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FMER > SEC Filings for FMER > Form 10-K on 25-Feb-2014All Recent SEC Filings

Show all filings for FIRSTMERIT CORP /OH/

Form 10-K for FIRSTMERIT CORP /OH/


25-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

    Consolidated Financial Highlights                                               44
    Highlights of 2013 Performance                                                  45
    Supervision and Regulation                                                      47
          New Capital Rules                                                         48
          Stress Testing                                                            49
          Other Legislation                                                         50
    Non-GAAP Financial Measures                                                     50
    Results of Operations                                                           56
          Average Tax-equivalent   Balance Sheets - Year to Date                    56
          Net Interest Income                                                       57
        Noninterest   Income                                                        59
        Noninterest   Expense                                                       60
          Income Taxes                                                              61
    Line of Business Results                                                        61
    Financial Condition                                                             64
          Acquisitions                                                              64
          Integration Update                                                        66
          Investment Securities                                                     66
          Loans                                                                     68
                Originated Loans                                                    70
                Acquired Loans                                                      71
                Covered Loans and Related Loss Share Receivable                     71
          Allowance for Loan Losses and Reserve for Unfunded Commitments            71
                Originated Allowance for Loan Losses                                71
                Acquired Allowance for Loan Losses                                  76
                Covered Allowance for Loan Losses                                   77
          Asset Quality   (excluding acquired loans and covered assets)             77
          Deposits, Securities Sold Under Agreements to Repurchase, Wholesale
        Borrowings and Long-term Debt                                               80
          Capital Resources                                                         81
                Shareholders' Equity                                                82
                Capital A  vailability                                              82
                Capital Adequacy                                                    83
    Risk Management                                                                 85
          Market Risk Management                                                    85
          Liquidity Risk Management                                                 87
          Operational Risk Management                                               88
        Contractual Obligations, Commitments and   Off-Balance Sheet
        Arrangements                                                                89
  Quarterly Financial Data                                                          90
    Critical Accounting Policies                                                    91
    Forward-looking Safe-harbor Statement                                           97


Table of Contents

The following commentary presents a discussion and analysis of the Corporation's financial condition and results of operations by Management. The review highlights the principal factors affecting earnings and the significant changes in balance sheet items for the years 2013, 2012 and 2011. Financial information for prior years is presented when appropriate. The objective of this financial review is to enhance the reader's understanding of the accompanying tables and charts, the consolidated financial statements, notes to financial statements, and financial statistics appearing elsewhere in this Annual Report on Form 10-K. Where applicable, this discussion also reflects Management's insights of known events and trends that have or may reasonably be expected to have a material effect on the Corporation's operations and financial condition.


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Figure 1. Consolidated Financial Highlights

