ITEM 1. BUSINESS
Registrant, FirstMerit Corporation ("FirstMerit" or the "Corporation"), is a multi-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 executive offices of FirstMerit are located in Akron, Ohio.
FirstMerit is the sole shareholder of each of the following entities: First National Bank of Ohio, a national banking association, Akron, Ohio ("First National"), The Old Phoenix National Bank of Medina, a national banking association, Medina, Ohio ("Old Phoenix"), EST National Bank, a national banking association, Elyria, Ohio ("EST"), Peoples National Bank, a national banking association, Wooster, Ohio ("Peoples Bank"), Citizens National Bank, a national banking association, Canton, Ohio ("Citizens"), Peoples Bank, N.A., Ashtabula, Ohio, a national banking association, Ashtabula, Ohio ("Peoples N.A."), (collectively, the "Banks"), FirstMerit Credit Life Insurance Company, an Arizona corporation ("FirstMerit Insurance"), FirstMerit Community Development Corporation ("FirstMerit CDC"), Citizens Investment Corporation, an Ohio corporation, and Citizens Savings Corporation of Stark County, an Ohio corporation (all, collectively, the "Subsidiaries").
FirstMerit is in the process of merging the Banks under a single charter. It is currently contemplated that this process will be completed in 1998. The resulting institution will be First National.
In 1996, FirstMerit Trust Company, N.A., a national trust company, Naples, Florida ("FirstMerit Trust"), expanded its charter and converted from a national trust company to a national bank. Subsequently, FirstMerit Bank, FSB, a federal savings association, Clearwater, Florida ("FirstMerit FSB"), was merged with FirstMerit Trust under the name FirstMerit Bank, N.A. On December 31, 1996, FirstMerit Bank N.A. was sold to the SouthTrust Corporation of Birmingham, Alabama.
Although principally a regional banking organization, FirstMerit through the Subsidiaries provides a wide range of banking, fiduciary, financial and investment services to corporate, institutional and individual customers throughout northern Ohio, including Ashtabula, Cuyahoga, Erie, Geauga, Lake, Lorain, Medina, Portage, Stark, Summit and Wayne Counties. FirstMerit directs the overall policies, including lending practices, and financial resources of the Subsidiaries, but most day-to-day affairs of Subsidiaries are managed by their own officers and directors, some of whom are also officers and directors of FirstMerit. In addition to the customary services of accepting funds for deposit and making loans, the Banks provide a wide range of specialized services tailored to specific markets, including personal and corporate trust services, personal financial services, cash management services and international banking services. FirstMerit's non-banking direct and indirect subsidiaries provide insurance sales services, reinsurance of credit life and accident and health insurance on loans made by the Banks, securities brokerage services, personal property and equipment lease financing and other financial services. FirstMerit has recently reactivated the health and life insurance license of one of its indirect subsidiaries.
At February 1, 1997, FirstMerit's Subsidiaries operated 128 full service banking offices, and had 161 automated teller machines, located in 11 counties in the State of Ohio, and employed approximately 2,330 full- and part-time employees.
Presented in the following schedule is further specific information concerning each of the financial institution Subsidiaries of FirstMerit as of February 1, 1997:
SUBSIDIARY OPERATIONS
Each Bank is engaged in commercial banking in its respective geographical market. Commercial banking includes the acceptance of demand, savings and time deposits and the granting of commercial and consumer loans for the financing of both real and personal property. Other services include automated banking programs, credit cards, the rental of safe deposit boxes, letters of credit, leasing, discount brokerage and credit life insurance. The Banks also operate trust departments which offer estate and trust services. Each Bank offers its services primarily to consumers and small and medium size businesses in its respective geographic market. None of the Banks are engaged in lending outside the continental United States. None of the Banks are dependent upon any one significant customer or a specific industry.
FirstMerit Insurance was formed in 1985 to engage in underwriting of credit life and credit accident and health insurance directly related to the extension of credit by the Banks to their customers.
FirstMerit CDC was established in 1994 to further the efforts of FirstMerit's Subsidiaries in meeting the credit needs of their lending communities, and the requirements of the Community Reinvestment Act ("CRA"). Congress enacted CRA to assure that banks and savings associations meet the deposit and credit needs of their communities. Through a community development corporation, financial institutions can meet these needs by non-traditional activities such as acquiring, rehabilitating, or investing in real estate in low to moderate income neighborhoods, and promoting the development of small business.
The Banks in 1995 jointly organized and capitalized FirstMerit Mortgage Corporation ("FirstMerit Mortgage"), which is located in Canton, Ohio, in offices owned by Citizens. FirstMerit Mortgage is engaged in the business of originating residential mortgage loans and providing mortgage loan servicing for itself, the Banks and third parties.
First National is the parent corporation of two wholly-owned Ohio corporations organized in 1993, FirstMerit Leasing Company ("FirstMerit Leasing") and FirstMerit Securities, Inc. ("FirstMerit Securities"). FirstMerit Leasing primarily provides equipment lease financing and related services, while FirstMerit Securities primarily provides discount brokerage services to customers of First National and other Subsidiaries.
ACQUISITIONS
FirstMerit engages on a regular basis in discussions concerning possible acquisitions of other financial institutions. During 1995, FirstMerit acquired control of Citizens Savings Bank of Canton, an Ohio savings association with its principal offices in Canton, Ohio ("Citizens Savings"). FirstMerit acquired Citizens Savings through the merger of The CIVISTA Corporation, the sole shareholder of Citizens Savings ("CIVISTA"), with and into FirstMerit in exchange for approximately 6,513,119 shares of FirstMerit common stock. FirstMerit then immediately effected a merger of Citizens Savings into The First National Bank in Massillon, a national bank subsidiary of FirstMerit, to form a new national bank subsidiary called Citizens National Bank, with its principal offices in Canton, Ohio.
When FirstMerit acquired control of Citizens Savings through the merger with CIVISTA, it also acquired control of certain other wholly-owned subsidiaries of CIVISTA, including Citizens Savings Corporation of Stark County ("CSC") and Citizens Investment Corporation ("CIC").
