portfolio, this risk will be significantly mitigated by the nearly 7% credit mark to be taken against the loan portfolio.

At the close, the acquisition will provide scale of operations, as the combined entity will have approximately $24 billion in assets, 415 branches and 5,000 employees. Positively, FirstMerit will be able to leverage its solid middle-market business banking platform in a larger footprint, with a fairly dense middle-market customer base, especially in Michigan. The internal rate of return on the acquisition is expected to be 18% and FirstMerit anticipates that the deal will be 7.5% accretive (full year basis) in 2014, the year after closing, without any additional synergies, which DBRS views as potentially possible. The acquisition bolsters the Company’s presence to five states in the upper Midwest and provides it with the opportunity to offer a broader product set throughout its footprint. Operating expense saves are expected to be roughly 22%.

After restructuring charges and the anticipated preferred stock and debt issuances, FirstMerit’s proforma tangible common equity is expected to be 7.15% of tangible assets, down from 8.01% at June 30, 2012. FirstMerit expects to recover this position within 2 years.

FirstMerit, a bank holding company headquartered in Akron, Ohio, reported $14.6 billion in assets at June 30, 2012.

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 commentary was disclosed to the issuer and no amendments were made following that disclosure.

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

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

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