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FirstMerit 10-K 2010 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Commission file number: 0-10161
(330) 996-6300
Securities registered pursuant to Section 12(b) of the
Exchange Act:
Securities registered pursuant to Section 12(g) of the
Exchange Act: None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes þ No o
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Exchange
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Exchange Act during the preceding 12 months (or for
such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing
requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to rule 405 of
Regulation S-T
(232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to
submit and post such
files). Yes o No o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule
12b-2 of the
Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
As of June 30, 2009, the aggregate market value of the
registrant’s common stock (the only common equity of the
registrant) held by
non-affiliates
of the registrant was $1,449,516,458 based on the closing sale
price as reported on The NASDAQ Stock Market.
Indicate the number of shares outstanding of each of the
registrant’s classes of common stock, as of the latest
practicable date.
DOCUMENTS INCORPORATED BY REFERENCE
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Performance
Graph
Set forth below is a line graph comparing the yearly percentage
change in the cumulative total shareholder return on
FirstMerit’s Common Stock against the cumulative return of
the Nasdaq Banks Index, the Nasdaq Index and the S&P 500
Index for the period of five fiscal years commencing
December 31, 2004 and ended December 31, 2009. The
graph assumes that the value of the investment in FirstMerit
Common Stock and each index was $100 on December 31, 2004
and that all dividends were reinvested.
TABLE OF CONTENTS
Table of Contents
PART I
BUSINESS
OF FIRSTMERIT
Registrant, FirstMerit Corporation (“FirstMerit” or
the “Corporation”), is a $10.5 billion bank
holding company organized in 1981 under the laws of the State of
Ohio and registered under the Bank Holding Company Act of 1956,
as amended (the “BHCA”). FirstMerit’s principal
business consists of owning and supervising its affiliates.
Although FirstMerit directs the overall policies of its
affiliates, including lending practices and financial resources,
most
day-to-day
affairs are managed by their respective officers. The principal
executive offices of FirstMerit are located at III Cascade
Plaza, Akron, Ohio 44308, and its telephone number is
(330) 996-6300.
At December 31, 2009, FirstMerit Bank, N.A.
(“FirstMerit Bank”), one of the Corporation’s
principal subsidiaries, operated a network of 160 full service
banking offices and 182 automated teller machines. Its offices
span a total of 24 counties in Ohio, including Ashland,
Ashtabula, Crawford, Cuyahoga, Delaware, Erie, Fairfield,
Franklin, Geauga, Holmes, Huron, Knox, Lake, Lorain, Lucas,
Madison, Medina, Portage, Richland, Seneca, Stark, Summit, Wayne
and Wood Counties, and Lawrence County in Pennsylvania. In its
principal market in Northeastern Ohio, FirstMerit serves nearly
599,216 households and businesses in the 16th largest
consolidated metropolitan statistical area in the country (which
combines the primary metropolitan statistical areas for
Cleveland, Lorain/Elyria and Akron, Ohio). FirstMerit and its
direct and indirect subsidiaries had approximately
2,495 employees at December 31, 2009.
Through its subsidiaries, FirstMerit operates primarily as a
line of business banking organization, providing a wide range of
banking, fiduciary, financial, insurance and investment services
to corporate, institutional and individual customers throughout
northern and central Ohio, and western Pennsylvania.
FirstMerit’s banking subsidiary is FirstMerit Bank.
Prior to 2007, the Corporation managed its operations through
the major line of business “Supercommunity Banking.”
To improve revenue growth and profitability as well as enhance
relationships with customers, the Corporation moved to a line of
business model during the first quarter of 2007. The major lines
of business are Commercial, Retail, Wealth and Other.
Accordingly, prior period information has been reclassified to
reflect this change. Note 15 (Segment Information) to the
consolidated financial statements provides performance data for
these lines of business.
Other services provided by FirstMerit Bank or its affiliates
include automated banking programs, credit and debit cards,
rental of safe deposit boxes, letters of credit, leasing,
securities brokerage and life insurance products. FirstMerit
Bank also operates a trust department, which offers wealth
management and trust services. The majority of its customers are
comprised of consumers and small and medium size businesses.
FirstMerit Bank is not engaged in lending outside the
continental United States and is not dependent upon any one
significant customer or specific industry.
FirstMerit’s non-banking direct and indirect subsidiaries
provide insurance sales services, credit life, credit accident
and health insurance, securities brokerage services, equipment
lease financing and other financial services.
FirstMerit’s principal direct operating subsidiary other
than FirstMerit Bank is FirstMerit Community Development
Corporation. FirstMerit Community Development Corporation was
organized in 1994 to further FirstMerit’s efforts in
identifying the credit needs of its lending communities and
meeting the requirements of the Community Reinvestment Act
(“CRA”). Congress enacted the CRA to ensure that
financial institutions meet the deposit and credit needs of
their communities. Through a community development corporation,
financial institutions can fulfill these requirements by
nontraditional activities such as acquiring, rehabilitating or
investing in real estate in low to moderate income
neighborhoods, and promoting the development of small business.
FirstMerit Bank is the parent corporation of 19 wholly-owned
subsidiaries a complete list of which is set forth in
Exhibit 21 filed as an attachment to this Annual Report on
Form 10-K.
FirstMerit Mortgage Corporation, located in
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Canton, Ohio, originates residential mortgage loans and provides
mortgage loan servicing for itself and FirstMerit Bank.
FirstMerit Equipment Finance Company, Inc. (f.k.a. FirstMerit
Credit Services and FirstMerit Leasing) provides commercial
lease financing and related services.
Bank subsidiaries FirstMerit Securities, Inc. and FirstMerit
Financial Services, Inc. provide investment securities and
annuities to customers. Securities trading has been a brokered
program in conjunction with third-party providers since 1999;
beginning January 14, 2010 FirstMerit is internalizing
broker dealer services through the new FirstMerit Financial
Services subsidiary, which will allow investment services and
solutions to be provided locally while building operational
efficiencies. In addition, FirstMerit Advisors, Inc. provides
certain financial planning services to customers of FirstMerit
Bank and other FirstMerit subsidiaries.
Two new subsidiaries, CPHCSub, LLC and CREPD, LLC, were opened
in 2009 to hold distressed commercial and construction
properties, received through the loan foreclosure process during
this time of economic downturn. These properties are held as
other real estate owned (OREO) while being managed and
remarketed for sale. The assets held as OREO for these two
subsidiaries were $2.8 million and $1.2 million,
respectively at December 31, 2009.
FirstMerit Bank is also the parent corporation of FirstMerit
Insurance Group, Inc.; FirstMerit Insurance Agency, Inc., a life
insurance and financial consulting firm an insurance agency
licensed to sell life insurance products and annuities;
FirstMerit Title Agency, Ltd., FirstMerit Mortgage
Reinsurance Company, Inc., and FirstMerit Risk Management, Inc.,
a captive insurance subsidiary.
Although FirstMerit is a corporate entity legally separate and
distinct from its affiliates, bank holding companies such as
FirstMerit, which are subject to the BHCA, are expected to act
as a source of financial strength for their subsidiary banks.
The principal source of FirstMerit’s income is dividends
from its subsidiaries. There are certain regulatory restrictions
on the extent to which financial institution subsidiaries can
pay dividends or otherwise supply funds to FirstMerit.
Additional information regarding FirstMerit’s business is
included in Management’s Discussion and Analysis of
Financial Condition and Results of Operations.
FirstMerit considers from time to time possible acquisitions of
other financial institutions and financial services companies.
FirstMerit also periodically acquires branches and deposits in
its principal markets. FirstMerit’s strategy for growth
includes strengthening market share in its existing markets,
expanding into complementary markets and broadening its product
offerings.
The financial services industry remains highly competitive.
FirstMerit and its subsidiaries compete with other local,
regional and national providers of financial services such as
other bank holding companies, commercial banks, savings
associations, credit unions, consumer and commercial finance
companies, equipment leasing companies, brokerage institutions,
money market funds and insurance companies. Primary financial
institution competitors include PNC Bank, KeyBank, Huntington
Bank, US Bank and Fifth Third Bank.
Under the Gramm-Leach-Bliley Act of 1999 (“GLBA”),
securities firms and insurance companies that elect to become
financial holding companies may acquire banks and other
financial institutions. GLBA continues to change the competitive
environment in which FirstMerit and its subsidiaries conduct
business and thereby engage in broader activities than
previously allowed for bank holding companies under the BHCA.
Mergers between financial institutions within and outside of
Ohio continue to add competitive pressure. FirstMerit competes
in its markets by offering high quality personal services at a
competitive price.
This report on
Form 10-K
has been posted on the Corporation’s website,
www.firstmerit.com, on the date of filing with the
Securities and Exchange Commission (“SEC”), and the
Corporation intends to post all future filings of its reports on
Forms 10-K,
10-Q and
8-K on its
website on the date of filing with the SEC in accordance with
the prompt notice requirements of the SEC.
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REGULATION AND
SUPERVISION
FirstMerit, its national banking subsidiary FirstMerit Bank, and
many of its nonbanking subsidiaries are subject to extensive
regulation by federal and state agencies. The regulation of bank
holding companies and their subsidiaries is intended primarily
for the protection of depositors, borrowers, other customers,
the federal deposit insurance fund and the banking system as a
whole and not for the protection of security holders. This
regulatory environment, among other things, may restrict
FirstMerit’s ability to diversify into certain areas of
financial services, acquire depository institutions in certain
markets and pay dividends on its capital stock. It also may
require FirstMerit to provide financial support to its banking
subsidiary, maintain capital balances in excess of those desired
by management and pay higher deposit insurance premiums as a
result of the deterioration in the financial condition of
depository institutions in general.
Bank Holding Company. FirstMerit, as a bank
holding company, is subject to regulation under the BHCA and to
inspection, examination and supervision by the Board of
Governors of the Federal Reserve System (“Federal Reserve
Board”) under the BHCA.
Subsidiary Bank. FirstMerit Bank is subject to
regulation and examination primarily by the Office of the
Comptroller of the Currency (“OCC”) and secondarily by
the Federal Deposit Insurance Corporation (“FDIC”).
Nonbank Subsidiaries. Many of
FirstMerit’s nonbank subsidiaries also are subject to
regulation by the Federal Reserve Board and other applicable
federal and state agencies. FirstMerit’s investment
advisory subsidiary and broker-dealer subsidiary are regulated
by the SEC, the Financial Industry Regulatory Authority, and
state securities regulators, which require education and
licensing of advisors, require reporting and impose business
conduct rules. FirstMerit’s insurance subsidiaries are
subject to regulation by applicable state insurance regulatory
agencies, which require education and licensing of agencies and
individual agents, require reports and impose business conduct
rules. Other nonbank subsidiaries of FirstMerit are subject to
the laws and regulations of both the federal government and the
various states in which they conduct business.
Securities and Exchange Commission and
NASDAQ. FirstMerit is also under the jurisdiction
of the SEC and certain state securities commissions for matters
relating to the offering and sale of its securities. FirstMerit
is subject to disclosure and regulatory requirements of the
Securities Act of 1933, as amended, and the Securities Exchange
Act of 1934, as amended, as administered by the SEC. FirstMerit
is listed on The NASDAQ Stock Market LLC (“NASDAQ”)
under the trading symbol “FMER,” and is subject to the
rules of NASDAQ.