Consolidated Financial
Highlights (a)                                         Three Months Ended                                         Year ended
(Unaudited)                 December 31,   September 30,     June 30,      March 31,     December 31,            December 31,
(Dollars in thousands,
except per share amounts)       2013           2013            2013           2013           2012             2013           2012
EARNINGS
Net interest income TE (b) $    202,145   $     207,079   $    201,605   $    114,376   $    119,130     $    725,202   $    482,988
TE adjustment (b)                 4,077           3,739          3,574          3,027          2,900           14,417         11,158
Provision for originated
loan losses                       1,552           2,523          3,151          5,808          7,116           13,034         33,976
Provision for acquired
loan losses                       5,515           2,033              -              -              -            7,548              -
Provision for covered loan
losses                            2,983           1,823          4,158          4,138          5,146           13,102         20,722
Noninterest income               72,420          71,090         69,439         57,392         61,652          270,343        223,604
Noninterest expense             179,391         211,378        189,640        106,925        112,181          687,334        453,613
Net income                       57,174          40,715         48,450         37,346         38,224          183,684        134,106
Diluted EPS (d)                    0.33            0.23           0.29           0.33           0.35             1.18           1.22
PERFORMANCE RATIOS
Return on average assets
(ROA)                              0.94 %          0.67 %         0.85 %         1.01 %         1.03 %           0.85 %         0.92 %
Return on average equity
(ROE)                              8.48 %          6.07 %         7.56 %         8.83 %         9.30 %           7.63 %         8.34 %
Return on average tangible
common equity (e)                 12.96 %          9.29 %        11.49 %        12.76 %        13.01 %          11.54 %        11.76 %
Net interest margin TE (b)         3.89 %          4.05 %         4.12 %         3.46 %         3.58 %           3.92 %         3.69 %
Efficiency ratio (f)              64.36 %         74.92 %        68.37 %        62.06 %        62.65 %          68.01 %        64.28 %
Number of full-time
equivalent employees              4,570           4,666          4,619          2,767          2,738            4,570          2,738
MARKET DATA
Book value per common
share                      $      16.38   $       16.08   $      16.06   $      15.99   $      15.00     $      16.38   $      15.00
Tangible book value per
common share (e)                  10.79           10.48          10.44          10.83          10.75            10.79          10.75
Period-end common share
market value                      22.23           21.72          20.03          16.54          14.19            22.23          14.19
Market value as a % of
book                                136 %           135 %          125 %          103 %           95 %            136 %           95 %
Cash dividends per common
share                      $       0.16   $        0.16   $       0.16   $       0.16   $       0.16     $       0.64   $       0.64
Common Stock dividend
payout ratio                      48.48 %         69.57 %        55.17 %        48.48 %        45.71 %          54.24 %        52.46 %
Average basic common
shares                          165,054         165,044        157,863        109,689        109,652          149,607        109,518
Average diluted common
shares                          166,097         165,874        158,390        110,238        109,652          150,421        109,518
Period end common shares        165,056         165,045        165,045        109,746        109,649          165,056        109,649
Common shares repurchased            17               7            168             26             12              218            198
Common Stock market
capitalization             $  3,669,195   $   3,584,777   $  3,305,851   $  1,815,199   $  1,555,919     $  3,669,195   $  1,555,919
ASSET QUALITY (excluding acquired and
covered loans) (c)
Gross charge-offs          $      9,913   $       8,515   $     10,969   $     10,776   $     12,475     $     40,173   $     65,905
Net charge-offs                   3,359           2,877          3,349          5,907          7,116           15,492         42,733
Allowance for originated
loan losses                      96,484          98,291         98,645         98,843         98,942           96,484         98,942
Reserve for unfunded
lending commitments               7,907           8,493          8,114          4,941          5,433            7,907          5,433
Nonperforming assets
(NPAs)                           60,883          55,426         66,177         52,231         50,224           60,883         50,224
Net charge-offs to average
loans ratio                        0.13 %          0.12 %         0.15 %         0.27 %         0.34 %           0.17 %         0.53 %
Allowance for originated
loan losses to period-end
loans                              0.94 %          1.00 %         1.08 %         1.13 %         1.13 %           0.94 %         1.13 %
Allowance for credit
losses to period-end loans         1.02 %          1.09 %         1.17 %         1.18 %         1.20 %           1.02 %         1.20 %
NPAs to loans and other
real estate                        0.60 %          0.57 %         0.72 %         0.59 %         0.57 %           0.60 %         0.57 %
Allowance for originated
loan losses to
nonperforming loans              228.62 %        276.19 %       216.97 %       242.21 %       269.69 %         228.62 %       269.69 %
Allowance for credit
losses to nonperforming
loans                            247.35 %        300.06 %       234.82 %       254.32 %       284.50 %         247.35 %       284.50 %
CAPITAL & LIQUIDITY
Period-end tangible common
equity to assets (e)               7.71 %          7.42 %         7.59 %         8.03 %         8.16 %           7.71 %         8.16 %
Average equity to assets          11.12 %         11.08 %        11.28 %        11.45 %        11.12 %          11.21 %        11.00 %
Average equity to total
loans                             18.81 %         18.97 %        18.95 %        17.88 %        17.37 %          18.72 %        17.47 %
Average total loans to
deposits                          72.84 %         72.11 %        74.04 %        81.36 %        81.21 %          74.36 %        79.66 %
AVERAGE BALANCES
Assets                     $ 24,034,846   $  24,013,594   $ 22,810,702   $ 14,983,543   $ 14,702,215     $ 21,489,775   $ 14,620,627
Deposits                     19,517,476      19,456,231     18,334,244     11,789,784     11,595,085       17,301,588     11,553,798
Originated loans              9,988,587       9,377,826      8,877,754      8,735,307      8,444,208        9,252,555      8,089,317
Acquired loans, including
covered loans and
excluding loss share
receivable                    4,227,693       4,652,101      4,696,740        856,875        971,589        3,612,590      1,114,566
Earning assets               20,593,750      20,276,825     19,609,974     13,408,789     13,246,693       18,492,995     13,072,691
Shareholders' equity          2,673,635       2,661,546      2,571,964      1,715,005      1,635,275        2,408,865      1,608,108
ENDING BALANCES
Assets                     $ 23,909,027   $  24,134,729   $ 23,531,872   $ 15,272,484   $ 14,913,012     $ 23,909,027   $ 14,913,012
Deposits                     19,533,601      19,489,533     19,119,722     11,925,767     11,759,425       19,533,601     11,759,425
Originated loans             10,213,387       9,789,139      9,132,625      8,779,970      8,731,659       10,213,387      8,731,659
Acquired loans, including
covered loans and
excluding loss share
receivable                    4,025,758       4,401,711      4,926,888        801,239        905,391        4,025,758        905,391
Goodwill                        739,819         739,819        739,819        460,044        460,044          739,819        460,044
Intangible assets                82,755          85,447         88,419          6,055          6,373           82,755          6,373
Earning assets               21,048,910      21,297,250     20,772,749     13,905,342     13,472,067       21,048,910     13,472,067
Total shareholders' equity    2,702,894       2,654,645      2,650,909      1,754,850      1,645,202        2,702,894      1,645,202

