DBRS Comments on Q2 Earnings of FirstMerit Corporation - Senior at A (low)

DBRS has today commented on the Q2 2009 earnings of FirstMerit Corporation (FirstMerit or the Company). FirstMerit reported net income available to common shareholders of $10.9 million, down from $27.5 million for the prior quarter and $29.1 million for Q2 2008. On a sequential quarter basis, Q2 2009 net income was negatively impacted by a 47% increase in provisions for loan loss reserves, in which 19% was for reserve build, a 9% increase in non-interest expenses, driven by a $3.7 million (after tax) FDIC special assessment fee, and a $4.5 million after tax expense associated with the unamortized discount on the preferred stock related to the TARP program. Offsetting these headwinds was a 3 basis points (bps) widening of net interest margin (NIM) to 3.56%, due to lower funding costs, and a 12% increase in service charges on deposits. Compared with a year ago, quarterly net income was negatively impacted by an 82% increase in provisions, a 12% increase in non-interest expenses, and a 13 bps narrowing of NIM. With FirstMerit’s franchise strengths and credit fundamentals maintained, its ratings, including its A (low) - rated senior obligations and Stable trend, remain unaffected.

Despite the recession, FirstMerit’s asset quality remains sound. At June 30, 2009, non-performing assets (NPAs) were down slightly to 1.03% of loans, from 1.04% at March 31, 2009, yet up from 0.57% at June 30, 2008. Meanwhile, net charge-offs (NCOs) increased to 1.19% of average loans, from 0.86% for the prior quarter and 0.60% for Q2 2008. The bulk of the Company’s charge-offs for the quarter consisted of commercial, installment and credit card loans. Positively, on a linked-quarter basis, nonaccrual commercial loans were down significantly, due to lower in-flows. At June 30, 2009, FirstMerit was adequately reserved, as its allowance for loan loss reserves to NPAs was a solid 152%. Given the recession, DBRS believes that further erosion in FirstMerit’s asset quality is likely.

FirstMerit’s liquidity is sound, as core deposits represent 99% of net loans (as of March 31, 2009). Overall, total deposits were down 3% on a linked-quarter basis, as lower levels of certificates and other time deposits were partially offset by increased amounts of savings and money market accounts and non-interest bearing demand deposits. At June 30, 2009, non-interest bearing deposits represented 25% of total deposits, up from 24% at March 31, 2009. The Company’s securities portfolio, which represents 25% of total assets, and access to the Federal Home Loan Bank and Federal Reserve discount window round out its liquidity profile.

On April 22, 2009, FirstMerit repurchased the $125 million in preferred shares that it had sold to the U.S. Treasury (Treasury), as part of the Treasury’s Capital Purchase Program. Even with the preferred stock buyback, the Company’s capital remains ample, especially given its current loss rates. At June 30, 2009, FirstMerit’s tangible common equity-to-tangible asset ratio was a high 8.36%, and Tier 1 and Total risk-based capital ratios were 11.38% and 12.63%, respectively.

Given FirstMerit’s solid deposit franchise in northeastern Ohio, its diverse business model, good earnings and relatively sound asset quality, DBRS expects the Company to continue generating operating results and maintaining credit fundamentals expected of banks in its rating range.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.