Bank
Holding Company Regulation
As a bank holding company, FirstMerit’s activities are
subject to extensive regulation by the Federal Reserve Board.
FirstMerit is required to file reports with the Federal Reserve
Board and such additional information as the Federal Reserve
Board may require, and is subject to examinations by the Federal
Reserve Board.
The Federal Reserve Board also has extensive enforcement
authority over bank holding companies, including, among other
things, the ability to:
In general, the Federal Reserve Board may initiate enforcement
actions for violations of laws and regulations and unsafe or
unsound practices.
Under Federal Reserve Board policy, a bank holding company is
expected to serve as a source of financial strength to each
subsidiary bank and to commit resources to support those
subsidiary banks. Under this policy, the Federal Reserve Board
may require a bank holding company to contribute additional
capital to an undercapitalized
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subsidiary bank and may disapprove of the payment of dividends
to the shareholders if the Federal Reserve Board believes the
payment of such dividends would be an unsafe or unsound practice.
The BHCA requires prior approval by the Federal Reserve Board
for a bank holding company to acquire more than a 5% interest in
any bank. Factors taken into consideration in making such a
determination include the effect of the acquisition on
competition, the public benefits expected to be received from
the acquisition, the projected capital ratios and levels on a
post-acquisition basis, and the acquiring institution’s
record of addressing the credit needs of the communities it
serves.
The BHCA also governs interstate banking and restricts the
nonbanking activities of FirstMerit to those determined by the
Federal Reserve Board to be financial in nature, or incidental
or complementary to such financial activity, without regard to
territorial restrictions. Transactions among FirstMerit Bank and
its affiliates are also subject to certain limitations and
restrictions of the Federal Reserve Board.
GLBA permits a qualifying bank holding company to become a
financial holding company and thereby affiliate with securities
firms and insurance companies and engage in other activities
that are financial in nature and not otherwise permissible for a
bank holding company. FirstMerit has not elected to become a
financial holding company.
FirstMerit is a legal entity separate and distinct from its
subsidiary bank and other subsidiaries. FirstMerit’s
principal source of funds to pay dividends on its common shares
and service its debt is dividends from these subsidiaries.
Various federal and state statutory provisions and regulations
limit the amount of dividends that FirstMerit Bank may pay to
FirstMerit without regulatory approval. FirstMerit Bank
generally may not, without prior regulatory approval, pay a
dividend in an amount greater than its undivided profits. In
addition, the prior approval of the OCC is required for the
payment of a dividend if the total of all dividends declared in
a calendar year would exceed the total of its net income for the
year combined with its retained net income for the two preceding
years. If, in the opinion of the applicable regulatory
authority, a bank under its jurisdiction is engaged in or is
about to engage in an unsafe or unsound practice, such authority
may require, after notice and hearing, that such bank cease and
desist from such practice. Depending on the financial condition
of the bank, the applicable regulatory authority might deem the
bank to be engaged in an unsafe or unsound practice if the bank
were to pay dividends. The Federal Reserve Board and the OCC
have issued policy statements that provide that insured banks
and bank holding companies should generally only pay dividends
out of current operating earnings. Thus the ability of
FirstMerit Bank to pay dividends in the future is currently
influenced, and could be further influenced, by bank regulatory
policies and capital guidelines.
FirstMerit’s banking subsidiary is subject to restrictions
under federal law that limit the transfer of funds or other
items of value to FirstMerit and its nonbanking subsidiaries,
including affiliates, whether in the form of loans and other
extensions of credit, investments and asset purchases, or as
other transactions involving the transfer of value from a
subsidiary to an affiliate or for the benefit of an affiliate.
Moreover, loans and extensions of credit to affiliates generally
are required to be secured in specified amounts. A bank’s
transactions with its nonbank affiliates also are generally
required to be on arm’s-length terms.
Capital loans from FirstMerit to its subsidiary bank are
subordinate in right of payment to deposits and certain other
indebtedness of the subsidiary bank. In the event of
FirstMerit’s bankruptcy, any commitment by FirstMerit to a
federal bank regulatory agency to maintain the capital of a
subsidiary bank will be assumed by the bankruptcy trustee and
entitled to a priority of payment.
The Federal Deposit Insurance Act provides that, in the event of
the “liquidation or other resolution” of an insured
depository institution such as FirstMerit Bank, the insured and
uninsured depositors, along with the FDIC, will have priority in
payment ahead of unsecured, nondeposit creditors, including
FirstMerit, with respect to any extensions of credit they have
made to such insured depository institution.
Regulation
of Nationally-Chartered Banks
As a national banking association, FirstMerit Bank is subject to
regulation under the National Banking Act and is periodically
examined by the OCC. OCC regulations govern permissible
activities, capital requirements, dividend limitations,
investments, loans and other matters. Furthermore, FirstMerit
Bank is subject, as a member bank, to
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certain rules and regulations of the Federal Reserve Board, many
of which restrict activities and prescribe documentation to
protect consumers. FirstMerit Bank is an insured institution as
a member of the Deposit Insurance Fund. As a result, it is
subject to regulation and deposit insurance assessments by the
FDIC. In addition, the establishment of branches by FirstMerit
Bank is subject to prior approval of the OCC. The OCC has the
authority to impose sanctions on FirstMerit Bank and, under
certain circumstances, may place FirstMerit Bank into
receivership.
The Federal Reserve Board has adopted risk-based capital
guidelines for bank holding companies. The OCC and the FDIC have
adopted risk-based capital guidelines for national banks and
state non-member banks, respectively. The guidelines provide a
systematic analytical framework which makes regulatory capital
requirements sensitive to differences in risk profiles among
banking organizations, takes off-balance sheet exposures
expressly into account in evaluating capital adequacy, and
minimizes disincentives to holding liquid, low-risk assets.
Capital levels as measured by these standards are also used to
categorize financial institutions for purposes of certain prompt
corrective action regulatory provisions.
The minimum guideline for the ratio of total capital to
risk-weighted assets (including certain off-balance sheet items
such as standby letters of credit) is 8%. At least half of the
minimum total risk-based capital ratio (4%) must be composed of
common shareholders’ equity, minority interests in certain
equity accounts of consolidated subsidiaries and a limited
amount of qualifying preferred stock and qualified trust
preferred securities, less goodwill and certain other intangible
assets, including the unrealized net gains and losses, after
applicable taxes, on
available-for-sale
securities carried at fair value (commonly known as
“Tier 1” risk-based capital). The remainder of
total risk-based capital (commonly known as
“Tier 2” risk-based capital) may consist of
certain amounts of hybrid capital instruments, mandatory
convertible debt, subordinated debt, preferred stock not
qualifying as Tier 1 capital, loan and lease loss allowance
and net unrealized gains on certain
available-for-sale
equity securities, all subject to limitations established by the
guidelines.
Under the guidelines, capital is compared to the relative risk
related to the balance sheet. To derive the risk included in the
balance sheet, one of four risk weights (0%, 20%, 50% and 100%)
is applied to different balance sheet and off-balance sheet
assets, primarily based on the relative credit risk of the
counterparty. The capital amounts and classification are also
subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
The Federal Reserve Board has established minimum leverage ratio
guidelines for bank holding companies. The Federal Reserve Board
guidelines provide for a minimum ratio of Tier 1 capital to
average assets (excluding the loan and lease loss allowance,
goodwill and certain other intangibles), or “leverage
ratio,” of 3% for bank holding companies that meet certain
criteria, including having the highest regulatory rating, and 4%
for all other bank holding companies. The guidelines further
provide that bank holding companies making acquisitions will be
expected to maintain strong capital positions substantially
above the minimum levels. The OCC and the FDIC have each also
adopted minimum leverage ratio guidelines for national banks and
for state non-member banks, respectively.
The Federal Reserve Board’s review of certain bank holding
company transactions is affected by whether the applying bank
holding company is “well-capitalized.” To be deemed
“well-capitalized,” the bank holding company must have
a Tier 1 risk-based capital ratio of at least 6% and a
total risk-based capital ratio of at least 10%, and must not be
subject to any written agreement, order, capital directive or
prompt corrective action directive issued by the Federal Reserve
Board to meet and maintain a specific capital level for any
capital measure. FirstMerit’s capital ratios meet the
requirements to be deemed “well capitalized” under the
Federal Reserve Board’s guidelines.
The federal banking agencies have established a system of prompt
corrective action to resolve certain of the problems of
undercapitalized institutions. This system is based on five
capital level categories for insured depository institutions:
“well capitalized,” “adequately
capitalized,” “undercapitalized,”
“significantly undercapitalized,” and “critically
undercapitalized.”
The federal banking agencies may (or in some cases must) take
certain supervisory actions depending upon a bank’s capital
level. For example, the banking agencies must appoint a receiver
or conservator for a bank within 90 days after it becomes
“critically undercapitalized” unless the bank’s
primary regulator determines, with the
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concurrence of the FDIC, that other action would better achieve
regulatory purposes. Banking operations otherwise may be
significantly affected depending on a bank’s capital
category. For example, a bank that is not “well
capitalized” generally is prohibited from accepting
brokered deposits and offering interest rates on deposits higher
than the prevailing rate in its market, and the holding company
of any undercapitalized depository institution must guarantee,
in part, specific aspects of the bank’s capital plan for
the plan to be acceptable.
In order to be “well-capitalized,” a bank must have
total risk-based capital of at least 10%, Tier 1 risk-based
capital of at least 6% and a leverage ratio of at least 5%, and
the bank must not be subject to any written agreement, order,
capital directive or prompt corrective action directive to meet
and maintain a specific capital level for any capital measure.
FirstMerit’s management believes that FirstMerit Bank meets
the ratio requirements to be deemed “well capitalized”
according to the guidelines described above. See Note 20 to
the consolidated financial statements.
The Federal Reserve Board may set capital requirements higher
than the minimums described previously for holding companies
whose circumstances warrant it. For example, holding companies
experiencing or anticipating significant growth may be expected
to maintain capital positions substantially above the minimum
supervisory levels without significant reliance on intangible
assets.
The risk-based capital guidelines adopted by the federal banking
agencies are based on the “International Convergence of
Capital Measurement and Capital Standards” (Basel I),
published by the Basel Committee on Banking Supervision (the
“Basel Committee”) in 1988. In 2004, the Basel
Committee published a new, more risk-sensitive capital adequacy
framework (Basel II) for large, internationally active
banking organizations. In December 2007, the federal banking
agencies issued final rules making the implementation of certain
parts of Basel II mandatory for any bank that has
consolidated total assets of at least $250 billion
(excluding certain assets) or has consolidated on-balance sheet
foreign exposure of at least $10 billion, and making it
voluntary for other banks.