Although FirstMerit is in the process of selling all assets, winding up the affairs, and formally dissolving CSC, it still owns a large portion of an office condominium in Stark County, and certain low to moderate income housing units. CIC owns and has participated in the development of residential real estate in La Quinta, California. FirstMerit also is in the process of selling all assets, winding up the affairs, and formally dissolving CIC.
COMPETITION
The financial services industry is 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. The Subsidiaries' primary financial institution competitors include Bank One, National City Bank, KeyBank, Star Bank and The Fifth Third Bank. Mergers between financial institutions within Ohio and in neighboring states have added competitive pressure, which pressure has intensified due to interstate banking which became permissible under the Interstate Banking and Branching Efficiency Act of 1994. FirstMerit competes in its markets by offering quality and innovative services at competitive prices.
REGULATION AND SUPERVISION
FirstMerit is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended ("BHCA"). Bank holding companies are subject to regulation by the Federal Reserve. Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support such subsidiary banks. The BHCA requires the prior approval of the Federal Reserve in any case where a bank holding company proposes to acquire direct or indirect ownership or control of more than five percent (5%) of the voting shares of any bank that is not already majority-owned by it, or to merge or consolidate with any other bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than five percent of the voting shares of any company that is not a bank and from engaging in any business other than banking or managing or controlling banks. Under the BHCA, the Federal Reserve is authorized to approve the ownership of shares by a bank holding company in any company the activities of which the Federal Reserve has determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. The Federal Reserve has by regulation determined that certain activities are closely related to banking within the meaning of the BHCA. These activities include: operating a savings association, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing investment and financial advice; and acting as an insurance agent for certain types of credit-related insurance.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to the bank holding company or any of its subsidiaries, on investments in the stock or other securities of the bank holding company or its subsidiaries and on the taking of such stock or securities as collateral for loans to any borrower. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of any services.
FirstMerit is also under the jurisdiction of the Securities and Exchange Commission and certain state securities commissions for matters relating to the offering and sale of its securities. FirstMerit is subject to the 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 Commission.
On September 29, 1994, President Clinton signed the Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act"). The Interstate Act generally permits nationwide interstate banking and branching commencing one year after enactment. After that time an "adequately capitalized" and "well managed" bank holding company may acquire a bank in any state, subject to certain concentration limitations. No banking organization may control more than ten percent of deposits nationwide or more than 30.0% of deposits in any one state. Individual states may waive the 30.0% limitation. Beginning June 1, 1997, interstate bank holding
companies may consolidate banks they own in multiple states into a single branch network, or acquire out-of-state banks as branches. States may authorize interstate branching earlier than June 1, 1997, or may opt out of the process altogether. De novo interstate branching is not authorized by the Interstate Act, but states may specifically authorize it. States may also limit the acquisition of newly-formed banks for a period of up to five years to restrict effective de novo branching. The Interstate Act requires CRA compliance by out-of-state branches and prohibits "deposit production offices" to ensure that local savings are not diverted to other states. Institutions must maintain a loan activity-to-deposit ratio within a host state at least equal to one-half of the average percentage for all banks in the host state, otherwise the institution's federal regulator may close the out-of-state branch and restrict the institution from opening new branches in that state. Certain state laws, such as those on intrastate branching, consumer protection and fair lending, will still apply to out-of-state banks or branches. The Interstate Act is expected to stimulate an already active merger environment in the banking industry.
SUMMARY RESULTS OF OPERATIONS
As of December 31, 1996, FirstMerit's consolidated total assets were $5,227,980,000. Earnings for FirstMerit in 1996 were $70,940,000, or $2.18 per share, compared with $31,318,000, or $0.94 per share, for the year ended December 31, 1995. The earnings reported for 1996 were impacted by the Savings Association Insurance Fund (SAIF) recapitalization charge of $6,652,000, recorded September 30, 1996. Excluding the SAIF charge, earnings were $77,592,000, or $2.38 per share. As reported last year, net income for 1995 included expenses of $2,198,000 related to an early retirement program, costs of $16,214,000 associated with the acquisition of The CIVISTA Corporation ("CIVISTA"), $11,596,000 of re-engineering charges and an extraordinary gain of $5,599,000 from the sale of several apartment complexes formerly owned by a subsidiary of CIVISTA. Excluding the unusual charges in 1995, earnings would have been $61,326,000, or $1.83 per share. Total cash dividends paid to shareholders for the entire year were $1.10, an increase of $0.08 per share over the previously stated annual payments of $1.02.
On a fully-tax equivalent basis, net interest income was $254,015,000, up 6% from last year. The improved net interest margin of 4.98% compared to 4.56% in 1995 was primarily responsible for the rise in net interest income. Other income for the year was $82,496,000, an increase of $13,979,000 or 20% over the prior year. Included in 1996 other income were net proceeds of $13,210,000 from sales of affiliate branches and $490,000 from the sale of FirstMerit Bank, N.A. in Clearwater, Florida. Higher trust income, service charges on depositors' accounts, and credit card fees also contributed to the improvement in other income. Other expenses were $209,702,000 compared to $227,779,000 in 1995. Included in the 1996 figure is the previously mentioned pre-tax SAIF assessment of $10,235,000. Other expenses for 1995 included portions of the early retirement, CIVISTA acquisition, and re-engineering charges totaling $22,404,000 on a pre-tax basis.
During 1996, the Corporation recorded a provision for possible loan losses of $17,751,000, a ten percent reduction from last year's provision of $19,763,000. The provisions in both years address the continuing shift in FirstMerit's loan portfolio from residential mortgages into commercial and consumer loans, which historically have higher loss rates. Nonperforming assets were 0.29% of total loans and other real estate compared to 0.37% one year ago. The allowance for loan losses as a percentage of outstanding loans was 1.35% at December 31, 1996 and 1.24% at December 31, 1995.
ITEM 2.