Notes


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(a) - Citizens' assets and liabilities were included in the Consolidated Balance Sheet as of the Acquisition Date at fair value. Citizens' results of operations were included in the Consolidated Statement of Income as of the Acquisition Date.
(b) - The interest income earned on certain earning assets is completely or partially exempt from federal and/or state income taxes. As such, these tax-exempt securities typically yield lower returns than taxable securities. To provide more meaningful comparisons of net interest margins for all earning assets, net interest income on a taxable-equivalent basis is used in calculating net interest margin by increasing the interest earned on tax-exempt assets to make it fully equivalent to interest income earned on taxable investments. This adjustment is not permitted under generally accepted accounting principles in the Consolidated Statement of Income.
(c) - Due to the impact of business combination accounting and protection of FDIC loss sharing agreements, which provide considerable protection against credit risk, acquired loans and covered assets are excluded from this table to provide for improved comparability to prior periods and better perspective into asset quality trends.
(d) - Net income used to determine diluted EPS was reduced by the cash dividends payable on the Corporation's 5.875% Non-Cumulative Perpetual Preferred Stock, Series A of approximately $1.5 million in each of the quarters ended December 31, 2013, September 30, 2013 and June 30, 2013, and approximately $0.9 million in the quarter ended March 31, 2013. Year to date cash dividends were $5.3 million in 2013.
(e) - Tangible book value per common share is a non-GAAP financial measure and is calculated based on tangible common equity divided by period end common shares outstanding. Tangible common equity excludes goodwill, intangible assets, and preferred stock. Management believes this non-GAAP measure serves as a useful tool to help evaluate the strength and discipline of a company's capital management strategies and as an additional, conservative measure of total company value.
(f) - The efficiency ratio is calculated as noninterest expense divided by total revenue, excluding net losses on the sale of securities of $2.8 million and $9.0 thousand in the quarters ended June 30, 2013 and March 31, 2013, respectively, and net gains of $2.4 million in the quarter ended December 31, 2012. There were net losses on the sale of securities of $2.8 million in 2013 compared to net gains of $3.8 million in 2012.