In response to concerns regarding the complexity and cost
associated with implementing the Basel II rules, in July
2008, the federal banking agencies issued a notice of proposed
rulemaking that would revise the existing risk-based capital
framework for banks that will not be subject to the
Basel II rules. The proposed rules would allow banks other
than the large Basel II banks to elect to adopt the new
risk weighting methodologies set forth in the proposed rules or
remain subject to the existing risk-based capital rules.
FirstMerit will not be required to implement Basel II. Until the
final rules for the non-Basel II banks are adopted by the
federal banking agencies, FirstMerit is unable to predict
whether and when its subsidiary banks will adopt the new capital
guidelines.
Federal law permits the OCC to order the pro rata assessment of
shareholders of a national bank whose capital stock has become
impaired, by losses or otherwise, to relieve a deficiency in
such national bank’s capital stock. This statute also
provides for the enforcement of any such pro rata assessment of
shareholders of such national bank to cover such impairment of
capital stock by sale, to the extent necessary, of the capital
stock owned by any assessed shareholder failing to pay the
assessment. As the sole shareholder of FirstMerit Bank,
FirstMerit is subject to such provisions.
Insurance premiums for each insured institution are determined
based upon the institution’s capital level and supervisory
rating provided to the FDIC by the institution’s primary
federal regulator and other information the FDIC determines to
be relevant to the risk posed to the deposit insurance fund by
the institution. The assessment rate determined by considering
such information is then applied to the amount of the
institution’s deposits to determine the institution’s
insurance premium. An increase in the assessment rate could have
a material adverse effect on the earnings of the affected
institutions, depending on the amount of the increase.
Insurance of deposits may be terminated by the FDIC upon a
finding that the insured institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to
continue operations, or has violated any applicable law,
regulation, rule, order or condition enacted or imposed by the
institution’s regulatory agency.
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FirstMerit’s business and earnings are affected
significantly by the fiscal and monetary policies of the federal
government and its agencies. FirstMerit is particularly affected
by the policies of the Federal Reserve Board, which regulates
the supply of money and credit in the United States. Among the
instruments of monetary policy available to the Federal Reserve
are (a) conducting open market operations in United States
government securities, (b) changing the discount rates of
borrowings of depository institutions, (c) imposing or
changing reserve requirements against depository
institutions’ deposits, and (d) imposing or changing
reserve requirements against certain borrowing by banks and
their affiliates. These methods are used in varying degrees and
combinations to affect directly the availability of bank loans
and deposits, as well as the interest rates charged on loans and
paid on deposits. For that reason alone, the policies of the
Federal Reserve Board have a material effect on the earnings of
FirstMerit.
Under GLBA, federal banking regulators were required to adopt
rules that limit the ability of banks and other financial
institutions to disclose non-public information about consumers
to nonaffiliated third parties. These limitations require
disclosure of privacy policies to consumers and, in some
circumstances, allow consumers to prevent disclosure of certain
personal information to a nonaffiliated third party.
The USA Patriot Act of 2001 and its related regulations require
insured depository institutions, broker-dealers, and certain
other financial institutions to have policies, procedures, and
controls to detect, prevent, and report money laundering and
terrorist financing. The statute and its regulations also
provide for information sharing, subject to conditions, between
federal law enforcement agencies and financial institutions, as
well as among financial institutions, for counter-terrorism
purposes. Federal banking regulators are required, when
reviewing bank holding company acquisition and bank merger
applications, to take into account the effectiveness of the
anti-money laundering activities of the applicants.
EESA and
ARRA
In response to the ongoing financial crisis affecting the
banking system and financial markets, EESA was signed into law
on October 3, 2008 and established TARP. As part of TARP,
the Treasury established the CPP to provide up to
$700 billion of funding to eligible financial institutions
through the purchase of mortgages, mortgage-backed securities,
capital stock and other financial instruments for the purpose of
stabilizing and providing liquidity to the U.S. financial
markets. On January 9, 2009, FirstMerit completed the sale
to the Treasury of $125.0 million of newly issued
FirstMerit non-voting preferred shares as part of the CPP and a
warrant to purchase 952,260 FirstMerit common shares at an
exercise price of $19.69 per share. The American Recovery and
Reinvestment Act of 2009 (“ARRA”), more commonly known
as the economic stimulus or economic recovery package, was
signed into law on February 17, 2009, by President Obama.
ARRA includes a wide variety of programs intended to stimulate
the economy and provide for extensive infrastructure, energy,
health, and education needs. In addition, ARRA imposes certain
new executive compensation and corporate expenditure limits on
all current and future TARP recipients, including FirstMerit,
until the institution has repaid the Treasury.
On April 22, 2009, FirstMerit completed the repurchase of
all 125,000 shares of its Fixed Rate Cumulative Perpetual
Preferred Stock, Series A, and on May 27, 2009,
FirstMerit completed the repurchase of the warrant held by the
Treasury. FirstMerit is therefore no longer subject to the
compensation and expenditure limits applicable to TARP
recipients.
Corporate
Governance
The Sarbanes-Oxley Act of 2002 effected broad reforms to areas
of corporate governance and financial reporting for public
companies under the jurisdiction of the SEC. Significant
additional corporate governance and financial reporting reforms
have since been implemented by NASDAQ, and apply to FirstMerit.
FirstMerit’s corporate governance policies include an Audit
Committee Charter, a Compensation Committee Charter, Corporate
Governance Guidelines, Corporate Governance and Nominating
Committee Charter, and Code of Business Conduct and Ethics.
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The Board of Directors reviews FirstMerit’s corporate
governance practices on a continuing basis. These and other
corporate governance policies have been provided previously to
shareholders and are available, along with other information on
FirstMerit’s corporate governance practices, on the
FirstMerit website at www.firstmerit.com.
As directed by Section 302(a) of the Sarbanes-Oxley Act,
FirstMerit’s chief executive officer and chief financial
officer are each required to certify that FirstMerit’s
Quarterly and Annual Reports do not contain any untrue statement
of a material fact. The rules have several requirements,
including having these officers certify that: they are
responsible for establishing, maintaining, and regularly
evaluating the effectiveness of FirstMerit’s internal
controls, they have made certain disclosures about
FirstMerit’s internal controls to its auditors and the
audit committee of the Board of Directors, and they have
included information in FirstMerit’s Quarterly and Annual
Reports about their evaluation and whether there have been
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to
the evaluation.
Various legislation affecting financial institutions and the
financial industry is from time to time introduced in Congress.
Such legislation may change banking statutes and the operating
environment of FirstMerit and its subsidiaries in substantial
and unpredictable ways, and could increase or decrease the cost
of doing business, limit or expand permissible activities or
affect the competitive balance depending upon whether any of
this potential legislation will be enacted, and if enacted, the
effect that it or any implementing regulations, would have on
the financial condition or results of operations of FirstMerit
or any of its subsidiaries. With the enactment of EESA and ARRA
and the current consideration of economic stimulus legislation
by Congress, the nature and extent of future legislative and
regulatory changes affecting financial institutions is very
unpredictable at this time.
Summary
To the extent that the previous information describes statutory
and regulatory provisions applicable to FirstMerit or its
subsidiaries, it is qualified in its entirety by reference to
the full text of those provisions or agreement. 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 FirstMerit could have a material effect on the
business of FirstMerit.
Our success depends, to a certain extent, upon economic and
political conditions, local and national, as well as
governmental monetary policies. Conditions such as inflation,
recession, unemployment, changes in interest rates, money supply
and other factors beyond our control may adversely affect our
asset quality, deposit levels and loan demand and, therefore,
our earnings.
Dramatic declines in the housing market beginning in the latter
half of 2007, with falling home prices and increasing
foreclosures, unemployment and underemployment, have negatively
impacted the credit performance of mortgage loans and resulted
in significant write-downs of asset values by financial
institutions. The resulting write-downs to assets of financial
institutions have caused many financial institutions to seek
additional capital, to merge with larger and stronger
institutions and, in some cases, to seek government assistance
or bankruptcy protection.
The capital and credit markets, including the fixed income
markets, have been experiencing volatility and disruption. In
some cases, the markets have produced downward pressure on stock
prices and credit capacity for certain issuers without regard to
those issuers’ financial strength.
Many lenders and institutional investors have reduced and, in
some cases, ceased to provide funding to borrowers, including to
other financial institutions because of concern about the
stability of the financial markets and the strength of
counterparties. It is difficult to predict how long these
economic conditions will exist, which of our
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markets, products or other businesses will ultimately be
affected, and whether management’s actions will effectively
mitigate these external factors. Accordingly, the resulting lack
of available credit, lack of confidence in the financial sector,
decreased consumer confidence, increased volatility in the
financial markets and reduced business activity could materially
and adversely affect our business, financial condition and
results of operations.
As a result of the challenges presented by economic conditions,
we may face the following risks in connection with these events:
The
enactment of new legislation and increased regulatory oversight
may significantly affect our financial condition.
The financial services industry is extensively regulated.
FirstMerit Bank is subject to extensive regulation, supervision
and examination by the OCC and the FDIC. As a holding company,
we also are subject to regulation and oversight by the Federal
Reserve Board. Federal and state regulation is designed
primarily to protect the deposit insurance funds and consumers,
and not to benefit our shareholders. Such regulations can at
times impose significant limitations on our operations.
Regulatory authorities have extensive discretion in connection
with their supervisory and enforcement activities, including the
imposition of restrictions on the operation of an institution,
the classification of assets by the institution and the adequacy
of an institution’s allowance for loan losses. Proposals to
change the laws governing financial institutions are frequently
raised in Congress and before bank regulatory authorities.
Substantial regulatory and legislation initiatives, including a
comprehensive overhaul of the regulatory system in the United
States, are possible in the years ahead. Changes in applicable
laws or policies could materially affect our business, and the
likelihood of any major changes in the future and their effects
are impossible to determine. Moreover, it is impossible to
predict the ultimate form any proposed legislation might take or
how it might affect us.
In 2008 and continuing into 2009 and 2010, the Federal Reserve
Board, Congress, the Treasury, the FDIC and others have taken
numerous actions to address the current liquidity and credit
crisis in the financial markets. These measures include
homeowner relief that encourages loan restructuring and
modification; the establishment of significant liquidity and
credit facilities for financial institutions and investment
banks; the lowering of the federal funds rate; and coordinated
efforts to address liquidity and other weaknesses in the banking
sector. There can be no assurance as to the actual impact that
new legislation will have on the economy or financial markets.
The failure of these programs to stabilize the financial markets
could weaken public confidence in financial institutions and
have a substantial and material adverse effect on our ability to
attract and retain new customers.
Further, additional legislation or regulations may be adopted in
the future that reduce the amount that our customers are
required to pay under existing loan contracts or limit our
ability to foreclose on collateral. For example, legislation has
been proposed to give judges the ability to adjust the principal
and interest payments on residential
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mortgages to allow homeowners to avoid foreclosure. There can be
no assurance that future legislation will not significantly
impact our ability to collect on our current loans or foreclose
on collateral.
Additional information regarding regulation and supervision is
included in the section captioned “Regulation and
Supervision” in Item 1. Business.
Changes
in economic and political conditions, particularly in Ohio,
could adversely affect our earnings, cash flows and capital, as
our borrowers’ ability to repay loans and the value of the
collateral securing our loans decline.
