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FMER > SEC Filings for FMER > Form 10-Q on 6-Aug-2013All Recent SEC Filings

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Form 10-Q for FIRSTMERIT CORP /OH/


6-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

AVERAGE CONSOLIDATED BALANCE SHEETS (Unaudited)
Fully Tax-equivalent Interest Rates and Interest Differential
                                        Three months ended                        Three months ended                        Three months ended
                                           June 30, 2013                            March 31, 2013                             June 30, 2012
                                 Average                     Average       Average                     Average       Average                     Average
(Dollars in thousands)           Balance        Interest       Rate        Balance        Interest       Rate        Balance        Interest       Rate
ASSETS
Cash and due from banks       $    806,129                              $    394,896                              $    410,533
Investment securities and
federal funds sold:
U.S. Treasury securities
and U.S. Government agency
obligations (taxable)            4,714,823     $  24,679       2.10 %      2,790,039     $  16,294       2.37 %      2,823,055     $  19,028       2.71 %
Obligations of states and
political subdivisions (tax
exempt)                            710,579         9,217       5.20 %        541,014         6,595       4.94 %        482,475         6,254       5.21 %
Other securities and
federal funds sold                 504,343         4,459       3.55 %        366,926         2,944       3.25 %        392,394         2,756       2.82 %
Total investment securities
and federal funds sold           5,929,745        38,355       2.59 %      3,697,979        25,833       2.83 %      3,697,924        28,038       3.05 %
Loans held for sale                 17,394           143       3.30 %         14,884           144       3.92 %         22,731           238       4.21 %
Loans, including loss share
receivable                      13,662,835       178,847       5.25 %      9,695,926        99,006       4.14 %      9,266,333       103,245       4.48 %
Total earning assets            19,609,974       217,345       4.45 %     13,408,789       124,983       3.78 %     12,986,988       131,521       4.07 %
Total allowance for loan
losses                            (146,565 )                                (141,735 )                                (143,565 )
Other assets                     2,541,164                                 1,321,593                                 1,304,558
Total assets                  $ 22,810,702                              $ 14,983,543                              $ 14,558,514
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing           $  5,095,977     $       -          - %   $  3,321,660     $       -          - %   $  3,144,183     $       -          - %
Interest-bearing                 2,347,155           656       0.11 %      1,300,816           318       0.10 %      1,060,771           236       0.09 %
Savings and money market
accounts                         8,210,780         6,469       0.32 %      5,835,750         5,315       0.37 %      5,732,007         5,033       0.35 %
Certificates and other time
deposits                         2,680,332         3,374       0.50 %      1,331,558         2,063       0.63 %      1,618,322         3,169       0.79 %
Total deposits                  18,334,244        10,499       0.23 %     11,789,784         7,696       0.26 %     11,555,283         8,438       0.29 %
Securities sold under
agreements to repurchase           927,451           329       0.14 %        906,717           313       0.14 %        920,352           276       0.12 %
Wholesale borrowings               237,887         1,169       1.97 %        136,298           850       2.53 %        177,987         1,118       2.53 %
Long-term debt                     314,597         3,743       4.77 %        155,506         1,748       4.56 %              -             -          - %
Total interest-bearing
liabilities                     14,718,202        15,740       0.43 %      9,666,645        10,607       0.45 %      9,509,439         9,832       0.42 %
Other liabilities                  424,559                                   280,233                                   305,705
Shareholders' equity             2,571,964                                 1,715,005                                 1,599,187
Total liabilities and
shareholders' equity          $ 22,810,702                              $ 14,983,543                              $ 14,558,514
Net yield on earning assets   $ 19,609,974     $ 201,605       4.12 %   $ 13,408,789     $ 114,376       3.46 %   $ 12,986,988     $ 121,689       3.77 %
Interest rate spread                                           4.02 %                                    3.34 %                                    3.66 %

Note: Interest income on tax-exempt securities and loans has been adjusted to a fully-taxable equivalent basis. Nonaccrual loans have been included in the average balances.