ITEM 2. PROPERTIES
FIRSTMERIT CORPORATION
FirstMerit's executive offices and certain holding company operational facilities, totaling 88,546 square feet, are leased from First National. FirstMerit relocated its executive offices in 1994 to III Cascade, a seven-story office building located in downtown Akron, Ohio. During 1993, a long-term leasehold interest in III Cascade was acquired by an Ohio general partnership (the "Partnership"), the general partners of which are FirstMerit and a Delaware corporation subsidiary of Banc One Capital Corporation. FirstMerit does not control the Partnership. The City of Akron is the lessor of the property. First National has subleased all of the premises of III Cascade from the Partnership, and FirstMerit subleases a portion of the premises from First National.
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.
FIRST NATIONAL BANK OF OHIO
The principal executive offices of First National are located in its 28-story main office building located at 106 South Main Street, Akron, Ohio, which is owned by First National. First National is the principal tenant of the building occupying approximately one-half of a total of 215,000 square feet of the building, with the remaining portion leased to tenants unrelated to First National. The properties occupied by 30 of First National's other branches are owned by First National, while the properties occupied by its remaining 27 branches are leased with various expiration dates. There is no mortgage debt owing on any of the above property owned by First National. First National also owns automated teller machines, on-line teller terminals and other computers and related equipment for use in its business. In 1996 First National completed major renovations to its main office building. First National renovated all space which it occupies in the building, as well as all public areas.
First National also owns 19.5 acres near downtown Akron, on which is located FirstMerit's Operations Center. The Operations Center is occupied and operated by FirstMerit Services Division, an operating division of FirstMerit. The Operations Center primarily provides computer and communications technology-based services to FirstMerit and the 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.
The Trust Department of First National is located in Main Place, a four-story office building located in downtown Akron. The Trust Department occupies 29,099 square feet of leased space in Main Place.
THE OLD PHOENIX NATIONAL BANK OF MEDINA
The principal executive offices of Old Phoenix are located in its main office building at 39 Public Square, Medina, Ohio. The building which houses its executive offices is leased by Old Phoenix. The properties occupied by five of Old Phoenix's branches are owned by Old Phoenix, while the properties occupied by its remaining nine branches are the subject of various lease obligations having various expiration dates. These facilities are leased from IRT Properties, a publicly-held real estate investment trust. Old Phoenix also owns automated teller machines, on-line teller terminals and other related equipment. The computer operations of Old Phoenix are provided through FirstMerit.
EST NATIONAL BANK
The principal executive offices of EST are located in its main office building at 105 Court Street, Elyria, Ohio, which is owned by EST. EST occupies approximately one-half of the total available space in the building. EST owns the land and buildings occupied by 13 of its banking offices. The remaining five banking offices are the subject of lease obligations with various lessors and varying lease terms and expiration dates. EST also has automated teller machines and on-line teller terminals. The computer operations of EST are provided through FirstMerit.
PEOPLES NATIONAL BANK
The principal executive offices of Peoples Bank are located in its main office building at 121 North Market Street, Wooster, Ohio, which is owned by Peoples Bank. The properties occupied by two of Peoples Bank branches are owned by Peoples Bank, while the properties occupied by its remaining two branches are leased at various expiration dates. No mortgage debt exists on the above property owned by Peoples Bank. Peoples Bank also has automated teller machines and on-line terminals. The computer operations of Peoples Bank are provided through FirstMerit.
CITIZENS NATIONAL BANK
The principal executive offices of Citizens are located in its main office building at 100 Central Plaza South, Canton, Ohio, which is leased by Citizens. Citizens owns the properties occupied by eight of its other banking offices, while the properties occupied by the remaining seven are leased under different leases with various expiration dates. Citizens also maintains a trust office and private banking office at two additional leased locations. Citizens also has automated teller machines and on-line terminals. The computer operations of Citizens are provided through FirstMerit.
PEOPLES BANK, N.A.
The principal executive offices of Peoples N.A. are located in its office at 6725 Center Street, Mentor, Ohio, which is owned by Peoples N.A. Peoples N.A. owns the properties occupied by five of its other branches, while the properties occupied by its remaining nine branches are leased at various expiration dates. Peoples N.A. also leases the property occupied by a loan production office. No mortgage debt exists on the above property owned by Peoples N.A. Peoples N.A. also has automated teller machines and on-line terminals. The computer operations of Peoples N.A. are provided through FirstMerit.
CITIZENS SAVINGS CORPORATION OF STARK COUNTY
CSC owns a large portion of an office condominium in Stark County, Ohio and certain low to moderate income housing units.
FIRSTMERIT MORTGAGE CORPORATION
The Banks in 1995 jointly organized and capitalized FirstMerit Mortgage, which is engaged in the business of originating residential mortgage loans and providing mortgage loan servicing for itself, the Banks and third parties. FirstMerit Mortgage conducts its business in property owned by Citizens located at 4455 Hills and Dales Road, Canton, Ohio.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The nature of FirstMerit's business results in a certain amount of litigation. Accordingly, FirstMerit and its subsidiaries are subject to various pending and threatened lawsuits in which claims for monetary damages are asserted. Management, after consultation with legal counsel, is of the opinion that the ultimate liability of such pending matters would not have a material adverse effect on FirstMerit's financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 1996 to a vote of security holders of FirstMerit.
EXECUTIVE OFFICERS OF REGISTRANT
The following persons are the executive officers of FirstMerit as of February 28, 1997. Unless otherwise designated, they are officers of FirstMerit, and unless otherwise stated, they have held their indicated positions for the past five years.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The outstanding shares of FirstMerit Common Stock are quoted on the Nasdaq National Market System. The following table contains bid and cash dividend information for FirstMerit Common Stock for the two most recent fiscal years:
* Based upon number of shares outstanding at the end of each quarter.
This table sets forth the high and low closing bid quotations, dividend rates and book values per share for the calendar periods indicated. These quotations furnished by the National Quotations Bureau Incorporated; represent prices between dealers, do not include retail markup, markdowns, or commissions, and may not represent actual transactions.