Our success depends, to a certain extent, upon economic and
political conditions, local and national, as well as
governmental fiscal and monetary policies. Conditions such as
inflation, recession, unemployment, changes in interest rates,
money supply and other factors beyond our control may adversely
affect our asset quality, deposit levels and loan demand and,
therefore, our earnings and our capital. Because we have a
significant amount of real estate loans, additional decreases in
real estate values could adversely affect the value of property
used as collateral and our ability to sell the collateral upon
foreclosure. Adverse changes in the economy may also have a
negative effect on the ability of our borrowers to make timely
repayments of their loans, which would have an adverse impact on
our earnings and cash flows.
The substantial majority of the loans made by our subsidiaries
are to individuals and businesses in Ohio. Consequently, a
significant continued decline in the economy in Ohio could have
a materially adverse effect on our financial condition and
results of operations and cash flows.
We continue to experience difficult credit conditions in the
markets in which we operate. It remains uncertain when the
negative credit trends in our markets will reverse. As a result,
our future earnings, cash flows and capital continue to be
susceptible to further declining credit conditions in the
markets in which we operate.
Increases
in FDIC insurance premiums may have a material adverse affect on
our earnings.
During 2008, there were higher levels of bank failures, which
dramatically increased resolution costs of the FDIC and depleted
the deposit insurance fund. In order to maintain a strong
funding position and restore reserve ratios of the deposit
insurance fund, the FDIC voted on December 16, 2008 to
increase assessment rates of insured institutions uniformly by
7 basis points (7 cents for every $100 of deposits),
beginning with the first quarter of 2009. Additional changes,
beginning April 1, 2009, were to require riskier
institutions to pay a larger share of premiums by factoring in
rate adjustments based on secured liabilities and unsecured debt
levels.
The Emergency Economic Stabilization Act of 2008 (the
“EESA”) instituted two temporary programs effective
through December 31, 2009 to further insure customer
deposits at FDIC-member banks: deposit accounts are now insured
up to $250,000 per customer (up from $100,000) and noninterest
bearing transactional accounts are fully insured (unlimited
coverage). On May 20, 2009, President Obama signed into law
the Helping Families Save Their Homes Act of 2009 (the
“HFSTHA”) which, among other things, amends the EESA
to extend the effectiveness of these temporary programs through
December 31, 2013. On January 1, 2014, the standard
insurance amount will return to $100,000 per depositor for all
account categories except IRAs and certain other retirement
accounts, which will remain at $250,000 per depositor.
On May 22, 2009, the FDIC adopted a final rule that imposed
a special assessment for the second quarter of 2009 of
5 basis points on each insured depositary
institution’s assets minus its Tier 1 capital as of
June 30, 2009, which was collected on September 30,
2009 in the amount of $4.9 million.
On November 12, 2009, the FDIC adopted a final rule
requiring insured institutions to prepay their estimated
quarterly risk-based assessments for the fourth quarter of 2009
and for all of 2010, 2011 and 2012. The prepaid assessments for
these periods were collected on December 30, 2009, along
with the regular quarterly risk-based deposit insurance
assessment for the third quarter of 2009. For the fourth quarter
of 2009 and for all of 2010, the prepaid assessment rate was
based on each institution’s total basis point assessment in
effect on September 30, 2009, adjusted to assume a 5%
annualized deposit growth rate; for the 2011 and 2012 periods
the computation is adjusted by an additional 3 basis points
increase in the assessment rate. The three-year prepayment for
FirstMerit totaled $43.9 million, and will be expensed over
three years.
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In January 2010, the FDIC issued an advance notice of proposed
rule-making asking for comments on how the FDIC’s
risk-based deposit insurance assessment system could be changed
to include the risks of certain employee compensation as
criteria in the assessment system.
We are generally unable to control the amount of premiums that
we are required to pay for FDIC insurance. If there are
additional financial institution failures, we may be required to
pay even higher FDIC premiums than the recently increased
levels. Increases in FDIC insurance premiums may materially
adversely affect our results of operations and our ability to
continue to pay dividends on our common shares at the current
rate or at all.
The actions and commercial soundness of other financial
institutions could affect our ability to engage in routine
funding transactions. Financial services to institutions are
interrelated as a result of trading, clearing, counterparty or
other relationships. We have exposure to different industries
and counterparties, and execute transactions with various
counterparties in the financial industry, including brokers and
dealers, commercial banks, investment banks, mutual and hedge
funds, and other institutional clients. Recent defaults by
financial services institutions, and even rumors or questions
about one or more financial services institution or the
financial services industry in general, have led to marketwide
liquidity problems and could lead to losses or defaults by us or
by other institutions. Many of these transactions expose us to
credit risk in the event of default of its counterparty or
client. In addition, our credit risk may increase when the
collateral held by us cannot be realized upon or is liquidated
at prices not sufficient to recover the full amount of the loan
or derivative exposure due us. Any such losses could materially
and adversely affect our results of operations.
The capital and credit markets have been experiencing volatility
and disruption for more than a year. In recent months, the
volatility and disruption has reached unprecedented levels. In
some cases, the markets have produced downward pressure on stock
prices and credit availability for certain issuers seemingly
without regard to those issuers’ underlying financial
strength. If current levels of market disruption and volatility
continue or worsen, there can be no assurance that we will not
experience an adverse effect, which may be material, on our
ability to access capital and on our business, financial
condition and results of operations.
The market price for our Common Shares has been volatile in the
past, and several factors could cause the price to fluctuate
substantially in the future, including:
Our earnings depend substantially on our interest rate spread,
which is the difference between (i) the rates we earn on
loans, securities and other earning assets and (ii) the
interest rates we pay on deposits and other borrowings. These
rates are highly sensitive to many factors beyond our control,
including general economic conditions and the policies of
various governmental and regulatory authorities. As market
interest rates rise, we will have competitive pressures to
increase the rates we pay on deposits, which will result in a
decrease of our net interest income and could have a material
adverse effect on our financial condition and results of
operations. Additional information regarding
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interest rate risk is included in the section captioned
“Interest Rate Sensitivity” within Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
The policies of the Federal Reserve Board impact us
significantly. The Federal Reserve Board regulates the supply of
money and credit in the United States. Its policies directly and
indirectly influence the rate of interest earned on loans and
paid on borrowings and interest-bearing deposits and can also
affect the value of financial instruments we hold. Those
policies determine to a significant extent our cost of funds for
lending and investing. Changes in those policies are beyond our
control and are difficult to predict. Federal Reserve Board
policies can also affect our borrowers, potentially increasing
the risk that they may fail to repay their loans. For example, a
tightening of the money supply by the Federal Reserve Board
could reduce the demand for a borrower’s products and
services. This could adversely affect the borrower’s
earnings and ability to repay its loan, which could have a
material adverse effect on our financial condition and results
of operations.
The availability of dividends from FirstMerit Bank is limited by
various statutes and regulations. It is possible, depending upon
the financial condition of FirstMerit Bank and other factors,
that the OCC could assert that payment of dividends or other
payments is an unsafe or unsound practice. In addition, the
payment of dividends by other subsidiaries is also subject to
the laws of the subsidiary’s state of incorporation.
FirstMerit’s right to participate in a distribution of
assets upon a subsidiary’s liquidation or reorganization is
subject to the prior claims of the subsidiary’s creditors.
In the event that FirstMerit Bank was unable to pay dividends to
us, we in turn would likely have to reduce or stop paying
dividends on our Common Shares. Our failure to pay dividends on
our Common Shares could have a material adverse effect on the
market price of our Common Shares. Additional information
regarding dividend restrictions is included in the section
captioned “Regulation and Supervision — Dividends
and Transactions with Affiliates” in Item 1. Business.
Our loan customers may not repay their loans according to their
terms, and the collateral securing the payment of these loans
may be insufficient to pay any remaining loan balance. We may
experience significant credit losses, which could have a
material adverse effect on our operating results. In accordance
with accounting principles generally accepted in the United
States, we maintain an allowance for credit losses to provide
for loan defaults and non-performance and a reserve for unfunded
loan commitments, which when combined, we refer to as the
allowance for credit losses. Our allowance for loan losses may
not be adequate to cover actual credit losses, and future
provisions for credit losses could have a material adverse
effect on our operating results. Our allowance for loan losses
is based on prior experience, as well as an evaluation of the
risks in the current portfolio. The amount of future losses is
susceptible to changes in economic, operating and other
conditions, including changes in interest rates that may be
beyond our control, and these losses may exceed current
estimates. Federal regulatory agencies, as an integral part of
their examination process, review our loans and allowance for
loan losses. We cannot assure you that we will not further
increase the allowance for loan losses or that regulators will
not require us to increase this allowance. Either of these
occurrences could have a material adverse effect on our
financial condition and results of operations. Additional
information regarding the allowance for loan losses is included
in the sections captioned “Allowance for Loan Losses and
Reserve for Unfunded Lending Commitments” and
“Allowance for Credit Losses” within Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
We
extend credit to a variety of customers based on internally set
standards and the judgment of our loan officers and bank
presidents. Our credit standards and on-going process of credit
assessment might not protect us from significant credit
losses.
We take credit risk by virtue of making loans and leases,
extending loan commitments and letters of credit and, to a
lesser degree, purchasing non-governmental securities. Our
exposure to credit risk is managed through the use of
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consistent underwriting standards that emphasize
“in-market” lending while avoiding highly leveraged
transactions as well as excessive industry and other
concentrations. Our credit administration function employs risk
management techniques to ensure that loans and leases adhere to
corporate policy and problem loans and leases are promptly
identified. While these procedures are designed to provide us
with the information needed to implement policy adjustments
where necessary, and to take proactive corrective actions, there
can be no assurance that such measures will be effective in
avoiding undue credit risk.
In deciding whether to extend credit or enter into other
transactions with customers and counterparties, we may rely on
information provided to us by customers and counterparties,
including financial statements and other financial information.
We may also rely on representations of customers and
counterparties as to the accuracy and completeness of that
information and, with respect to financial statements, on
reports of independent auditors. For example, in deciding
whether to extend credit to a business, we may assume that the
customer’s audited financial statements conform with
generally accepted accounting principles and present fairly, in
all material respects, the financial condition, results of
operations and cash flows of the customer. We may also rely on
the audit report covering those financial statements. Our
financial condition and results of operations could be
negatively impacted to the extent we rely on financial
statements that do not comply with generally accepted accounting
principles or that are materially misleading.
Derivative
transactions may expose us to unexpected risk and potential
losses.
We are party to a number of derivative transactions. Many of
these derivative instruments are individually negotiated and
non-standardized, which can make exiting, transferring or
settling the position difficult. We carry borrowings which
contain embedded derivatives. These borrowing arrangements
require that we deliver underlying securities to the
counterparty as collateral. If market interest rates were to
decline, we may be required to deliver more securities to the
counterparty. We are dependent on the creditworthiness of the
counterparties and are therefore susceptible to credit and
operational risk in these situations.
