DBRS Confirms FirstMerit Corporation at A (Low), Maintains Negative Trend

DBRS, Inc. (DBRS) has today confirmed the ratings of FirstMerit Corporation (FirstMerit or the Company), including its Issuer & Senior Debt rating of A (low). At the same time DBRS maintained the Negative trend on the Company’s ratings, with the exception of the short-term instruments rating for FirstMerit Bank, N.A, it’s bank subsidiary, which remained on Stable trend. The ratings action follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

FirstMerit’s ratings consider the Company’s strong community focused commercial banking franchise, its resilient earnings generation capacity, stabilizing credit quality, solid capital position and strong funding profile. Ratings also reflect the challenge of integrating its Citizens Republic Bancorp (Citizens) acquisition, the Company’s largest transaction to date, along with the operating pressures associated with the difficult business environment. DBRS views favorably, FirstMerit’s success to date with the Citizens transaction (closed April 12, 2013), its repayment of Citizens’ TARP, and the re-branding of the Michigan and Wisconsin branches. Over the near term, the Company will be focused on the Citizens systems conversion, which is expected in 3Q13 along with continued realization of synergies embedded in the combined entity. DBRS notes that a smooth systems conversion, visibility in achieving the targeted annual expense synergies, and the absence of unexpected customer and/or employee turnover, would likely return the ratings trend to Stable. Conversely, a troubled conversion, material unexpected customer disruption, and/or degradation in earnings capacity, would lead to further negative rating pressure.

The Citizens acquisition enhanced FirstMerit’s commercial focused banking franchise which now has over 400 branches and a footprint that extends through five contiguous upper Midwestern states. The Company has positioned itself positively for future growth, especially in Michigan, with the recent hiring of seasoned managers and lenders and the refocus to offense from defense. Furthermore, the Company has a defensible deposit franchise, especially on a more granular basis. Indeed, a DBRS deposit study shows that within the 289 cities that FirstMerit operates in, it has leading deposit market share in 29% of the cities and ranks within the top four banks in 65% of the cities.

Reflecting FirstMerit’s resilient earnings generation capacity, the Company was profitable through the recent financial crisis. The addition of Citizens’ balance sheet bolstered 2Q13 earnings as the Company reported net income available for common shareholders of $46.6 million for 2Q13, up from $36.1 million for 1Q13. The improvement was driven by higher revenues and lower provisions for originated loan loss reserves, partially offset by an increase in expenses. Higher 2Q13 revenues reflected improved spread income which was attributable to both acquired and organic earning asset growth, and purchase accounting adjustments which helped widen the net interest margin (NIM) to a high 4.12% (FTE basis). As with most community banks, FirstMerit’s earnings are mostly spread driven as only 27% of 2Q13 total revenues (excluding net investment losses) were generated from non-interest revenue sources, allowing for future growth opportunities. For 1H13, FirstMerit’s net income available for common shareholders totaled $82.6 million, up 35.9% from $60.8 million for 1H12, driven by many of the same attributes that led to the recent QoQ earnings growth.

FirstMerit’s expenses fall in-line with similarly rated peers but remain elevated, due in part to acquisition related costs. Positively, management anticipates achieving annual cost saves related to the acquisition above the original estimation of $59 million. Moreover, the Company expects only $79 million in one-time costs associated with the merger, down from the previously estimated $88 million. DBRS notes that with the larger franchise, the Company should be able to benefit from economies of scale.

Over the past year, asset quality remained sound and continued to stabilize, despite the difficult operating environment. Specifically, 2Q13 net charge-offs (excluding acquired and covered loans) represented a low 0.15% of average loans, down from 0.27% in 1Q13 and 0.44% for 2Q12. Meanwhile non-performing assets (excluding acquired and covered loans) represented a manageable 0.72% of loans at June 30, 2013, up from 0.59% at March 31, 2013, yet slightly down from 0.75% at June 30, 2012. Importantly, DBRS anticipates that losses related to the acquired loan portfolio will be manageable given the nearly 7% credit mark taken on the exposure. Finally, DBRS notes that the Company’s reserve coverage (excluding covered and acquired loans) remains acceptable, as represented by an allowance for credit losses to loans ratio of 1.17%, and an allowance for credit losses to non-performing loan ratio of nearly 235%.

FirstMerit maintains a solid capital profile and strong funding position, which is supportive of its ratings level. Although pressured by the Citizens acquisition, capital provides solid loss absorption capacity, as well as support for future growth, as evidenced by its June 30, 2013 risk-based capital ratios, including Tier 1 of 11.40% and Total of 13.91%. Furthermore, the Company’s tangible common equity ratio was sound at 7.61%, down 42 bps from before the acquisition. FirstMerit’s Tier 1 common ratio under Basel III rules was estimated at 10.51%, which reflects a solid cushion above the minimum requirement. Meanwhile, its funding profile remains strong, underpinned by a large core deposit base, which represented a high 129% of net loans (DBRS calculated) at the end of 2Q13.

FirstMerit, a bank holding company with headquarters in Akron, Ohio, reported $23.5 billion in assets at June 30, 2013.

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 applicable methodologies include the DBRS Criteria: Intrinsic and Support Assessments, DBRS Criteria: Rating Bank Preferred Shares & Equivalent Hybrids and DBRS Criteria: Rating Bank Subordinated Debt & Hybrid Instruments with Discretionary Payments. These can be found at: http://www.dbrs.com/about/methodologies

[Amended on June 18, 2014, to reflect actual methodologies used]

The sources of information used for this rating include company documents, the Federal Reserve, 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.

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

Lead Analyst: Mark Nolan
Rating Committee Chair: Elisabeth Rudman
Initial Rating Date: 3 February 2005
Most Recent Rating Update: 14 February 2013

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