On February 1, 1997 there were approximately 6,976 shareholders of record of FirstMerit Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
FIRSTMERIT CORPORATION AND SUBSIDIARIES
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEARS ENDED 1996, 1995, 1994
The following commentary presents Management's discussion and analysis of the Corporation's financial condition and results of operations. The review highlights the principal factors affecting earnings and the significant changes in balance sheet items for the years 1996, 1995 and 1994. 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.
All financial data has been restated to give effect to acquisitions accounted for on a pooling of interests basis and stock splits in previous periods. The results of other bank and branch acquisitions, accounted for as purchases, have been included effective with the respective dates of acquisition.
EARNINGS SUMMARY
FirstMerit Corporation's net income for 1996 totaled $70,940,000, or $2.18 per share, compared with $31,318,000, or $0.94 per share, earned in 1995. The Savings Association Insurance Fund (SAIF) recapitalization charge of $6,652,000, recorded September 30, 1996, had a significant impact on 1996 earnings. Excluding the SAIF charge, earnings were $77,592,000, or $2.38 per share. Net income for 1995 included several one-time charges and an extraordinary gain. Without the one-time charges, 1995 earnings would have been $61,326,000, or $1.83 per share.
As reported last year end, 1995 net income contained expenses of $2,198,000 related to an early retirement program, costs of $16,214,000 associated with the acquisition of The CIVISTA Corporation ("CIVISTA"), an extraordinary gain of $5,599,000 from the sale of several apartment complexes acquired by the Corporation in its acquisition of CIVISTA, and $11,596,000 of reengineering charges implemented to improve overall operating efficiencies, improve branch network productivity, and centralize operations. The implementation of these programs contributed significantly to FirstMerit's 1996 success.
Return on average equity for the year was 14.70% and return on average assets was 1.42%, when the SAIF charge was not considered. The comparable ratios for 1995, excluding the prior year one-time charges, were 11.35% and 1.10%, respectively. For the quarter, return on equity was 14.48% versus 2.34% in 1995 and return on assets was 1.39% compared to 0.23% for the same period last year.
Net interest income, on a fully-tax equivalent basis, was $254,015,000, up 6% from last year. The improved net interest margin of 4.98% compared to 4.56% in 1995 was primarily responsible for the rise in net interest income.
Other income for the year was $82,496,000, an increase of $13,979,000 or 20% over the prior year. Included in 1996 other income were net proceeds of $13,210,000 from sales of affiliate branches and $490,000 from the sale of FirstMerit Bank, N.A. in Clearwater, Florida. Higher trust income, service charges on depositors' accounts, and credit card fees also contributed to the improvement in other income.
Other expenses were $209,702,000 compared to $227,779,000 in 1995. Included in the 1996 figure is the pretax SAIF assessment of $10,235,000. Other expenses for 1995 included portions of the early retirement, CIVISTA acquisition, and reengineering charges totaling $22,404,000 on a pretax basis. The efficiency ratio, excluding unusual charges in both years, was approximately 59% in 1996 versus 66% for 1995. The improvement in the efficiency ratio is directly attributable to the reengineering plan developed in 1995 that focused on improving overall efficiencies, improving branch network productivity, and centralizing operations.
During 1996, the Corporation recorded a provision for possible loan losses of $17,751,000, a ten percent reduction from last year's provision of $19,763,000. The provisions in both years address the continuing shift in FirstMerit's loan portfolio from residential mortgages into commercial and consumer loans, which historically have higher loss rates. Nonperforming assets were 0.29% of total loans and other real estate compared to
0.37% one year ago. The allowance for loan losses as a percentage of outstanding loans was 1.35% at December 31, 1996 and 1.24% at December 31, 1995.
As reported in November 1996, FirstMerit increased its regular quarterly cash dividend 7% from $0.27 per share to $0.29 per share. In September 1996, the Corporation implemented its second share repurchase plan. On a combined basis, the two plans authorize repurchase of up to 3,000,000 shares of FirstMerit's outstanding common stock. Through December 31, 1996, approximately 1,800,000 shares have been repurchased in the open market and through privately negotiated transactions.
The following table summarizes the changes in earnings per share for 1996 and 1995.
NET INTEREST INCOME
Net interest income, the difference between interest and loan fee income on earning assets and the interest paid on deposits and borrowed funds, is the principal source of earnings for the Corporation. Throughout this discussion net interest income is presented on a fully taxable equivalent (FTE) basis which restates interest on tax-exempt securities and loans as if such interest were subject to federal income tax at the statutory rate.
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, non-interest bearing liabilities and equity, and the growth in earning assets. The following table shows the allocation to assets, the source of funding and their respective interest spreads.
Net interest income increased $14.5 million, or 6.0%, to $254.0 million in 1996 compared to $239.5 million in 1995. The increase occurred because the decline in interest expense was greater than the reduction in interest income. Specifically, interest income fell $5.7 million while interest expense decreased $20.2 million, or 11%.
Interest income was lower than last year because earning assets fell 2.9% or $153.7 million. Sales of affiliate branches in markets where FirstMerit did not hold a dominant market share, the sale of FirstMerit Bank, N.A. in Clearwater, Florida and sales and maturities of investment securities contributed to the decline in assets. The average yield on earning assets increased 13 basis points from 8.01% to 8.14% during 1996.
Lower interest expense was due to fewer interest bearing liabilities and a reduced cost of funds. Also contributing to less interest expense was a shift in the composition of customer deposits as earning assets funded by non-interest bearing liabilities and equity increased from 17.5% in 1995 and 16.8% in 1994 to 18.9% in 1996.
The following table provides an analysis of the effect of changes in interest rates and volumes on net interest income in 1996 and 1995.
CHANGES IN NET INTEREST DIFFERENTIAL -- FULLY-TAX EQUIVALENT RATE/VOLUME ANALYSIS
- - ---------------
Note: The rate volume variance has been allocated entirely to volume.