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                                                     Six months ended                          Six months ended
                                                       June 30, 2013                             June 30, 2012
                                             Average                     Average       Average                     Average
(Dollars in thousands)                       Balance        Interest       Rate        Balance        Interest       Rate
ASSETS
Cash and due from banks                   $    601,649                              $    394,634
Investment securities and federal funds
sold:
U.S. Treasury securities and U.S.
Government agency obligations (taxable)      3,757,748     $  40,974       2.20 %      2,852,550     $  38,707       2.73 %
Obligations of states and political
subdivisions (tax exempt)                      626,265        15,812       5.09 %        459,640        12,118       5.30 %
Other securities and federal funds sold        436,014         7,403       3.42 %        382,184         5,494       2.89 %
Total investment securities and federal
funds sold                                   4,820,027        64,189       2.69 %      3,694,374        56,319       3.07 %
Loans held for sale                             16,146           287       3.58 %         24,607           522       4.27 %
Loans, including loss share receivable      11,690,339       277,852       4.79 %      9,242,105       206,400       4.49 %
Total earning assets                        16,526,512       342,328       4.18 %     12,961,086       263,241       4.08 %
Total allowance for loan losses               (144,164 )                                (143,096 )
Other assets                                 1,930,584                                 1,314,888
Total assets                              $ 18,914,581                              $ 14,527,512
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing                       $  4,213,720     $       -          - %   $  3,090,386     $       -         -%
Interest-bearing                             1,826,876           974       0.11 %      1,063,451           483       0.09 %
Savings and money market accounts            7,029,826        11,784       0.34 %      5,703,530        10,136       0.36 %
Certificates and other time deposits         2,009,671         5,437       0.55 %      1,656,284         6,693       0.81 %
Total deposits                              15,080,093        18,195       0.24 %     11,513,651        17,312       0.30 %
Securities sold under agreements to
repurchase                                     917,141           642       0.14 %        904,033           544       0.12 %
Wholesale borrowings                           187,373         2,019       2.17 %        181,323         2,269       2.52 %
Long-term debt                                 235,491         5,491       4.70 %              -             -          - %
Total interest-bearing liabilities          12,206,378        26,347       0.44 %      9,508,621        20,125       0.43 %
Other liabilities                              348,632                                   338,408
Shareholders' equity                         2,145,851                                 1,590,097
Total liabilities and shareholders'
equity                                    $ 18,914,581                              $ 14,527,512
Net yield on earning assets               $ 16,526,512     $ 315,981       3.86 %   $ 12,961,086     $ 243,116       3.77 %
Interest rate spread                                                       3.74 %                                    3.66 %

Note: Interest income on tax-exempt securities and loans has been adjusted to a fully-taxable equivalent basis. Nonaccrual loans have been included in the average balances.


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HIGHLIGHTS OF SECOND QUARTER 2013 PERFORMANCE

Earnings Summary

The Corporation reported second quarter 2013 net income of $48.5 million, or $0.29 per diluted share. This compares with $37.3 million, or $0.33 per diluted share, for the first quarter 2013 and $30.6 million, or $0.28 per diluted share, for the second quarter 2012. Included in net income for the second quarter of 2013 were $29.3 million of one time pre-tax merger-related costs as well as a loss on sale of securities of $2.8 million resulting from the sale of securities acquired from Citizens. One time pre-tax merger costs for the first quarter of 2013 totaled $3.6 million and were recorded as noninterest expense.

The Corporation completed its acquisition of Citizens headquartered in Flint, Michigan in the quarter ended June 30, 2013. The impact of the acquisition is reflected in the Corporation's financial information from Acquisition Date. The acquisition added $9.3 billion in assets, $4.6 billion in loans and $7.3 billion in deposits. The purchase price of the acquisition was $1.3 billion, including the exchange of Citizens' common stock for 55.5 million shares of the Corporation's outstanding common stock and $355.4 million paid to the U.S. Treasury for Citizens' preferred stock and unpaid dividends and interest. Citizens' results of operations are included in the results for the three and six month periods ending June 30, 2013 since the Acquisition Date. Additional information can be found in the Financial Condition section under the heading "Acquisitions".

Returns on average common equity ("ROE") and average assets ("ROA") for the second quarter 2013 were 7.56% and 0.85%, respectively, compared with 8.83% and 1.01%, respectively, for the first quarter 2013 and 7.69% and 0.84% for the second quarter 2012.

Net Interest Income

Net interest income on a fully tax-equivalent ("FTE") basis was $201.6 million in the second quarter 2013 compared with $114.4 million in the first quarter 2013 and $121.7 million in the second quarter 2012.

Net interest margin was 4.12% for the second quarter 2013 compared with 3.46% for the first quarter 2013 and 3.77% for the second quarter 2012. Net interest margin in the second quarter 2013 was impacted by the net accretion of the fair value adjustments on the acquired loans and certificates of deposits.

