DBRS Ratings on FirstMerit Corp. Unchanged after 4Q12 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 4Q12 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 $38.2 million for 4Q12, up from $35.0 million for 3Q12. DBRS does not consider the earnings improvement to be core, given that the increase in Quarter-on Quarter (QoQ) earnings mostly reflected gains on sales of loans and securities. Nonetheless, DBRS notes that the securities gains offset the costs associated with the early termination of FHLB advances. Specifically, higher QoQ earnings were attributable to a 2.9% increase in total revenues and a 29% decrease in provisions for non-covered loans, partially offset by a 3.3% increase in non-interest expense.

Despite the difficult business environment, FirstMerit’s 4Q12 earnings remained resilient, underscored by its solid net interest margin and sound fee income generation. Additionally, the Company’s balance sheet fundamentals remain solid, reflecting sustained loan and deposit growth and sound asset quality.

Higher total revenues, which increased by $5.1 million to $177.9 million sequentially, mostly reflected a $5 million gain on covered loan sales and a $1.9 million increase in gains from securities sales. Specifically, higher total revenues were driven by a 12.2% increase in non-interest income, partially offset by a 1.4% decrease in net interest income. Higher linked-quarter non-interest income reflected the securities and loan sale gains, as most other fee line items declined during the quarter.

As with most banks, the low interest rate environment continued to pressure FirstMerit’s spread income, which decreased $1.6 million (on a fully taxable equivalent (FTE) basis) to $119.1 million, sequentially. Lower net interest income reflected an 8 bp narrowing of net interest margin (NIM) to 3.58% (on a fully taxable equivalent basis), which more than offset the impact of 1.0% growth in average earning assets. The narrower NIM resulted from decreasing earning asset yields outpacing declining funding costs. Indeed, most of the decline in NIM was driven by a 7 bp decrease in covered loan yields.

Meanwhile, higher linked-quarter average earning assets were attributable to a $137 million, or 1.4% increase in average loans, partially offset by a $6.8 million, or 0.2%, decrease in average securities. Higher loans were driven by a $258.7 million or 3.2% increase in average non-covered loans, mostly reflecting a $156.8 million, or 2.9% increase in average commercial loans. Somewhat offsetting total loan growth, the Company continued to manage down its covered loan portfolio, which declined $121.5 million, or 10.0% linked-quarter.

Total noninterest expense increased $3.6 million, or 3.3% to $112.2 million QoQ. Higher sequential expense was mostly driven by a $3.5 million, or 6.0% increase in salaries/wages/benefits, and a $1.4 million or 30% increase in professional services fees. Higher professional fees were related to the proposed acquisition of Citizens. Additionally, higher expenses reflected $2.3 million of fees related to early termination of $15 million of higher cost Federal Home Loan Banks (FHLB) advances.

Importantly, the Company’s asset quality remains sound, despite the difficult business environment.
Specifically, 4Q12 net charge offs (excluding covered loans) totaled $7.1 million, or a low 0.34% of average loans for 4Q12, down from $14.9 million or 0.72% in 3Q12 (0.59%, excluding the impact of Office of the Comptroller of the Currency (OCC) guidance related to chapter 7 discharges). Meanwhile, non-performing assets decreased $13.8 million or 21.6% and represented 0.57% of loans, at December 31, 2012, down from 0.77% at September 30, 2012 (0.64% excluding the impact of OCC guidance related to chapter 7 discharges). Finally, DBRS notes that the Company’s reserve coverage remains solid at 284.5% of non-performing loans.

FirstMerit maintains a solid funding profile that is underpinned by a gross loan to deposit ratio of 83%. Average deposit growth was sustained in 4Q12, up 0.03% sequentially. Positively, the mix improved, as non-time deposits increased by 1.1%, while certificates of deposits decreased by 6.9%. Rounding out the Company’s liquidity position is a good quality securities portfolio, which represents 24% of total assets, and access to the FHLB and Federal Reserve.

DBRS views FirstMerit’s capital as ample, providing solid loss absorption capacity. At 4Q12, the Company’s tangible common equity ratio was a solid 8.16%.

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

[Amended on June 25, 2014 to remove unnecessary disclosures.]