Total interest income decreased by $5.7 million in 1996 or 1.4% compared to 1995, which increased 11.9% from 1994. The 1996 decrease resulted from a decline in earning assets that was partially offset by an improved earning asset yield. Sales and maturities of investment securities contributed $8.7 million or 93.4% to the total drop in average earning assets of $9.3 million. The 13 basis point improvement in the earning asset yield, from 8.01% to 8.14%, was entirely due to higher rates earned on loans during 1996. A higher yield on loans contributed $4.9 million more to interest income in 1996 when compared to the prior year. The increased yield earned on loans was primarily due to a change in the loan portfolio mix from residential mortgages to higher yielding commercial and consumer loans. Lower yields on federal funds sold and investment securities resulted in $1.2 million less interest income than the prior year.
Interest expense decreased $20.2 million or 11.1% compared to last year, which increased 29.1% compared to 1994. Lower average savings and other borrowing balances lessened interest expense by $2.7 million and $4.6 million, respectively, and were responsible for 97.2% of the total decline caused by fewer outstandings. Lower rates paid on all interest bearing liabilities resulted in a $12.7 million decline in 1996 interest expense. Reduced rates paid on other borrowings lowered interest expense by $6.1 million, or 48.0% of the total drop in interest expense caused by decreased interest rates. Lower savings rates accounted for another $3.3 million or 26.1% of the decline in interest expense due to lower deposit yields.
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.
The net interest margin for 1996 was 4.98% compared to 4.56% in 1995 and 4.71% in 1994. As mentioned earlier in this discussion, even though interest rates were lower in 1996, the yield on earning assets increased due to a shift in FirstMerit's loan portfolio toward higher yielding commercial and consumer loans. The cost of funding the earning assets decreased 29 basis points from 4.18% in 1995 to 3.89% in 1996. The combination of a higher yield on earning assets and a lower cost of funding boosted the Corporation's net interest income and net interest margin significantly, and was principally responsible for the increases in both categories as earning assets declined 2.9% during the year.
OTHER INCOME
Other income totaled $82.5 million in 1996, an increase of $14.0 million or 20.4% over 1995 and 16.8% over 1994.
Trust fees increased $1.5 million or 13.7% to $12.2 million in 1996. Trust fees for 1994 included nonrecurring fees of approximately $2.5 million. Service charges on deposits rose $3.8 million or 18.2% compared to last year. Contributing to the increase was the implementation of standard service charges and procedures among affiliate banks as well as changes to the deposit product lines. Service charges accounted for 35.4% of total other income when net gains from sales of affiliate branches and FirstMerit Bank, N.A. in Clearwater, Florida are excluded. Credit card fees increased $2.0 million during 1996 further illustrating the shift of the Corporation's loan portfolio from residential mortgage loans to consumer and commercial credits.
Income from mortgage sales and servicing rose $1.6 million, or 50.3%, to $4.9 million for the year. The net increase was a result of implementation of Statement of Financial Accounting Standards No. 122 "Accounting for Mortgage Servicing Rights," which added $2.3 million in 1996, and fewer loan sales during the year, compared to 1995, which lowered this category by approximately $0.7 million. The Corporation's practice is to sell all fixed rate thirty year residential mortgage loans originated while retaining the servicing for these loans.
Securities losses were $1.8 million for 1996 compared to gains of $0.5 million in 1995. The Corporation sold certain securities at a loss, principally in the fourth quarter, to reinvest the proceeds into higher yielding assets for 1997 and future years.
Other operating income was $25.3 million, $7.0 million higher than the $18.3 million earned in 1995. Net gains on sales of affiliate branches accounted for $13.2 million and the sale of FirstMerit Bank, N.A. in Clearwater, Florida added another $0.5 million to 1996's total.
Total other income, excluding the net gain on branch sales of $13.2 million, covered 34.7% of other expenses, excluding the Savings Association Insurance Fund ("SAIF") recapitalization charge of $10.2 million. Adjusted coverage ratios for 1995 and 1994 were 30.1% and 36.5%, respectively. Unusual charges for both 1996 and 1995 are discussed in more detail in the "Other Expense" section of this Annual Report as well as in Note 18 to the consolidated financial statements.
OTHER EXPENSES
Other expenses were $209.7 million in 1996 compared to $227.8 million in 1995 and $193.4 million in 1994. Both 1996 and 1995 contained unusual charges. In 1996, the Corporation recorded a $10.2 million SAIF recapitalization charge. Excluding the one-time SAIF assessment, other expenses would have been $199.5 million. Other expenses for 1995 included nonrecurring costs associated with an early retirement program, the CIVISTA acquisition, and reengineering charges that totaled $22.4 million. If unusual charges for both 1996 and 1995 are not considered, other expenses for 1996 were $5.9 million less than the comparable 1995 total.
OTHER EXPENSES
Salaries, wages, pension and benefits totaled $94.6 million in 1996, a decline of $13.2 million or 12.2% from 1995 and 4.2% less than 1994. Included in these costs for 1995 were severance and related charges of $4.1 million and an early retirement charge of $3.9 million. Excluding these expenses, 1996 salaries, wages, pension and benefits were still $5.1 million or 5.1% less than the prior year's adjusted total. The current year reduction was attributable to the actions taken in 1995 to reengineer the Corporation's retail delivery systems and consolidate back-room operations. In 1996, the Corporation spent 30.3 cents in benefits for every dollar of salary and wages compared to 30.5 cents in 1995, excluding the severance and early retirement charges, and 30.8 cents in 1994.
The Corporation has a benefit plan which presently provides postretirement medical and life insurance for retired employees. The Corporation reserves the right to terminate or make additional plan changes at any time. The Corporation's accumulated postretirement benefit obligation (APBO) as of January 1, 1993 totaled $19.0 million, and is being amortized over twenty years at an annual cost of $0.9 million.