Derivative contracts and other transactions entered into with
third parties are not always confirmed by the counterparties on
a timely basis. While the transaction remains unconfirmed, we
are subject to heightened credit and operational risk and, in
the event of a default, may find it more difficult to enforce
the contract. In addition, as new and more complex derivative
products are created, covering a wider array of underlying
credit and other instruments, disputes about the terms of the
underlying contracts could arise, which could impair our ability
to effectively manage our risk exposures from these products and
subject us to increased costs. Any regulatory effort to create
an exchange or trading platform for credit derivatives and other
over-the-counter
derivative contracts, or a market shift toward standardized
derivatives, could reduce the risk associated with such
transactions, but under certain circumstances could also limit
our ability to develop derivatives that best suit the needs of
our clients and ourselves and adversely affect our profitability.
In the normal course of business, FirstMerit and its
subsidiaries are routinely subject to examinations and
challenges from federal and state tax authorities regarding the
amount of taxes due in connection with investments we have made
and the businesses in which we have engaged. Recently, federal
and state taxing authorities have become increasingly aggressive
in challenging tax positions taken by financial institutions.
These tax positions may relate to tax compliance, sales and use,
franchise, gross receipts, payroll, property and income tax
issues, including tax base, apportionment and tax credit
planning. The challenges made by tax authorities may result in
adjustments to the timing or amount of taxable income or
deductions or the allocation of income among tax jurisdictions.
If any such challenges are made and are not resolved in our
favor, they could have a material adverse effect on our
financial condition and results of operations.
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In the course of our business, we may acquire, through
foreclosure, commercial properties securing loans that are in
default. There is a risk that hazardous substances could be
discovered on those properties. In this event, we could be
required to remove the substances from and remediate the
properties at our cost and expense. The cost of removal and
environmental remediation could be substantial. We may not have
adequate remedies against the owners of the properties or other
responsible parties and could find it difficult or impossible to
sell the affected properties. These events could have a material
adverse effect on our financial condition and results of
operation.
We intend to continue pursuing a profitable growth strategy both
within our existing markets and in new markets. Our prospects
must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in significant
growth stages of development. We cannot assure you that we will
be able to expand our market presence in our existing markets or
successfully enter new markets or that any such expansion will
not adversely affect our results of operations. Failure to
manage our growth effectively could have a material adverse
effect on our business, future prospects, financial condition or
results of operations and could adversely affect our ability to
successfully implement our business strategy. Also, if we grow
more slowly than anticipated, our operating results could be
materially adversely affected.
Our ability to grow successfully will depend on a variety of
factors, including the continued availability of desirable
business opportunities, the competitive responses from other
financial institutions in our market areas and our ability to
manage our growth. While we believe we have the management
resources and internal systems in place to successfully manage
our future growth, there can be no assurance growth
opportunities will be available or growth will be successfully
managed.
We may acquire other financial institutions or parts of those
institutions in the future and we may engage in de novo branch
expansion. We may also consider and enter into new lines of
business or offer new products or services. Acquisitions and
mergers involve a number of expenses and risks, including:
We may incur substantial costs to expand, and we can give no
assurance such expansion will result in the levels of profits we
seek. There can be no assurance integration efforts for any
future mergers or acquisitions will be successful. Also, we may
issue equity securities in connection with future acquisitions,
which could cause ownership and
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economic dilution to our current shareholders. There is no
assurance that, following any future mergers or acquisitions,
our integration efforts will be successful or that, after giving
effect to the acquisition, we will achieve profits comparable to
or better than our historical experience.
In our market area, we encounter significant competition from
other commercial banks, savings and loan associations, credit
unions, mortgage banking firms, consumer finance companies,
securities brokerage firms, insurance companies, money market
mutual funds and other financial institutions. The increasingly
competitive environment is a result primarily of changes in
regulation, changes in technology and product delivery systems
and the accelerating pace of consolidation among financial
service providers. Many of our competitors have substantially
greater resources and lending limits than we do and may offer
services that we do not or cannot provide. Our financial
performance and return on investment to shareholders will depend
in part on our continued ability to compete successfully in our
market area and on our ability to expand our scope of available
financial services as needed to meet the needs and demands of
our customers.
Technology and other changes are allowing parties to complete
financial transactions that historically have involved banks at
one or both ends of the transaction. For example, consumers can
now pay bills and transfer funds directly without banks. The
process of eliminating banks as intermediaries, known as
disintermediation, could result in the loss of fee income, as
well as the loss of customer deposits and income generated from
those deposits.
Our business is primarily relationship-driven in that many of
our key employees have extensive customer relationships. Loss of
a key employee with such customer relationships may lead to the
loss of business if the customers were to follow that employee
to a competitor. While we believe our relationship with our key
producers is good, we cannot guarantee that all of our key
personnel will remain with our organization. Loss of such key
personnel, should they enter into an employment relationship
with one of our competitors, could result in the loss of some of
our customers.
Under current accounting standards, goodwill and certain other
intangible assets with indeterminate lives are no longer
amortized but, instead, are assessed for impairment periodically
or when impairment indicators are present. Assessment of
goodwill and such other intangible assets could result in
circumstances where the applicable intangible asset is deemed to
be impaired for accounting purposes. Under such circumstances,
the intangible asset’s impairment would be reflected as a
charge to earnings in the period during which such impairment is
identified.
We may
be exposed to liability under non-solicitation agreements to
which one or more of our employees may be a party to with
certain of our competitors.
From time to time, we may hire employees who may be parties to
non-solicitation or non-competition agreements with one or more
of our competitors. Although we expect that all such employees
will comply with the terms of their non-solicitation agreements,
it is possible that if customers of our competitors choose to
move their business to us, or employees of our competitor seek
employment with us, even without any action on the part of any
employee bound by any such agreement, that one or more of our
competitors may choose to bring a claim against us and our
employee.
As part of our business we collect, process, and retain
sensitive and confidential client and customer information on
behalf of FirstMerit and other third parties. Despite the
security measures we have in place, our facilities and
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systems, and those of our third party service providers, may be
vulnerable to security breaches, acts of vandalism, computer
viruses, misplaced or lost data, programming
and/or human
errors, or other similar events. Any security breach involving
the misappropriation, loss or other unauthorized disclosure of
confidential customer information, whether by FirstMerit or by
our vendors, could severely damage our reputation, expose us to
the risks of litigation and liability, disrupt our operations
and have a material adverse effect on our business.
We may
elect or be compelled to seek additional capital in the future,
but that capital may not be available when it is
needed.
We are required by federal and state regulatory authorities to
maintain adequate levels of capital to support our operations.
As we experience loan losses, additional capital may need to be
infused. In addition, we may elect to raise additional capital
to support our business or to finance acquisitions, if any, or
we may otherwise elect or be required to raise additional
capital. Our ability to raise additional capital will depend on
our financial performance, conditions in the capital markets,
economic conditions and a number of other factors, many of which
are outside our control. Accordingly, there can be no assurance
that we can raise additional capital if needed or on terms
acceptable to us. If we cannot raise additional capital when
needed, it may have a material adverse effect on our financial
condition, results of operations and prospects.
Our
organizational documents, state laws and regulated industry may
discourage a third party from acquiring FirstMerit by means of a
tender offer, proxy contest or otherwise.
Certain provisions of our amended and restated articles of
incorporation and amended and restated code of regulations,
certain laws of the State of Ohio, and certain aspects of the
BHCA and other governing statutes and regulations, may have the
effect of discouraging a tender offer or other takeover attempt
not previously approved by our Board of Directors.
FirstMerit’s executive offices and certain holding company
operational facilities, totaling approximately
108,230 square feet, are located in a seven-story office
building at III Cascade in downtown Akron, Ohio owned by
FirstMerit Bank. The building is the subject of a ground lease
with the City of Akron as the lessor of the land.
The facilities owned or leased by FirstMerit and its
subsidiaries are considered by management to be adequate, and
neither the location nor unexpired term of any lease is
considered material to the business of FirstMerit.
The principal executive offices of FirstMerit Bank are located
in a 28-story office building at 106 South Main Street, Akron,
Ohio, which is owned by FirstMerit Bank. FirstMerit Bank Akron
is the principal tenant of the building, occupying approximately
122,500 square feet of the building. The remaining portion
is leased to tenants unrelated to FirstMerit Bank. The
properties occupied by 99 of FirstMerit Bank’s other
branches are owned by FirstMerit Bank, while the properties
occupied by its remaining 60 branches are leased with various
expiration dates. FirstMerit Mortgage Corporation, FirstMerit
Title Agency, Ltd., and certain of FirstMerit Bank’s
loan operation and documentation preparation activities are
conducted in owned space in Canton, Ohio. There is no mortgage
debt owing on any of the above property owned by FirstMerit
Bank. FirstMerit Bank also owns automated teller machines,
on-line teller terminals and other computers and related
equipment for use in its business.
FirstMerit Bank also owns 15.5 acres near downtown Akron,
on which FirstMerit’s primary Operations Center is located.
The Operations Center is occupied and operated by FirstMerit
Services Division, an operating division of FirstMerit Bank. The
Operations Center primarily provides computer and communications
technology-based services to FirstMerit and its subsidiaries,
and also markets its services to non-affiliated institutions.
There is no mortgage debt owing on the Operations Center
property. In connection with its Operations Center, the Services
Division has a disaster recovery center at a remote site on
leased property, and leases additional space for activities
related to its operations.
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In the normal course of business, FirstMerit is at all times
subject to pending and threatened legal actions, some for which
the relief or damages sought are substantial. Although
FirstMerit is not able to predict the outcome of such actions,
after reviewing pending and threatened actions with counsel,
management believes that the outcome of such actions will not
have a material adverse effect on the results of operations or
stockholders’ equity of FirstMerit. Although FirstMerit is
not able to predict whether the outcome of such actions may or
may not have a material adverse effect on results of operations
in a particular future period as the time and amount of any
resolution of such actions and its relationship to the future
results of operations are not known.
No matters were submitted to a vote of security holders in the
fourth quarter of 2009.
The following persons were the executive officers of FirstMerit
as of December 31, 2009. Unless otherwise stated, each
listed position was held on January 1, 2005.
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FirstMerit’s common shares are quoted on The NASDAQ Stock
Market under the trading symbol “FMER”. The following
table contains bid and cash dividend information for FirstMerit
common Shares for the two most recent fiscal years:
Stock
Performance and Dividends (1)
On February 6, 2010, there were approximately
7,870 shareholders of record of FirstMerit common shares.
The following table provides information with respect to
purchases FirstMerit made of its shares of common shares during
the fourth quarter of the 2009 fiscal year.
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SELECTED
FINANCIAL DATA
FIRSTMERIT
CORPORATION AND SUBSIDIARIES
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The following commentary presents a discussion and analysis of
the Corporation’s financial condition and results of
operations by its management (“Management”). The
review highlights the principal factors affecting earnings and
the significant changes in balance sheet items for the years
2009, 2008 and 2007. 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 report. 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.