HIGHLIGHTS OF 2013 PERFORMANCE

Earnings Summary

The Corporation reported fourth quarter 2013 net income of $57.2 million, or $0.33 per diluted share. This compares with $40.7 million, or $0.23 per diluted share, for the third quarter 2013 and $38.2 million, or $0.35 per diluted share, for the fourth quarter 2012. Included in noninterest expense for the fourth quarter 2013 were $6.0 million of pre-tax merger related costs compared to $33.4 million for the third quarter 2013. Pre-tax costs associated with anticipated branch closures of $1.0 million were recognized in the fourth quarter of 2013 and are included within noninterest income.

ROE and ROA for the fourth quarter 2013 were 8.48% and 0.94%, respectively, compared with 6.07% and 0.67%, respectively, for the third quarter 2013 and 9.30% and 1.03%, respectively, for the fourth quarter 2012.

Except as noted, the Citizens acquisition is primarily contributing to the increases over the prior year period in the income statement and balance sheets. Citizens' results of operations are included in the reported current year to date period results since the date of acquisition, April 12, 2013.

"Acquired loans", as used herein, are those assumed in the Citizens acquisition. (As used herein, "originated loans" refer to loans that have been originated in the normal course of business and "covered loans" refer to loans covered by loss sharing agreements with the FDIC providing considerable protection against credit risk.)

Net Interest Income

Net interest income on a TE basis was $202.1 million in the fourth quarter 2013 compared with $207.1 million in the third quarter 2013 and $119.1 million in the fourth quarter 2012.

Net interest margin was 3.89% for the fourth quarter 2013 compared with 4.05% for the third quarter 2013 and 3.58% for the fourth quarter 2012. Fourth quarter 2013 net interest margin compression compared with the third quarter 2013 was primarily driven by both lower yields and decline in the acquired loan portfolio. Notably present this quarter was stability in the yields of both the Corporation's investment portfolio and originated loans, compared with the prior quarter.

Average originated loans were $10.0 billion during the fourth quarter 2013, an increase of $610.8 million, or 6.51%, compared with the third quarter 2013, and an increase of $1.5 billion, or 18.29%, compared with the fourth quarter 2012. Average originated commercial loans increased $394.8 million, or 6.44%, compared with the prior quarter, and increased $925.7 million, or 16.53%, compared with the year ago quarter.


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Average deposits were $19.5 billion during the fourth quarter 2013, an increase of $0.1 billion, or 0.31%, compared with the third quarter 2013, and an increase of $7.9 billion, or 68.33%, compared with the fourth quarter 2012. During the fourth quarter 2013, average core deposits, which exclude time deposits, increased $0.2 billion, or 1.38%, compared with the third quarter 2013 and increased $6.8 billion, or 66.78%, compared with the fourth quarter 2012. Average time deposits decreased $169.2 million, or 6.22%, and increased $1.1 billion, or 79.41%, respectively, over the prior and year-ago quarters. For the fourth quarter 2013, average core deposits accounted for 86.93% of total average deposits, compared with 86.02% for the third quarter 2013 and 87.73% for the fourth quarter 2012.

Average investments increased $149.9 million, or 2.44%, compared with the third quarter 2013 and increased $2.6 billion, or 70.92% compared with the fourth quarter 2012.

Noninterest Income

Noninterest income, excluding gains and losses on securities transactions, for the fourth quarter 2013 was $72.4 million, an increase of $1.3 million, or 1.87%, from the third quarter 2013 and an increase of $13.2 million, or 22.28%, from the fourth quarter 2012. Included in noninterest income in the fourth quarter 2013 was$0.8 million of gains on covered loans paid in full, compared to $1.8 million and $5.0 million in the third quarter 2013 and fourth quarter 2012, respectively.

Noninterest income, excluding net securities gains and losses, as a percentage of net revenue for the fourth quarter 2013 was 26.38% compared with 25.56% for third quarter 2013 and 33.21% for the fourth quarter 2012. Net revenue is defined as net interest income, on an TE basis, plus noninterest income, excluding gains and losses from securities sales.