Professional services totaled $4.3 million in 1996 compared to $7.9 million in 1995 and $4.7 million in 1994. In 1995, external support groups were used to help develop the reengineering plan to improve operating
efficiencies, increase revenues and shareholder value, and to help train our employees to effectively sell our new products and services.
On January 1, 1994, the FDIC implemented a risk-based assessment system for depository institutions. Under the system, the annual assessment rate for each insured institution is determined on the basis of both capital and supervisory measures, and can range from 23 cents to 31 cents per one hundred dollars of deposits. During the third quarter of 1995, the FDIC reduced the effective rate of the annual assessment on Bank Insurance Fund ("BIF") deposits to approximately 4 cents per one hundred dollars of deposits.
As mentioned earlier in this section, the Corporation's FDIC assessment for 1996 included a one-time recapitalization of the Savings Association Insurance Fund totaling $10.2 million. Excluding the one-time charge, FDIC expense would have been $2.7 million. The adjusted expense of $2.7 million is considerably less than the 1995 and 1994 amounts due to the reduction in the effective rate applicable to Bank Insurance Fund ("BIF") deposits.
Other operating expenses amounted to $23.6 million in 1996 compared to $33.7 million last year and $18.9 million in 1994. Included in 1995 costs were $4.6 million of severance payments and fees paid to financial advisors as part of the CIVISTA acquisition as well as $6.6 million of reengineering charges for the adjustment to the value of buildings, equipment and other assets.
FEDERAL INCOME TAX
Federal income tax expense totaled $35.1 million in 1996 compared to $34.0 million in 1995, when tax expense of $3.0 million associated with the extraordinary gain is included, and $32.1 million in 1994. In 1996 the effective federal income tax rate for the Corporation equaled 33.1% compared to 52.0% in 1995 and 31.0% in 1994.
The effective tax rate in 1995 was higher than normally seen due to the recapture of the bad debt reserve totaling approximately $12.4 million, and the nondeductibility of certain professional fees associated with the CIVISTA acquisition.
INVESTMENT SECURITIES
The investment portfolio is maintained by the Corporation to provide liquidity, earnings, and as a means of diversifying risk. In accordance with the Financial Accounting Standards Board Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," securities are required to be classified as held-to-maturity, available-for-sale, or trading. All investment securities are currently classified as availablefor-sale. In this classification, adjustment to fair value of the securities available-for-sale in the form of unrealized holding gains and losses, is excluded from earnings and reported net of taxes in a separate component of shareholders' equity. The adjustments to reduce fair value at December 31, 1996 and December 31, 1995 were $3.4 million and $2.0 million, respectively. Higher interest rates at the end of 1996 accounted for the increase in the fair market adjustment.
At December 31, 1996, investment securities totaled $1,187.5 million compared with $1,403.1 million one year earlier, a decline of 15.4%. Investment securities totaled $1,610.4 million at the end of 1994.
During 1996 approximately $343.6 million in securities were sold for which a net loss of $1.8 million was realized. The sales and resultant losses occurred as the Corporation restructured portions of its investment portfolio.
A summary of investment securities' carrying value is presented below as of December 31, 1996, 1995 and 1994. Presented with the summary is a maturity distribution schedule with corresponding weighted average yields.
CARRYING VALUE OF INVESTMENT SECURITIES
The yield on the portfolio was 6.32% in 1996 compared to 6.37% in 1995 and 6.03% in 1994. The current year reduction in the investment portfolio funded increases in loan portfolios and the sale of branch deposits.
LOANS
Total loans outstanding at December 31, 1996 decreased 3.0% compared to one year ago or $3,656.0 million compared to $3,770.4 million. A breakdown by category is presented below, along with a maturity summary of commercial, financial and agricultural loans.
Real estate loans at December 31, 1996 totaled $1,936.3 million or 53.0% of total loans outstanding compared to 59.0% one year ago. Residential loans (1-4 family dwellings) totaled $998.8 million, home equity loans $196.4 million, construction loans $126.4 million and commercial real estate loans $614.7 million. The year-end real estate totals point out the shift in the composition of the Corporation's loan portfolio from residential real estate to higher yielding commercial and consumer loans.
Commercial real estate loans include both commercial loans where real estate has been taken as collateral as well as loans for commercial real estate. The majority of commercial real estate loans are to owner occupants where cash flow to service debt is derived from the occupying business cash flow instead of normal building rents. These loans are generally part of an overall relationship with existing customers primarily within northeast Ohio.
Consumer loans or loans to individuals increased 4.3% compared to last year and accounted for 22.2% of total loans compared to 20.6% in 1995.
Commercial, financial, and agricultural loans increased 27.2% during 1996 and make-up 20.5% of total outstanding loans compared to 15.6% last year. Again, the increase in consumer and commercial loans is evidence of FirstMerit's shifting loan portfolio.
The decline in lease financing loans from $180.0 million in 1995 to $159.2 million at December 31, 1996 is primarily due to decreased originations in the highly competitive auto lease business. Auto leases totaled $74.0 million with equipment leasing totaling $81.8 million, and leveraged leases were $3.5 million at year-end 1996.
There is no 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.
ASSET QUALITY
Making a loan to earn an interest spread inherently includes taking the risk of not getting 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 subsidiary banks, 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.
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.
Effective December 31, 1995, the Corporation adopted Statement of Financial Accounting Standard No. 114," Accounting by Creditors for Impairment of a Loan," and Statement No. 118, an amendment of Statement No. 114, "Accounting by Creditors for Impairment of a loan -- Income Recognition and Disclosures." These statements prescribe how the allowance for loan losses related to impaired loans should be
determined and the required disclosures. Impaired loans are loans for which, based on current information or events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans must be valued based on the present value of the loans' expected future cash flows at the loans' effective interest rates, at the loans' observable market price, or the fair value of the loan collateral.
NON-PERFORMING ASSETS
Non-performing assets consist of :
- NON-ACCRUAL LOANS on which interest is no longer accrued because its collection is doubtful.
- RESTRUCTURED LOANS on which, due to deterioration in the borrower's financial condition, the original terms have been modified in favor of the borrower or either principal or interest has been forgiven.