HIGHLIGHTS
OF 2009 PERFORMANCE
FirstMerit Corporation reported fourth quarter 2009 net
income of $14.5 million, or $0.17 per diluted share. This
compares with $22.8 million, or $0.27 per diluted share,
for the third quarter 2009 and $29.1 million, or $0.35 per
diluted share, for the fourth quarter 2008. For the full year
2009, the Corporation reported net income of $82.2 million,
or $0.90 per diluted share, compared with $119.5 million,
or $1.46 per diluted share in 2008.
Returns on average common equity (“ROE”) and average
assets (“ROA”) for the fourth quarter 2009 were 5.38%
and 0.54%, respectively, compared with 8.69% and 0.85%,
respectively, for the third quarter 2009 and 12.47% and 1.08%
for the fourth quarter 2008. ROE and ROA for the year ended
December 31, 2009 were 8.09% and 0.76%, respectively,
compared with 12.76% and 1.13%, respectively, for the year ended
December 31, 2008.
On December 16, 2009, the FirstMerit Bank acquired
$102.0 million in outstanding principal of asset based
lending loans (“ABL loans”), as well as the staff to
service and build new business, from First Bank Business
Capital, Inc., (“FBBC”). FBBC is a wholly owned
subsidiary of First Bank, a Missouri state chartered bank. This
acquisition expands the Corporation’s market presence and
asset based lending business into the Midwest.
Average loans during the fourth quarter of 2009 decreased
$108.0 million, or 1.53%, compared with the third quarter
of 2009 and also decreased $417.3 million, or 5.66%,
compared with the fourth quarter of 2008. Decreases against the
respective periods were due to a reduction in both consumer and
commercial demand for borrowing. In the fourth quarter of 2009,
average commercial loans decreased $46.9 million, or 1.14%,
and $214.3 million, or 5.01%, compared with the third
quarter of 2009 and fourth quarter of 2008, respectively.
Average consumer loans decreased $62.3 million, or 2.15%,
and $194.8 million, or 6.78%, over the same periods.
Average deposits were $7.4 billion during the fourth
quarter of 2009, up $13.1 million, or 0.18%, compared with
the third quarter of 2009, and a decrease of
$275.0 million, or 3.58%, compared with the fourth quarter
of 2008. For the fourth quarter 2009, average core deposits
(which are defined as checking accounts, savings accounts and
money market savings products) increased $344.1 million, or
6.24%, compared with the third quarter 2009 and
$1.1 billion, or 21.98%, compared with the fourth quarter
2008. Core deposits represented 79.16% of total average
deposits, compared with 74.64% for the third quarter 2009 and
62.57% for the fourth quarter 2008. The Corporation increased
average core deposits for the ninth consecutive quarter.
Strategic retail and business marketing campaigns, primarily
focused on new Reality Checking and Savings deposit products,
drove the continued growth which began in the fourth quarter of
2007.
Average investments increased $20.8 million, or 0.76%,
compared with the third quarter of 2009 and $248.3 million,
or 9.93% compared with the fourth quarter of 2008. The
Corporation’s investment portfolio yield decreased in the
fourth quarter of 2009, to 4.35%, compared with 4.51% in the
third quarter of 2009, and decreased from 5.01% in the fourth
quarter of 2008, reflective of the declining interest rate
environment.
Net interest margin was 3.64% for the fourth quarter of 2009
compared with 3.61% for the third quarter of 2009 and 3.82% for
the fourth quarter of 2008, marking a third consecutive quarter
of net interest margin expansion. The Corporation’s success
both migrating existing and attracting new depository accounts
into its Reality Checking and Savings products continued to
reduce funding costs and positively impact the net interest
margin.
Net interest income on a fully tax-equivalent (“FTE”)
basis was $89.2 million in the fourth quarter 2009 compared
with $89.1 million in the third quarter of 2009 and
$94.9 million in the fourth quarter of 2008. Declining
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average loan balances in the fourth quarter of 2009 compared
with the third quarter of 2009 offset net interest margin
expansion during the quarter.
Noninterest income net of securities transactions for the fourth
quarter of 2009 was $50.8 million, an increase of
$2.1 million, or 4.37%, from the third quarter of 2009 and
a decrease of $0.5 million, or 0.09%, from the fourth
quarter of 2008. In the fourth quarter of 2008 the Corporation
recorded $5.8 million of other income from the sale of
Class B Visa Inc. stock. Noninterest income net of
securities transactions as a percentage of net revenue for the
fourth quarter of 2009 was 36.28% compared with 35.32% for third
quarter of 2009 and 35.07% for the fourth quarter of 2008. Net
revenue is defined as net interest income, on an FTE basis, plus
other income, less gains from securities sales.
Noninterest expense for the fourth quarter of 2009 was
$94.9 million, an increase of $10.7 million, or
12.74%, from the third quarter of 2009 and an increase of
$6.6 million, or 7.53%, from the fourth quarter of 2008.
The fourth quarter of 2009 noninterest expenses included
$2.5 million of professional services related to due
diligence and acquisition expense, $1.3 million provision
for unfunded lending commitments and $3.9 million related
to the discontinuation of hedge accounting for a portfolio of
interest rate swaps associated with fixed-rate commercial loans.
For the fourth quarter of 2009, the efficiency ratio was 67.74%,
compared with 61.05% for the third quarter of 2009 and 60.34%
for the fourth quarter of 2008.
Net charge-offs totaled $31.2 million, or 1.79% of average
loans, in the fourth quarter of 2009 compared with
$18.8 million, or 1.05% of average loans, in the third
quarter 2009 and $15.2 million, or 0.82% of average loans,
in the fourth quarter of 2008.
Nonperforming assets totaled $101.0 million at
December 31, 2009, an increase of $12.1 million, or
13.64%, compared with September 30, 2009. Nonperforming
assets at December 31, 2009 represented 1.48% of period-end
loans plus other real estate compared with 1.26% at
September 30, 2009 and 0.77% million at December 31,
2008.
The allowance for loan losses totaled $115.1 million at
December 31, 2009. At December 31, 2009, the allowance
for loan losses was 1.68% of period-end loans compared with
1.66% at September 30, 2009 and 1.40% at December 31,
2008. The allowance for credit losses is the sum of the
allowance for loan losses and the reserve for unfunded lending
commitments. For comparative purposes the allowance for credit
losses was 1.77% at December 31, 2009 compared with 1.72%
at September 30, 2009 and 1.49% at December 31, 2008.
The allowance for credit losses to nonperforming loans was
131.82% at December 31, 2009, compared with 153.27% at
September 30, 2009 and 211.38% at December 31, 2008.
The Corporation’s total assets at December 31, 2009
were $10.5 billion, a decrease of $222.9 million, or
2.07%, compared with September 30, 2009 and a decrease of
$561.5 million, or 5.06%, compared with December 31,
2008. Commercial loans decreased $286.2 million, or 6.58%
and installment loans decreased $149.2 million or 9.48%,
compared with December 31, 2008, contributing to the
majority of asset declines over the prior year period.
Total deposits were $7.5 billion at December 31, 2009,
an increase of $244.5 million, or 3.36%, from
September 30, 2009 and an increase of $81.9 million,
or 1.08%, from December 31, 2008. Core deposits totaled
$6.2 billion at December 31, 2009, an increase of
$576.5 million, or 10.33%, from September 30, 2009 and
an increase of $1.34 billion, or 27.80%, from
December 31, 2008.
Shareholders’ equity was $1.08 billion at
December 31, 2009, compared with $1.06 billion at
September 30, 2009, and $937.8 million at
December 31, 2008. The Corporation maintained a strong
capital position as tangible common equity to assets was 8.89%
at December 31, 2009, compared with 8.65% at
September 30, 2009 and 7.27% at December 31, 2008. The
common cash dividend per share paid in the fourth quarter 2009
was $0.16.
Prior to 2007, the Corporation managed its operations through
the major line of business “Supercommunity Banking.”
To improve revenue growth and profitability as well as enhance
relationships with customers, the Corporation moved to a line of
business model during the first quarter of 2007. The major lines
of business are Commercial, Retail, Wealth and Other.
Note 15 (Segment Information) to the consolidated financial
statements provides performance data for these lines of business.
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AVERAGE
CONSOLIDATED BALANCE SHEETS (Unaudited)
Fully Tax-equivalent Interest Rates and Interest Differential
FIRSTMERIT
CORPORATION AND SUBSIDIARIES
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RESULTS
OF OPERATIONS
Net interest income, the Corporation’s principal source of
earnings, is the difference between interest income generated by
earning assets (primarily loans and investment securities) and
interest paid on interest-bearing funds (namely customer
deposits and wholesale borrowings). Net interest income is
affected by market interest rates on both earning assets and
interest bearing liabilities, the level of earning assets being
funded by interest bearing liabilities, noninterest-bearing
liabilities, the mix of funding between interest bearing
liabilities, noninterest-bearing liabilities and equity, and the
growth in earning assets.
Net interest income for the year ended December 31, 2009
was $348.8 million compared to $356.2 million for year
ended December 31, 2008 and $337.5 million for the
year ended December 31, 2007. The $7.4 million
decrease in net interest income occurred because the
$94.3 million decrease in interest income was more than the
$86.9 million decrease in interest expense during the same
period. For the purpose of this remaining discussion, net
interest income is presented on a FTE basis, to provide a
comparison among all types of interest earning assets. That is,
interest on tax-free securities and tax-exempt loans has been
restated as if such interest were taxed at the statutory Federal
income tax rate of 35% adjusted for the non-deductible portion
of interest expense incurred to acquire the tax-free assets. Net
interest income presented on a FTE basis is a non-GAAP financial
measure widely used by financial services corporations. The FTE
adjustment for full year 2009 was $6.9 million compared
with $6.0 million in 2008 and $5.5 million in 2007.
Net interest income presented on an FTE basis decreased
$6.5 million or 1.80% to $355.6 million in 2009
compared to $362.2 million in 2008 and $343.0 million
in 2007. The decrease from 2008 to 2009 occurred because the
$93.4 million decrease in interest income was more than the
$86.9 million decrease in interest expense during same
period. The $19.1 million increase from 2008 to 2007
occurred because the $101.8 million decrease in interest
expense was more than the $82.7 million decrease in
interest income during same period. As illustrated in the
following rate/volume analysis table, interest income and
interest expense both decreased due to the decline in interest
rates throughout the year.
The average yield on earning assets decreased 105 basis
points from 5.75% in 2008 to 4.70% in 2009 decreasing interest
income by $102.0 million. Higher outstanding balances on
total average earning assets in 2009 caused interest income to
increase $8.6 million from year-ago levels. Average
balances for investment securities were up from last year
increasing interest income by $12.0 million, and lower
rates earned on the securities decreased interest income by
$9.5 million. Average loans outstanding, down from last
year, decreased 2009 interest income by $3.4 million and
lower yields earned on the loans, decreased 2009 loan interest
income by $92.5 million. Similarly, the average yield on
earning assets decreased 103 basis points from 6.78% in
2007 to 5.75% in 2008 decreasing interest income by
$100.6 million. Higher outstanding balances on total
average earning assets in 2008 caused interest income to
increase $16.9 million from 2007 levels. At
December 31, 2008 average balances for investment
securities were up from the 2007 year increased interest
income by $2.5 million, and higher rates earned on the
securities also increased interest income by $2.7 million.
