DBRS Ratings on FirstMerit Corp. Unchanged after 3Q12 Results; Senior at A (low), Negative Trend

DBRS, Inc. (DBRS) has today commented that its ratings for FirstMerit Corporation (FirstMerit or the Company), including its A (low) Issuer & Senior Debt ratings, are unchanged following the release of 3Q12 results. The trend on all ratings is Negative, except for the short-term instruments rating for FirstMerit Bank, N.A, which is Stable. The Company reported net income of $35.0 million for 3Q12, up 14.3% from $30.6 million for 2Q12. Improved QoQ earnings mostly reflected the non-recurrence of a sizable 2Q12 expense related to the Company’s cost reduction initiatives, yet positively FMER was still able to generate positive operating leverage. Specifically, higher QoQ earnings were attributable to an 8.8% decrease in noninterest expense which more than offset a 13.7% or $1.2 million increase in provisions for non-covered loan losses and a 0.8% decline in total revenues.

Although pressured by the slow growth economic environment, FirstMerit’s balance sheet fundamentals remain sound. Indeed, the Company’s average noncovered loans (loans not covered by a loss share agreement) grew $244.4 million or 3.1% during 3Q12, mostly driven by a $169.4 million, or 3.2% increase in average commercial loans. Meanwhile, deposit growth continued, albeit modest, and the mix improved, as noninterest bearing deposits increased 2.9%, while certificates of deposits were down 5.6%.

While reflecting mostly non-core items, the QoQ decline in noninterest expense exhibited the Company gaining some traction with its expense reduction initiatives. Overall, noninterest expense decreased 8.8% sequentially, mostly due to the non-recurrence of $8.9 million of efficiency initiative expense reported in 2Q12. Moreover, lower linked-quarter expense reflected 3Q12 decreases in both professional & service fees (down $4.6 million or 49.5%) and salaries & employee benefit expense (down $3.5 million or 5.7%). Excluding one-time items in both quarters, FirstMerit’s operating expense decreased by approximately 3% QoQ, reflecting favorably on the Company’s expense reduction initiatives.

Lower QoQ revenues mostly reflected pressured spread income driven by a narrower net interest margin (NIM), and lower gains reported in noninterest income. The Company’s spread income decreased by 0.9% sequentially to $117.9 million, driven by an 11 bps narrowing of NIM to 3.66%, partially offset by a 1% increase in average earning assets. The narrower NIM resulted from decreasing earning asset yields outpacing declining funding costs. Higher average earning assets reflected a 3.1% increase in average loans. Meanwhile, noninterest income decreased by 0.7%, QoQ, largely due to a $2.6 million contraction in gains on covered loans paid in full, partially offset by higher sales and servicing income, which increased by $2.1 million, or 41.1%.

As with many banks, the new regulatory guidance for loans related to customers who went through Chapter 7 bankruptcy, impacted FirstMerit’s net charge-offs (NCOs) and nonperforming assets (NPAs). Specifically, the new OCC guidance resulted in $10.6 million of consumer loans reclassified into nonaccrual status and $2.8 million in additional NCOs and provisions for loan loss reserves in 3Q12. Specifically, 3Q12 NCOs (excluding covered loans) totaled $14.9 million or 0.72% of average loans, up from $8.8 million or 0.44% in 2Q12. Meanwhile, NPAs increased $3.0 million or 4.9% to $64.1 million and represented 0.77% of loans, up from 0.75% at 2Q12. Excluding the impact of the OCC guidance, NCOs (excluding covered loans) would have contracted to 0.59% of average loans while NPAs would have declined to 0.64% of total loans. Finally, DBRS notes that the Company’s reserve coverage remains solid at 208.1% of non-performing loans.

FirstMerit maintains a strong funding profile that is underpinned by a high level of core deposits which more than amply fund its loans. During 3Q12, average deposits increased 0.3% and the mix improved. Rounding out the Company’s liquidity position is a good quality securities portfolio, which represents 25% 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. At 3Q12, the Company’s tangible common equity ratio was up 17 bps QoQ to a solid 8.18%.

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 include 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: Alan G. Reid
Initial Rating Date: 3 February 2005
Most Recent Rating Update: 14 September 2012

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