- OTHER REAL ESTATE (OREO) acquired through foreclosure in satisfaction of a loan.
Under the Corporation's credit policies and practices, all non-accrual and restructured commercial, agricultural, construction, and commercial real estate loans, meet the definition of impaired loans under Statement No.'s 114 and 118. Impaired loans as defined by Statements 114 and 118 exclude certain consumer loans, residential real estate loans, and leases classified as non-accrual. Consumer installment loans are charged off when they reach 120 days past due. Credit card loans are charged off when they reach 180 days past due. When any other loan becomes 90 days past due, it is placed on non-accrual status unless it is well secured and in the process of collection. Any losses are charged against the allowance for possible loan losses as soon as they are identified.
Non-performing assets at December 31, 1996 totaled $10.6 million, down from $13.9 million in 1995 and $26.0 million in 1994. As a percentage of total loans outstanding plus OREO, non-performing assets were 0.29% at year-end 1996 compared to 0.37% in 1995 and 0.70% in 1994. The average balances of impaired loans for the years ended December 31, 1996 and 1995 were $9.3 million and $10.7 million, respectively.
For the year ended December 31, 1996, impaired assets earned $622,000 in interest income. Had they not been impaired, they would have earned $1.2 million. For the same period, total non-performing loans earned $662,000 in interest income. Had they paid in accordance with the payment terms in force prior to being considered impaired, on non-accrual status, or restructured, they would have earned $1.3 million.
In addition to non-performing loans and loans 90 days past due and still accruing interest, Management identified potential problem loans totaling $23.7 million at December 31, 1996. 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.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The Corporation maintains what Management believes is an adequate allowance for possible loan losses. The Parent Company and the subsidiary banks regularly analyze the adequacy of their allowances through ongoing reviews of trends in risk ratings, delinquencies, non-performing assets, charge-offs, economic conditions, and changes in the composition of the loan portfolio.
At year end the Corporation boosted its allowance for possible loan losses in response to the continuing shift of its portfolio out of residential mortgage loans and into commercial and consumer loans, which historically have exhibited higher loss rates. During the year, consumer delinquencies continued at high levels and losses in the consumer portfolio were higher than in the recent past. Management felt it was prudent to increase the allowance at year end to ensure its adequacy for changes that have occurred and will continue to occur in the loan portfolio.
At December 31, 1996, the allowance was $49.3 million or 1.35% of loans outstanding compared to $46.8 million or 1.24% in 1995 and $35.8 million or 0.97% in 1994. The allowance equaled 471.75% of non-performing loans at December 31, 1996 compared to 364.8% in 1995. The allowance for possible loan losses related to impaired loans at December 31, 1996 and December 31, 1995 totaled $1,913,000 and $676,000, respectively.
Net charge-offs were $15.3 million in 1996 compared to $8.8 million in 1995 and $3.8 million in 1994. As a percentage of average loans outstanding, net charge-offs equaled 0.40% in 1996, 0.23% in 1995 and 0.11% in 1994. Losses are charged against the allowances as soon as they are identified.
A six-year summary of activity follows:
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
DEPOSITS
Average deposits for 1996 totaled $4,363.8 million, a decrease of 1.9% and 1.8% compared to 1995 and 1994 levels, respectively. Sales of affiliate branches and their respective deposits, and the strength of the stock market during 1996 were factors in the overall decline in deposit balances. The success of the Corporation's "free-checking" campaigns brought in additional demand deposits that partially offset the overall decline in deposits and contributed to an improved cost of funds and net interest margin.
As market interest rates decreased during the year, and the stock market strengthened, savings deposits were withdrawn and reinvested in equity funds not held by the Corporation. Specifically, the decline in average savings deposits from $1,514.4 million in 1995 to $1,399.0 million in 1996 accounted for more than 100% of the decline in total average deposits.
Average demand deposits, including both interest-bearing and noninterest-bearing categories, totaled $1,192.6 million for the year, an increase of 3.5% over last year's average. Additionally, the average rate paid on interest-bearing demand deposits decreased 41 basis points to 1.75%. The combination of higher demand deposit balances and a lower yield contributed positively to the Corporation's decrease in total cost of funds.
Certificates and other time deposits ("CDs") averaged $1,772.2 million for 1996, down less than one percent from 1995's average of $1,782.8 million. The average yield paid on CDs declined 9 basis points from 5.47% in 1995 to 5.38% in 1996.
CDs accounted for 40.6% of average deposits in 1996 compared to 40.1% in 1995. Savings equaled 32.1% and 34.0% in 1996 and 1995, respectively, and demand deposits, both interest and non-interest bearing, were 27.3% and 25.9%, respectively.
The average cost of deposits and other borrowings was down 29 basis points compared to one year ago, or 3.89% in 1996 compared to 4.18% last year.
The following table summarizes the certificates and other time deposits in amounts of $0.1 million or more as of December 31, 1996, by time remaining until maturity.
INTEREST RATE SENSITIVITY
Interest rate sensitivity measures the potential exposure of earnings and capital to changes in market interest rates. The Corporation has a policy which provides guidelines in the management of interest rate risk. This policy is reviewed periodically to ensure it complies to trends within the financial markets and within the industry.
The analysis presented below divides interest bearing assets and liabilities into maturity categories and measures the "GAP" between maturing assets and liabilities in each category. The Corporation analyzes the historical sensitivity of its interest bearing transaction accounts to determine the portion which it classifies as interest rate sensitive versus the portion classified over one year. The analysis shows that liabilities maturing within one year exceed assets maturing within the same period by a moderate amount. The Corporation uses the GAP analysis and other tools to monitor rate risk.
At December 31, 1996 the Corporation was in a moderate asset-sensitive position as illustrated in the following table:
CAPITAL RESOURCES
Shareholders' equity at December 31, 1996 totaled $523.7 million compared to $542.9 million at December 31, 1995, a decrease of 3.5%. The Corporation's stock repurchase program, detailed in the "Earnings Summary" portion of Management's Discussion and Analysis, reduced equity during 1996.