Noninterest Expense

Noninterest expense for the fourth quarter 2013 was $179.4 million, a decrease of $32.0 million, or 15.13%, from the third quarter 2013 and an increase of $67.2 million, or 59.91%, from the fourth quarter 2012. Included in noninterest expense in the fourth quarter 2013 and third quarter 2013 were merger related costs associated with the Citizens acquisition of $6.0 million and $33.4 million, respectively. The majority of the merger related costs incurred in the fourth quarter of 2013 were associated with professional and legal services rendered in connection with the merger. The majority of the merger related costs incurred in the third quarter 2013 were from fees for early termination of existing agreements assumed from the merger and are included within Bankcard, loan processing and other costs in the accompanying year to date consolidated statements of comprehensive income. The Corporation's efficiency ratio was 64.36% for the fourth quarter 2013, compared with 74.92% for the third quarter 2013 and 62.65% for the fourth quarter 2012.

Asset Quality (excluding acquired loans and covered assets)

Due to the impact of business combination 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 at the date of acquisition with no allowance brought forward in accordance with business combination accounting. Impaired acquired and covered loans are considered to be performing due to the application of the accretion method under the applicable accounting guidance.


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Net charge-offs on originated loans totaled $3.4 million, or 0.13% of average originated loans in the fourth quarter 2013, compared with $2.9 million, or 0.12% of average originated loans, in the third quarter 2013 and $7.1 million, or 0.34% of average originated loans, in the fourth quarter 2012.

Nonperforming assets totaled $60.9 million at December 31, 2013, an increase of $5.5 million, or 9.85%, compared with September 30, 2013 and an increase of $10.7 million, or 21.22%, compared with December 31, 2012. Nonperforming assets at December 31, 2013 represented 0.60% of period-end originated loans plus other real estate compared with 0.57% at September 30, 2013 and 0.57% at December 31, 2012.

The allowance for originated loan losses totaled $96.5 million at December 31, 2013. At December 31, 2013, the allowance for originated loan losses was 0.94% of period-end originated loans compared with 1.00% at September 30, 2013 and 1.13% at December 31, 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 1.02% of period end originated loans at December 31, 2013, compared with 1.09% at September 30, 2013 and 1.20% at December 31, 2012. The allowance for credit losses to nonperforming loans was 247.35% at December 31, 2013, compared with 300.06% at September 30, 2013 and 284.50% at December 31, 2012.

Balance Sheet

The Corporation's total assets at December 31, 2013 were $23.9 billion, a decrease of $225.7 million, or 0.94%, compared with September 30, 2013 and an increase of $9.0 billion, or 60.32%, compared with December 31, 2012.

Total deposits were $19.5 billion at December 31, 2013, an increase of $44.1 million, or 0.23%, from September 30, 2013 and an increase of $7.8 billion, or 66.11%, from December 31, 2012. Core deposits totaled $17.1 billion at December 31, 2013, an increase of $220.3 million, or 1.31%, from September 30, 2013 and an increase of $6.7 billion, or 64.41%, from December 31, 2012.

Shareholders' equity was $2.7 billion as of December 31, 2013 and September 30, 2013 and $1.6 billion as of December 31, 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 7.71% at December 31, 2013, compared with 7.42% at September 30, 2013 and 8.16% at December 31, 2012. The cash dividend per common share paid in the fourth quarter 2013 was $0.16.

REGULATION AND SUPERVISION

The United States and the banking, securities and commodities regulators, as well as fiscal and monetary authorities, have taken a number of significant actions over the past several years in response to the 2008 credit crisis. The single most important of these was the enactment of the Dodd-Frank Act in July 2010. The Dodd-Frank Act affects almost every aspect of the nation's financial services industry, including regulation and compliance of financial institutions and systemically important nonbank financial companies, securities regulation, executive compensation, regulation of derivatives, corporate governance and consumer protection. Hundreds of implementing regulations are required, but these are only partially finished.

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


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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 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, and the Federal Reserve is appealing this ruling. If the Federal Reserve's appeals fail, the Federal Reserve may be forced to revisit its interchange fees analysis and may further decrease 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. and LCH.Clearnet Group Ltd. are the Bank's approved clearing houses. To the extent that the information contained with in this section 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 . . .

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