Average loans outstanding, up from 2007 year, increased
2008 interest income by $16.9 million while lower yields
earned on the loans also decreased 2008 loan interest
$103.4 million.
The cost of funds for the year as a percentage of average
earning assets decreased 91 basis points from 2.03% in 2008
to 1.12% in 2009. The cost of funds for the year as a percentage
of average earning assets decreased 113 basis points from
3.16% in 2007 to 2.03% in 2008. As discussed in the deposits and
wholesale borrowings section of management’s discussion and
analysis of financial condition and operating results, the drop
in interest rates was the primary factor in this decrease.
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CHANGES
IN NET INTEREST INCOME- FULLY TAX-EQUIVALENT RATE/VOLUME
ANALYSIS
The net interest margin is calculated by dividing net interest
income FTE by average earning assets. As with net interest
income, the net interest margin is affected by the level and mix
of earning assets, the proportion of earning assets funded by
non-interest bearing liabilities, and the interest rate spread.
In addition, the net interest margin is impacted by changes in
federal income tax rates and regulations as they affect the
tax-equivalent adjustment.
As discussed in the previous section, the decrease in the net
interest margin during 2009 was a result of lack of loan demand
and lower interest rates. The increase in 2008 over 2007 was
primarily a result of the drop in interest rates and the
increase in core deposits.
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Excluding investment securities gains, other income totaled
$204.3 million in 2009 an increase of $5.0 million or
2.49% from 2008 and an increase of $8.5 million or 4.32%
from 2007. Other income as a percentage of net revenue (FTE net
interest income plus other income, less gains from securities)
was 36.48% compared to 35.50% in 2008. Explanations for the most
significant changes in the components of other income are
discussed immediately after the following table.
Trust department income decreased by 6.53%, down
$1.4 million in 2009 after an increase of 4.81%, or
$1.1 million in 2008 over 2007. Service charges on deposits
increased by $0.5 million or 0.80% in 2009, and were down
$4.5 million or 6.70% in 2008 versus 2007. The decrease in
service charges on deposits during both years is due primarily
to changes in customer behavior whereby they maintain higher
balances in order to avoid being charged fees as well as new
product initiatives that do not charge fees. Credit card fees
decreased $0.5 million or 1.15% in 2009, and
$0.6 million or 1.19% in 2008 over 2007 primarily due to
decreasing volumes. ATM and other service charge fees have
increased $0.2 million or 1.98% in 2009; this increase was
volume driven. Bank owned life insurance income increased
$1.7 million or 14.42% compared to 2008 which was up
primarily due to death proceeds. Investment services and
insurance income decreased $0.5 million in 2009 after a
decrease of $0.7 in 2008 over 2007. During 2009, investment
securities were sold for a gain of $3.9 million up 183.96%
from 2008. Loan sales and servicing income increased
$6.0 million or 86.66% in 2009 after a decrease of
$3.4 million or 32.69% in 2008 over 2007. This increase was
primarily attributable to mortgage modifications. During the
first quarter of 2009, the Corporation recorded
$9.5 million due to the curtailment of the postretirement
medical plan for active employees. During the fourth quarter of
2008, the Corporation recorded $5.8 million from the sale
of Class B Visa, Inc stock. This followed a
$7.9 million gain from the partial redemption of the shares
in the first quarter of 2008. During the first quarter of 2007
$4.1 million of net gains were recorded from the commercial
loan sale more fully described in the Asset Quality section of
this report.
Federal income tax expense totaled $25.6 million in 2009
compared to $48.9 million in 2008 and $50.4 million in
2007. The effective federal income tax rate for the year ended
December 31, 2009 was 23.79%, compared to 29.04% and 29.05%
for the year ended December 31, 2008 and 2007,
respectively. Tax reserves have been specifically estimated for
potential at-risk items in accordance with ASC 740, Income
Taxes. Further federal income tax information is contained
in Note 11 (Federal Income Taxes) to the consolidated
financial statements.
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Other expenses were $352.8 million in 2009 compared to
$330.6 million in 2008 and $330.2 million in 2007, an
increase of $22.2 million or 6.71% over 2008 and an
increase of $22.6 million or 6.84% over 2007.
Salaries and wages were $132.6 million in 2009, a decrease
of $0.4 million or 0.34% over 2008. There was an increase
in salaries and wages in from 2007 to 2008 of $6.4 million
or 5.05%. Increases generally reflect the annual employee merit
increases which were offset by decrease in headcount. Pension
and employee benefits were $43.3 million in 2009, a
decrease of $3.1 million or 6.70% from 2008, primarily due
to the reduction in the ongoing expense resulting from the
curtailment of the postretirement medical plan for active
employees. Note 12 (Benefit Plans) to the consolidated
financial statements more fully describes the changes in pension
and postretirement medical expenses. Professional services
expenses increased $4.7 million or 40.35% in 2009 over 2008
due in part to an increase in acquisition due diligence
activity. During 2008, the economic environment caused higher
levels of bank failures which dramatically increased FDIC
resolution costs. The FDIC significantly increased assessments
during 2009 which resulted in additional FDIC insurance expense
of $15.2 million over 2008 which is recorded in other
operating expense.
Also included in other expense is $3.9 million related to
the discontinuation of hedge accounting for a portfolio of
interest rate swaps associated with fixed-rate commercial loans.
In December 2009, the Corporation corrected an error in hedge
accounting for a portfolio of interest rate swaps associated
with fixed-rate commercial loans recorded in prior periods. The
Corporation assessed the materiality of the error in accordance
with Staff Accounting Bulletin (“SAB”) No. 108
and concluded the error was not material, either individually or
in the aggregate, to the results of operations of any prior
period or for the year ending December 31, 2009, to trends
for those periods affected, or to a fair presentation of the
Corporation’s financial statements for those periods.
Accordingly, results for prior periods have not been restated.
Instead, the Corporation increased other expenses and reduced
the commercial loans balance by $3.9 million to correct
this error in the fourth quarter. In addition, this portfolio of
interest rate swaps was terminated in January 2010.
The efficiency ratio for 2009 was 62.95%, compared to 58.78% in
2008 and 61.12% in 2007. The “lower is better”
efficiency ratio indicates the percentage of operating costs
that are used to generate each dollar of net revenue —
that is during 2009, 62.95 cents were spent to generate each $1
of net revenue. Net revenue is defined as net interest income,
on a tax-equivalent basis, plus other income less gains from the
sales of securities.
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FINANCIAL
CONDITION
At December 31, 2009, the securities portfolio totaled
$2.7 billion; $50.7 million of that amount was
held-to-maturity
securities and the remainder was securities
available-for-sale.
In comparison, as of December 31, 2008, the total portfolio
was $2.8 billion, including $30.3 million of
held-to-maturity
securities and $2.6 billion of securities
available-for-sale.
Available-for-sale
securities are held primarily for liquidity, interest rate risk
management and long-term yield enhancement. Accordingly, the
Corporation’s investment policy is to invest in securities
with low credit risk, such as U.S. Treasury securities,
U.S. Government agency obligations, state and political
obligations and mortgage-backed securities (“MBSs”).
Held-to-maturity
securities consist principally of securities issued by state and
political subdivisions. Other investments include Federal Home
Loan Bank (“FHLB”) and Federal Reserve Bank
(“FRB”) stock.
Net unrealized gains were $55.1 million at
December 31, 2009, compared to $1.2 million at
December 31, 2008. The improvement in the fair value of the
investment securities is driven by government agency securities
held in portfolio.
The Corporation conducts a regular assessment of its investment
securities to determine whether any securities are
other-than-temporary
impaired. Only the credit portion of
other-than-temporary
impairment (“OTTI”) is to be recognized in current
earnings for those securities where there is no intent to sell
or it is more likely than not the Corporation would not be
required to sell the security prior to expected recovery. The
remaining portion of OTTI is to be included in accumulated other
comprehensive loss, net of income tax.
Gross unrealized losses of $21.6 million as of
December 31, 2009, compared to $38.3 million at
December 31, 2008 were concentrated within trust preferred
securities held in portfolio. The Corporation holds eight,
single issuer, trust preferred securities. Such investments are
less than 2% of the fair value of the entire investment
portfolio. None of the bank issuers have deferred paying
dividends on their issued trust preferred shares in which the
Corporation is invested. The fair values of these investments
have been impacted by market conditions which have caused risk
premiums to increase markedly resulting in the decline in the
fair value of the Corporation’s trust preferred securities.
Further detail of the composition of the securities portfolio
and discussion of the results of the most recent OTTI assessment
are in Note 3 (Investment Securities) to the consolidated
financial statements.
Loans
Total loans outstanding at year-end 2009 decreased 6.76% to
$6.9 billion compared to one year ago, at $7.4 billion.
The following tables breakdown outstanding loans by category and
provide a maturity summary of commercial loans.
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Consistent with the slowdown of the manufacturing-based economy
in Northeast Ohio commercial loans decreased 6.58% in 2009 but
increased 11.42% in 2008. The 2009 decrease was partially
mitigated by the ABL Loans acquired from First Bank Business
Capital, Inc. Single-family mortgage loans continue to be
originated by the Corporation’s mortgage subsidiary and
then sold into the secondary mortgage market or held in
portfolio. Low interest rates during 2009 resulted in an
increase in mortgage loan originations; however, due to the
downturn in the housing market there was an overall decrease of
15.30% in balances retained in portfolio.
Outstanding home equity loan balances increased
$19.3 million or 2.63% from December 31, 2008 and
installment loans decreased $149.2 million or 9.48%
reflecting the on-going economic downturn. Credit card loans
were up $3.8 million or 2.52% from December 31, 2008.
There is no predominant concentration of loans in any particular
industry or group of industries. Most of the Corporation’s
business activity is with customers located within the state of
Ohio.
The Corporation maintains what Management believes is an
adequate allowance for loan losses. The Corporation and
FirstMerit Bank regularly analyze the adequacy of their
allowance through ongoing review of trends in risk ratings,
delinquencies, nonperforming assets, charge-offs, economic
conditions, and changes in the composition of the loan
portfolio. Notes 1 and 4 to the consolidated financial
statements provide detailed information regarding the
Corporation’s credit policies and practices.
The Corporation uses a vendor based loss migration model to
forecast losses for commercial loans. The model creates loss
estimates using twelve-month (monthly rolling) vintages and
calculates cumulative three years loss rates within two
different scenarios. One scenario uses five year historical
performance data while the other one uses two year historical
data. The calculated rate is the average cumulative expected
loss of the two and five year data set. As a result, this
approach lends more weight to the more recent performance and
would be more conservative.
The uncertain economic conditions in which we are currently
operating have resulted in risks that differ from our historical
loss experience. Accordingly, Management deemed it appropriate
and prudent to apply qualitative factors (“q-factors”)
and assign additional reserves. These q-factors are supported by
judgments made by experienced credit risk management personnel
and represent risk associated with the portfolio given the
uncertainty and the inherent imprecision of estimating future
losses.