Average originated loans were $8.9 billion during the second quarter 2013, an increase of $142.4 million, or 1.63%, compared with the first quarter 2013, and an increase of $936.6 million, or 11.79%, compared with the second quarter 2012. Average originated commercial loans increased $29.1 million, or 0.50%, compared with the prior quarter, and increased $614.6 million, or 11.65%, compared with the year ago quarter.

Average deposits were $18.3 billion during the second quarter 2013, an increase of $6.5 billion, or 55.51%, compared with the first quarter 2013, and an increase of $6.8 billion, or 58.67%, compared with the second quarter 2012. Average balances include Citizens' deposit portfolio since the Acquisition Date. During the second quarter 2013, average core deposits, which exclude time deposits, increased $5.2 billion, or 49.68%, compared with the first quarter 2013 and increased $5.7 billion, or 57.53%, compared with the second quarter 2012. Average time deposits increased $1.3 billion, or 101.29%, and increased $1.1 billion, or 65.62%, respectively, over prior and year-ago quarters. For the second quarter 2013, average core deposits accounted for 85.38% of total average deposits, compared with 88.71% for the first quarter 2013 and 85.99% for the second quarter 2012.


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Average investments increased $2.2 billion, or 60.35%, compared with the first quarter 2013 and increased $2.2 billion, or 60.35% compared with the second quarter 2012.

Noninterest Income

Noninterest income for the second quarter 2013, excluding losses on securities transactions of $2.8 million related to dispositions of securities acquired from Citizens, was $72.2 million, an increase of $14.8 million, or 25.84%, from the first quarter 2013 and an increase of $17.5 million, or 31.93%, from the second quarter 2012. Included in noninterest income in the second quarter of 2013, the first quarter of 2013 and the second quarter of 2012 was approximately $1.0 million, $5.0 million and $2.6 million of gains on covered loans paid in full, respectively.

Other income, excluding net securities gains and losses, as a percentage of net revenue for the second quarter 2013 was 26.38% compared with 33.42% for first quarter 2013 and 31.03% for the second quarter 2012. Net revenue is defined as net interest income, on an FTE basis, plus other income, excluding gains and losses from securities sales.

Noninterest Expense

Noninterest expense for the second quarter 2013 was $189.6 million, an increase of $82.7 million, or 77.36%, from the first quarter 2013 and an increase of $70.6 million, or 59.26%, from the second quarter 2012. Included in noninterest expense in the second quarter of 2013 and first quarter of 2013 were one-time merger related costs associated with the Citizens acquisition of $29.3 million and $3.6 million, respectively. The majority of these one time costs were from severance arrangements and professional and legal services rendered in connection with the merger. The Corporation's efficiency ratio was 68.37% for the second quarter 2013, compared with 62.06% for the first quarter 2013 and 67.21% for the second quarter 2012.

Asset Quality (excluding acquired loans and covered assets)

Due to the impact of acquisition accounting and protection against credit risk from FDIC loss sharing agreements, acquired loans and covered assets are excluded from the asset quality discussion to provide for improved comparability to prior periods and better perspective into asset quality trends. Acquired loans are recorded at fair value with no allowance brought forward in accordance with acquisition accounting. Impaired acquired and covered loans are considered to be performing due to the application of the accretion method under acquisition accounting.

Net charge-offs on originated loans totaled $3.3 million, or 0.15% of average originated loans in the second quarter 2013, compared with $5.9 million, or 0.27% of average originated loans, in the first quarter 2013 and $8.8 million, or 0.44% of average originated loans, in the second quarter 2012.

Nonperforming assets totaled $66.2 million at June 30, 2013, an increase of $13.9 million, or 26.70%, compared with March 31, 2013 and an increase of $5.1 million, or 8.34%, compared with June 30, 2012. Nonperforming assets at June 30, 2013 represented 0.72% of period-end originated loans plus other real estate compared with 0.59% at March 31, 2013 and 0.75% at June 30, 2012.

The allowance for originated loan losses totaled $98.6 million at June 30, 2013. At June 30, 2013, the allowance for originated loan losses was 1.08% of period-end originated loans compared with 1.13% at


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March 31, 2013 and 1.28% at June 30, 2012. The allowance for credit losses is the sum of the allowance for originated loan losses and the reserve for unfunded lending commitments. For comparative purposes, the allowance for credit losses was 1.17% of period end originated loans at June 30, 2013, compared with 1.18% at March 31, 2013 and 1.35% at June 30, 2012. The allowance for credit losses to nonperforming loans was 234.82% at June 30, 2013, compared with 254.32% at March 31, 2013 and 234.57% at June 30, 2012.

