DBRS: FirstMerit’s 4Q13 Earnings Up QoQ On Lower Merger Expense; Positive Operating Leverage

Summary:

• Higher quarter-on-quarter (QoQ) earnings reflected lower merger related expenses; While on an adjusted basis, FirstMerit generated positive operating leverage, as declining adjusted expenses outpaced decreasing adjusted revenues
• Credit quality remains solid, despite an uptick in non-performing assets
• DBRS rates FirstMerit’s Issuer & Senior debt at A (low) with a Negative trend

DBRS, Inc. (DBRS) considers FirstMerit Corporation’s (FirstMerit or the Company) 4Q13 earnings to be solid, despite lower total revenues QoQ. For 4Q13, the Company reported net income attributable to common shareholders of $55.3 million, up from $38.9 million, mostly due to lower merger expenses. Importantly, the Company generated positive operating leverage, as declining adjusted expenses outpaced decreasing adjusted revenues. DBRS considers FirstMerit’s sustained profitability and solid balance sheet fundamentals, including sound credit quality and continued loan and deposit growth as supportive of its rating level.

Linked-quarter, adjusted income before provisions and taxes (IBPT, adjusted for merger and branch closure expense) improved 1.7%, driven by a 2.6% decrease in non-interest expense, partially offset by a 1.1% decrease in total revenues. Improved adjusted expenses reflected lower levels of salaries and loan processing expenses. Positively, future earnings will benefit from enhanced costs saves, related to the Citizens Republic transaction. Indeed, the Company announced additional expense saves, including the closure of additional branches, enterprise sourcing efficiencies, as well as several others that will boost the full year run rate for cost saves to $77 million from $59 million.

Spread income declined 2.6% sequentially, driven by a 16 basis points (bps) narrowing of net interest margin (NIM), partially offset by a moderate increase in average earning assets. The narrower NIM mostly reflected lower yields and lower levels of acquired loans. Better than many banks, FirstMerit reported a 6.5% sequential increase in average originated loans, reflecting a broad-based increase across most loan types, the bulk of which was commercial loans. Additionally, adjusted non-interest income improved 3.3% sequentially, reflecting recoveries on acquired loan charge-offs, along with higher levels of swap fees, letters of credit fees, commitment fees, and asset based lending fees.

Despite slightly higher QoQ levels of net charge-offs and non-performing assets, the Company’s credit quality remains sound. Furthermore, reserve coverage (reserves for originated loans) remains adequate at 229% of non-performing loans and 0.9% of period-end loans.

FirstMerit’s liquidity and capital profiles remain solid. Funding reflects a core deposit base that fully funds loans. Meanwhile, capital metrics improved during the quarter and provide sound loss absorption capacity, and the potential for balance sheet growth.

DBRS rates FirstMerit Corporation Issuer & Senior debt at A (low) with a Negative trend.

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

[Amended on December 23th, 2014 to remove unnecessary disclosures.]