DBRS Comments on FirstMerit Corp’s 2Q13 Results; Senior at A (low), Negative Trend

DBRS, Inc. (DBRS) has today commented on the 2Q13 Results of FirstMerit Corporation (FirstMerit or the Company). FirstMerit has an Issuer & Senior Debt rating of A (low) with a Negative trend. The Company reported net income of $46.6 million for the quarter, up from $36.1 million for 1Q13 and $30.5 million for 2Q12. Higher QoQ earnings were reflective of the Citizens Republic Bancorp, Inc. (Citizens) acquisition, which closed on April 12, 2013. Specifically, higher linked-quarter earnings were attributable to a 58.5% increase in total revenues to $267.5 million and a $2.7 million or 45.7%, decrease in provisions for originated loan loss reserves, partially offset by a 77.3% increase in non-interest expense to $189.6 million.

Highlights for the quarter included sustained average originated loan growth, sound asset quality, and a solid capital and liquidity profile. Financial results also reflected FirstMerit’s resilient earnings generation, as results for 2Q13 represented the Company’s fifty seventh consecutive quarter of profitability. Importantly, during the quarter, FirstMerit completed its acquisition of Citizens, which contributed $9.3 billion in assets, $4.7 billion in loans and $7.3 billion in deposits to the balance sheet. By June 13, 2013, the company had rebranded all of the Citizens’ Michigan and Wisconsin branches while the systems conversion is scheduled to occur in 4Q13.

Higher linked-quarter total revenues reflected the Citizens acquisition, as net interest income increased by 77.8% to $198.0 million and non-interest income increased by 21.0% to $69.4 million. Improved sequential net interest income was attributable to a 66 basis point widening of net interest margin (NIM) to 4.12%, along with a 46.2% increase in average earning assets. The wider NIM reflected the net accretion of the fair value adjustments on the acquired loans and certificates of deposits. Reflective of FirstMerit’s sound interest rate risk management, NIM, excluding the acquisition, would have approximated that of 1Q13. Overall, the increase in average earning assets reflected a $4.0 billion, or 40.9%, increase in average loans (including loss share receivable), a $2.2 billion or 60.3%, increase in average securities and a $411.2 million or 104.4%, increase in average cash balances. Importantly, average originated loan growth was sustained, up 1.6% QoQ. This growth was broad-based, across all reported loan types.

Higher QoQ non-interest income was driven by the Citizens acquisition. During 2Q13, FirstMerit reported higher levels of deposit service charges (up 63.5%), credit card fees (up 40.0%) and trust department income (up 59.7%).

The linked-quarter increase in non-interest expense included $29.3 million of merger related expenses, the bulk of which were severance arrangements and professional and legal services expense related to the merger. Overall, salaries/wages/pensions and employee benefits increased by $47.1 million, or 81.4%, and professional services expense increased by $11.7 million or 217%, sequentially. As of June 30, 2013, merger related costs associated with the Citizens acquisition have totaled $38.7 million. The Company anticipates total merger related costs will approximate $79.4 million. Overall, FirstMerit expects to exceed its goal of $59 million of total projected annualized costs saves.

Asset quality remains sound, despite the difficult operating environment. Specifically, 2Q13 net charge offs (excluding acquired and covered loans) declined 43.3% to $3.3 million and represented a low 0.15% of average loans, down from 0.27% in 1Q13. Meanwhile, non-performing assets (NPAs: excluding acquired and covered loans) increased $13.9 million or 26.7% sequentially and represented a still manageable 0.72% of loans at June 30, 2013, up from 0.59% at March 31, 2013. DBRS notes that the bulk of the increase in NPAs represented the transfer of OREO out the Citizens book. Finally, DBRS notes that the Company’s reserve coverage (reserves for non-covered loans) remains solid at 217% of non-performing loans and 1.08% of period-end loans.

Despite the impact of the acquisition, FirstMerit’s capital remains sound, as evidenced by its solid estimated risk based capital ratios for the quarter, including Tier 1 of 11.40% and Total of 13.91%. The Company’s tangible common equity ratio was 7.61% at June 30, 2013.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]