At December 31, 2009 the allowance for loan losses was
$115.1 million or 1.68% of loans outstanding, compared to
$103.8 million or 1.40% at year-end 2008. The allowance
equaled 125.55% of nonperforming loans at year-end 2009 compared
to 198.76% at year-end 2008. During 2008 additional reserves
were established to address identified risks associated with the
slow down in the housing markets and the decline in residential
and commercial real estate values. These reserves totaled
$19.1 million at year-end 2009 and $18.3 million at
year-end 2008. The increase in the
28
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additional allocation augmented the increase in the calculated
loss migration analysis as the loans were downgraded during
2009. Nonperforming loans have increased by $43.4 million
over December 31, 2008 primarily attributable to the
declining economic conditions.
As required by current accounting guidance, the acquired ABL
loans from FBBC were recorded at fair value as of the date of
acquisition, with no carryover of related allowances. The
determination of the fair value of the ABL loans resulted in a
write-down in the value of the loans, which was assigned to an
accretable balance with the accretable balance being recognized
as interest income over the remaining term of the loan. Because
acquired loans are required to be accounted for at fair value on
the date of acquisition, Management believes that asset quality
measures excluding the acquired ABL loans are generally more
meaningful. Therefore, the asset quality ratios included herein
exclude these acquired ABL loans.
Net charge-offs were $87.1 million in 2009 compared to
$49.1 million in 2008 and $28.0 million (including the
loans held for sale) in 2007. As a percentage of average loans
outstanding, net charge-offs and allowance for loans held for
sale equaled 1.22% in 2009, 0.68% in 2008 and 0.40% in 2007.
Losses are charged against the allowance for loan losses as soon
as they are identified.
The allowance for unfunded lending commitments at
December 31, 2009, 2008 and 2007 was $5.8 million,
$6.6 million and $7.4 million, respectively. The
allowance for credit losses, which includes both the allowance
for loan losses and the reserve for unfunded lending
commitments, amounted to $120.8 million at year-end 2009,
$110.3 million at year-end 2008 and $101.6 million at
year-end 2007.
Allowance
for Credit Losses
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The following tables display the components of the allowance for
loan losses at December 31, 2009, 2008 and 2007.
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31
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32
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A five-year summary of activity follows:
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Asset
Quality
Making a loan to earn an interest spread inherently includes
taking the risk of not being repaid. Successful management of
credit risk requires making good underwriting decisions,
carefully administering the loan portfolio and diligently
collecting delinquent accounts.
The Corporation’s Credit Policy Division manages credit
risk by establishing common credit policies for its
subsidiaries, participating in approval of their largest loans,
conducting reviews of their loan portfolios, providing them with
centralized consumer underwriting, collections and loan
operations services, and overseeing their loan workouts.
Notes 1 and 4 to the consolidated financial statements,
provide detailed information regarding the Corporation’s
credit policies and practices.
The Corporation’s objective is to minimize losses from its
commercial lending activities and to maintain consumer losses at
acceptable levels that are stable and consistent with growth and
profitability objectives.
Nonperforming Loans are defined as follows:
Nonperforming Assets are defined as follows:
During 2009 the economic conditions in our markets continued to
be challenging. Residential developers and homebuilders have
been the most adversely affected, with the significant decrease
of buyer resulting from a combination of the restriction of
available credit and economic pressure impacting the consumer.
The Corporation executed a comprehensive review of pass grade
commercial loans (greater than $250 thousand) corporate-wide
utilizing a more conservative interpretation of defined
weakness. The review, coordinated by Loan Review, resulted in
covering over 71% of the commercial portfolio. Consumers
continue to be under pressure due to high debt levels, limited
refinance opportunities, increased cost of living and increasing
unemployment. These conditions have resulted in increases in
bankruptcies as well as charge offs. Commercial nonperforming
loans increased $33.8 million while criticized loans
increased $73.2 million from December 31, 2008.
During the first quarter of 2007, $73.7 million of
commercial loans and $7.1 million of other real estate were
sold. The loans were written down to their fair market value of
$50.6 million and reclassified as loans held for sale in
the fourth quarter of 2006. (Of the loans identified as held for
sale, $41.1 million were classified as nonperforming and
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$32.6 million were performing.) The loan sale yielded a
gain of $4.1 million which was recorded in loan sales and
servicing during the first quarter of 2007. The sale of other
real estate resulted in a $0.5 million loss and was
recorded in other operating loss also during the first quarter
of 2007.
In 2009 nonperforming assets, other real estate includes
$1.0 million of vacant land no longer considered for branch
expansion and in 2008 other real estate includes
$1.1 million of vacant land no longer considered for branch
expansion and executive relocation properties both of which are
not related to loan portfolios.
During 2009 and 2008, total nonperforming loans earned $51.8
thousand and $36.7 thousand, respectively, in interest income.
Had they been paid in accordance with the payment terms in force
prior to being considered impaired, on nonaccrual status, or
restructured, they would have earned $5.5 million and
$2.7 million in interest income for the years ended
December 31, 2009 and 2008, respectively.
In addition to nonperforming loans and loans 90 day past
due and still accruing interest, Management identified potential
problem commercial loans (classified as substandard and
doubtful) totaling $260.1 million at year-end 2009 and
$194.4 million at year-end 2008. These loans are closely
monitored for any further deterioration in the borrowers’
financial condition and for the borrowers’ ability to
comply with terms of the loans.
Nonaccrual commercial loans have increased $33.8 million
since December 31, 2008.
Deposits,
Securities Sold Under Agreements to Repurchase and Wholesale
Borrowings
Average deposits for 2009 totaled $7.5 billion compared to
$7.4 billion in 2008. Increases in non-interest bearing and
interest bearing demand accounts reflect a shift in customer
preference for liquidity.
The following ratios and table provide additional information
about the change in the mix of customer deposits.
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Total average demand deposits comprised 34.18% of average
deposits in 2009 compared to 29.89% in 2008 and 28.74% in 2007.
Savings accounts, including money market products, made up
38.44% of average deposits in 2009 compared to 32.34% in 2008
and 30.40% in 2007. CDs made up 27.38% of average deposits in
2009, 37.77% in 2008 and 40.86% in 2007.
The average cost of deposits, securities sold under agreements
to repurchase and wholesale borrowings was down 104 basis
points compared to one year ago, or 1.46% in 2009 due to a drop
in interest rates and the disruption in the capital markets.
The following table summarizes CDs in amounts of $100 thousand
or more as of year-end 2009, by time remaining until maturity.
Capital
Resources
The capital management objectives of the Corporation are to
provide capital sufficient to cover the risks inherent in the
Corporation’s businesses, to maintain excess capital to
well-capitalized standards and to assure ready access to the
capital markets.
Shareholder’s
Equity
Shareholders’ equity was $1,065.6 million at
December 31, 2009, compared with $937.8 million at
December 31, 2008. As of December 31, 2009, the annual
common share dividend was $0.77. The market price ranges of the
Corporation’s common shares, and dividends by quarter for
each of the last two years is shown in Item 5, Market For
Registrant’s Common Equity And Related Stockholder Matters
And Issuer Purchases Of Equity Securities of this Report.
Capital
Availability
On January 9, 2009, the Corporation completed the sale to
the United States Department of the Treasury (the
“Treasury”) of $125.0 million of newly issued
FirstMerit non-voting preferred shares as part of the
Treasury’s Troubled Assets Relief Program
(“TARP”) Capital Purchase Program (“CPP”).
FirstMerit issued and sold to the Treasury for an aggregate
purchase price of $125.0 million in cash
(1) 125,000 shares of FirstMerit’s Fixed Rate
Cumulative Perpetual Preferred Shares, Series A, each
without par value and having a liquidation preference of $1,000
per share, and (2) a warrant to purchase 952,260 FirstMerit
common shares, each without par value, at an exercise price of
$19.69 per share.
On April 22, 2009, the Corporation repurchased all
125,000 shares of its Fixed Rate Cumulative Perpetual
Preferred Stock, Series A for $126.2 million which
included all accrued and unpaid dividends as well as the
unamortized discount on the preferred stock.
On May 27, 2009, the Corporation completed the repurchase
of the warrant held by the Treasury. The Corporation paid
$5.0 million to the Treasury to repurchase the warrant.
On May 6, 2009, the Corporation entered into a Distribution
Agency Agreement with Credit Suisse Securities (USA) LLC
(“Credit Suisse”) pursuant to which the Corporation,
from time to time, may offer and sell shares of the
Corporation’s common stock. Sales of the common stock are
made by means of ordinary brokers’ transactions on the
Nasdaq Global Select Market at market prices, in block
transactions, or as otherwise agreed with Credit Suisse. At
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December 31, 2009, the Corporation had sold
4.3 million shares with an average value of $18.98 per
share and has authorization to raise an additional
$19.0 million through this program.
Capital
Adequacy
Capital adequacy is an important indicator of financial
stability and performance. The Corporation maintained a strong
capital position as tangible common equity to assets was 8.89%
at December 31, 2009, compared with 7.27% at
December 31, 2008.
Financial institutions are subject to a strict uniform system of
capital-based regulations. Under this system, there are five
different categories of capitalization, with “prompt
corrective actions” and significant operational
restrictions imposed on institutions that are capital deficient
under the categories. The five categories are: well capitalized,
adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized.
To be considered well capitalized an institution must have a
total risk-based capital ratio of at least 10%, a Tier I
capital ratio of at least 6%, a leverage capital ratio of at
least 5%, and must not be subject to any order or directive
requiring the institution to improve its capital level. An
adequately capitalized institution has a total risk-based
capital ratio of at least 8%, a Tier I capital ratio of at
least 4% and a leverage capital ratio of at least 4%.
Institutions with lower capital levels are deemed to be
undercapitalized, significantly undercapitalized or critically
undercapitalized, depending on their actual capital levels. The
appropriate federal regulatory agency may also downgrade an
institution to the next lower capital category upon a
determination that the institution is in an unsafe or unsound
practice. Institutions are required to monitor closely their
capital levels and to notify their appropriate regulatory agency
of any basis for a change in capital category. At year-end 2009
the Corporation, on a consolidated basis, as well as FirstMerit
Bank, exceeded the minimum capital levels of the well
capitalized category.
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RISK
MANAGEMENT
Market
Risk Management
Market risk refers to potential losses arising from changes in
interest rates, foreign exchange rates, equity prices and
commodity prices, including the correlation among these factors
and their volatility. When the value of an instrument is tied to
such external factors, the holder faces “market risk.”
The Corporation is primarily exposed to interest rate risk as a
result of offering a wide array of financial products to its
customers.
Interest
rate risk management
Changes in market interest rates may result in changes in the
fair market value of the Corporation’s financial
instruments, cash flows, and net interest income. The
Corporation seeks to achieve consistent growth in net interest
income and capital while managing volatility arising from shifts
in market interest rates. The Asset and Liability Committee
(“ALCO”) oversees market risk management, establishing
risk measures, limits, and policy guidelines for managing the
amount of interest rate risk and its effect on net interest
income and capital. According to these policies, responsibility
for measuring and the management of interest rate risk resides
in the Corporate Treasury function.
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