Balance Sheet

The Corporation's total assets at June 30, 2013 were $23.5 billion, an increase of $8.3 billion, or 54.08%, compared with March 31, 2013 and an increase of $8.9 billion, or 60.94%, compared with June 30, 2012.

Total deposits were $19.1 billion at June 30, 2013, an increase of $7.2 billion, or 60.32%, from March 31, 2013 and an increase of $7.5 billion, or 64.60%, from June 30, 2012. Core deposits totaled $16.3 billion at June 30, 2013, an increase of $5.7 billion, or 53.47%, from March 31, 2013 and an increase of $6.3 billion, or 62.42%, from June 30, 2012.

Shareholders' equity was $2.7 billion as of June 30, 2013 and $1.8 billion as of March 31, 2013 and $1.6 billion as of June 30, 2012. The increases mainly reflect the addition of $928.3 million in equity from the Citizen acquisition. The Corporation maintained a strong capital position as tangible common equity to assets was 7.61% at June 30, 2013, compared with 8.03% at March 31, 2013 and 8.01% at June 30, 2012. The common cash dividend per share paid in the second quarter 2013 was $0.16.

SUPERVISION AND REGULATION

In response to the worldwide economic and credit conditions, and in efforts to stabilize and strengthen the financial markets and banking industries, the United States Congress and governmental agencies have taken a number of significant actions over the past several years, including the passage of legislation and implementation of a number of programs and regulations. The most comprehensive of these actions was the passage into law, on July 21, 2010, of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"). The Dodd-Frank Act affects almost every aspect of the nation's financial services industry and mandates change in several key areas, including regulation and compliance (both with respect to financial institutions and systemically important nonbank financial companies), securities regulation, executive compensation, regulation of derivatives, corporate governance, and consumer protection.

The preemption of certain state laws previously granted to national banking associations by the OCC under the National Bank Act have been limited, especially with respect to consumer laws. Thus, Congress has authorized states to enact their own substantive protections and to allow state attorneys general to initiate civil actions to enforce federal consumer protections. The Corporation is also subject to regulation by the new Bureau of Consumer Financial Protection (the "Bureau" or "CFPB"). The Bureau has the power to examine the Corporation and to make and interpret the rules under the various consumer financial laws, and to enforce such laws and rules.
On July 31, 2013, a United States District Court in Washington D.C., granted summary judgment to several retailers and retail trade associations regarding their claims that the Federal Reserve had not properly evaluated and set debit card interchange fees consistent with the Durbin Amendment to the Dodd-Frank Act. If this ruling stands, the Federal Reserve may revisit its interchange fees analysis and may further decrease


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permissible interchanges fees from those it initially determined under the Durbin Amendment, which could adversely affect our revenue from these activities.

Many aspects of the Dodd-Frank Act remain subject to intensive agency rulemaking and subsequent public comment prior to implementation, and it is difficult to predict at this time the ultimate effect of the Dodd-Frank Act on the Corporation. It is likely, however, that the Corporation's expenses will increase as a result of new compliance requirements.

On June 10, 2013, the Bank became subject to the Dodd-Frank Act requirements to centrally clear certain interest rate swaps. A cleared swap is subject to continuous collateralization of swap obligations, real time reporting, additional agreements and other regulatory constraints. The CME Group Inc. (Chicago Mercantile Exchange) and LCH.Clearnet Group Ltd. are the Bank's approved clearing houses.
New Capital Rules

In July 2013, the Federal Reserve and the OCC jointly adopted final rules to implement the Basel Committee on Banking Supervision's (the "Basel Committee") regulatory capital reforms ("Basel III") and regulatory capital changes required by the Dodd-Frank Act.

These changes will apply to the Corporation and the Bank. Among other things, the rules include new minimum risk-based and leverage capital requirements for all banking organizations and removal of references to credit ratings. Consistent with the Basel III framework, the rules include a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5%. A new common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets is being phased-in over a transition period ending December 31, 2018. The minimum ratio of tier 1 capital to risk-weighted assets is increased from 4.0% to 6.0% and includes a minimum leverage ratio of 4.0% for all banking organizations. The required total risk based capital ratio will not change. The new rules provide strict eligibility criteria for regulatory capital instruments, and change the prompt corrective action scheme to reflect the new capital ratios. The final rule also changes the method for calculating risk-weighted assets in an effort to better identify riskier assets requiring higher capital cushions and to enhance risk sensitivity.

Management is evaluating the new rules and their effects on the Corporation, but Management believes the Corporation will remain "well-capitalized" under the new rules. The new rules generally will be effective for the Corporation and the Bank beginning January 1, 2015. There are various transition rules. Other changes are being considered and the Federal Reserve and the other federal banking agencies have not yet proposed rules implementing Basel III's liquidity rules.

Stress Testing

The Dodd-Frank Act requires stress testing of bank holding companies and banks, such as the Corporation and the Bank, that have more than $10 billion but less than $50 billion of consolidated assets ("medium sized companies"). Additional stress testing is required for banking organizations having $50 billion or more of assets. Medium-sized companies, including the Corporation and the Bank, are required to conduct annual company-run stress tests beginning Fall 2013 under rules the federal bank regulatory agencies issued in October 2012. The first stress tests by medium sized companies currently are due to be submitted to the regulators in early March 2014.

Stress tests assess the potential impact of scenarios on the consolidated earnings, balance sheet and capital of a bank holding company or bank over a designated planning horizon of nine quarters, taking into


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account the organization's current condition, risks, exposures, strategies, and activities, and such factors as the regulators may request of a specific organization. These are tested against baseline, adverse, and severely adverse scenarios specified by the Federal Reserve for the Corporation and by the OCC for the Bank.

The banking agencies issued "Supervisory Guidance on Stress Testing for Banking Organizations With More Than $10 Billion in Total Consolidated Assets" on May 17, 2012. On July 30, 2013, the federal banking agencies issued "Proposed Supervisory Guidance on Implementing Dodd-Frank Act Company-Run Stress Tests for Banking Organizations with Total Consolidated Assets of more than $10 Billion but less than $50 Billion," which describes supervisory expectations for stress tests by medium sized companies.

Each banking organization's board of directors and senior management are required to approve and review the policies and procedures of their stress testing processes as frequently as economic conditions or the condition of the organization may warrant, and at least annually. They are also required to consider the results of the stress test in the normal course of business, including the banking organization's capital planning (including dividends and share buybacks), assessment of capital adequacy and maintaining capital consistent with its risks, and risk management practices. The results of the stress tests are provided to the applicable federal banking agencies. Public disclosure of stress test results is required beginning in 2015. The Corporation is in the process of preparing for our initial stress tests.

Other Legislation

Various legislation affecting financial institutions and the financial industry will likely continue to be introduced in Congress, and such legislation may further change banking statutes and the operating environment of the Corporation and its subsidiaries in substantial and unpredictable ways, and could increase or decrease the Corporation's cost of doing business, limit or expand permissible activities or affect the competitive balance depending upon whether any of this potential legislation is enacted, and if enacted, the effect that it or any implementing regulations, would have on the financial condition or results of operations of the Corporation or any of its subsidiaries.

To the extent that the previous information describes statutory and regulatory provisions applicable to the Corporation or its subsidiaries, it is qualified in its entirety by reference to the full text of those provisions. Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies and are subject to change at any time, particularly in the current economic and regulatory environment. Any such change in statutes, regulations or regulatory policies applicable to the Corporation could have a material effect on the business of the Corporation.

NON-GAAP FINANCIAL MEASURES
The table below presents computations of earnings (loss) and certain other financial measures including "tangible common equity," "Tier 1 common equity", "tangible common equity to tangible assets ratio", "Basel III Tier 1 common ratio", "fee income ratio" and "efficiency ratio", all of which are non-GAAP measures. The table below also reconciles the U.S. GAAP performance measures to the corresponding non-GAAP measures. Management believes these non-GAAP financial measures enhance an investor's understanding of the business by providing a meaningful base for period-to-period comparisons, assisting in operating results analysis, and predicting future performance on the same basis as applied by Management and the Board of Directors. Management and the Board of Directors utilize these non-GAAP financial measures as follows:
Preparation of operating budgets

Monthly financial performance reporting


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Monthly, quarterly and year-to-date assessment of the Corporation's business

Monthly close-out reporting of consolidated results (Management only)

. . .

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