The Federal Deposit Insurance Corporation Act of 1991 ("FDICIA") set capital guidelines for a financial institution to be considered "well-capitalized." These guidelines require a risk-based capital ratio of 10%, a Tier I capital ratio of 6% and a leverage ratio of 5%. At December 31, 1996, the Corporation's risk-based capital equaled 13.82% of risk-adjusted assets, its Tier I capital ratio equaled 12.63% and its leverage ratio equaled 9.63%.
The Corporation's Board of Directors declared a 2-for-1 split of the Corporation's common stock on August 19, 1993. The split was paid to shareholders of record as of August 30, 1993.
During 1996, the Corporation's Directors increased the quarterly cash dividend, marking the fifteenth consecutive year of annual increases since the Corporation's formation in 1981. The cash dividend of $.29 paid has an indicated annual rate of $1.16 per share. Over the past five years the dividend has increased at an annual rate of approximately 8%.
LIQUIDITY
The Corporation's primary source of liquidity is its strong core deposit base, raised through its retail branch system, along with a strong capital base. These funds, along with investment securities, provide the ability to meet the needs of depositors while funding new loan demand and existing commitments.
The banking subsidiaries individually maintain sufficient liquidity in the form of temporary investments and a short-term maturity structure within the investment portfolio, along with cash flow from loan repayment. Asset growth in the banking subsidiaries is funded by the growth of core deposits.
Reliance on borrowed funds decreased during the year as maturing investment portfolio securities were used to fund deposit withdrawals and repay borrowings. During the year, the Corporation sold, for liquidity purposes, approximately $200 million of fixed and adjustable rate residential real estate loans. The loan sales improved liquidity while restructuring the balance sheet to higher yielding assets.
The liquidity needs of the Parent Company, primarily cash dividends and other corporate purposes, are met through cash, short-term investments and dividends from banking subsidiaries.
Management is not aware of any trend or event, other than noted above, which will result in or that is reasonably likely to occur that would result in a material increase or decrease in the Corporation's liquidity.
REGULATION AND SUPERVISION
A strict uniform system of capital-based regulation of financial institutions became effective on December 19, 1992. 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 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 December 31, 1996, the Parent Company and its subsidiaries all exceeded the minimum capital levels of the adequately capitalized category.
EFFECTS OF INFLATION
The assets and liabilities of the Corporation are primarily monetary in nature and are more directly affected by the fluctuation in interest rates than inflation. Movement in interest rates is a result of the perceived changes in inflation as well as monetary and fiscal policies. Interest rates and inflation do not move with the same velocity or within the same time frame, therefore, a direct relationship to the inflation rate cannot be shown. The financial information presented in this annual report, based on historical data, has a direct correlation to the influence of market levels of interest rates. Therefore, Management believes that there is no material benefit in presenting a statement of financial data adjusted for inflationary changes.
FORWARD-LOOKING STATEMENTS -- SAFE HARBOR STATEMENT
Information in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section above and within this report, which is not historical or factual in nature, and which relates to expectations for future shifts in loan portfolio to consumer and commercial loans, increase in core deposit base, allowance for loan losses, demands for FirstMerit services and products, future services and products to be offered, increased numbers of customers, and like items, constitute forward-looking statements that involve a number of risks and uncertainties. The following factors are among the factors that could cause actual results to differ materially from the forward-looking statements: general economic conditions, including their impact on capital expenditures; business conditions in the banking industry; the regulatory environment; rapidly changing technology and evolving banking industry standards; competitive factors, including increased competition with regional and national financial institutions; new service and product offerings by competitors and price pressures; and like items.
FirstMerit cautions that any forward-looking statements contained in this report, in a report incorporated by reference to this report, or made by management of FirstMerit in this report, in other reports and filings, in press releases and in oral statements, involve risks and uncertainties and are subject to change based upon the factors listed above and like items. Actual results could differ materially from those expressed or implied, and therefore the forward-looking statements should be considered in light of these factors. FirstMerit may from time to time issue other forward-looking statements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and accompanying notes, and the reports of management and independent auditors, are set forth immediately following Item 9
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
FirstMerit has had no disagreement with its accountants on accounting and financial disclosure matters and has not changed accountants during the two year period ending December 31, 1996.
CONSOLIDATED BALANCE SHEETS
FIRSTMERIT CORPORATION AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
FIRSTMERIT CORPORATION AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FIRSTMERIT CORPORATION AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FIRSTMERIT CORPORATION AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FIRSTMERIT CORPORATION AND SUBSIDIARIES
DECEMBER 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of FirstMerit Corporation and its subsidiaries (the "Corporation") conform to generally accepted accounting principles and to general practices within the banking industry. The Corporation's activities are considered to be a single industry segment for financial reporting purposes. The following is a description of the more significant accounting policies:
(a) Principles of Consolidation
The consolidated financial statements include the accounts of FirstMerit Corporation (the "Parent Company") and its wholly-owned subsidiaries: Citizens Investment Corporation, Citizens National Bank, Citizens Savings Corporation of Stark County, EST National Bank, First National Bank of Ohio, FirstMerit Community Development Corporation, FirstMerit Credit Life Insurance Company, Old Phoenix National Bank of Medina, Peoples Bank, N.A., and Peoples National Bank. The results of operations of two former wholly-owned subsidiaries, FirstMerit Bank, N.A. and FirstMerit Trust Company, N.A., are included in the consolidated statements of income through December 30, 1996. These former subsidiaries were sold December 31, 1996. All significant intercompany balances and transactions have been eliminated in consolidation.
(b) Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and related notes. Actual results could differ from those estimates.
(c) Investment Securities
Debt and equity securities are classified as held-to-maturity, available-for-sale, or trading. Securities classified as held-to-maturity are measured at amortized or historical cost, securities available-for-sale and trading at fair value. Adjustment to fair value of the securities available-for-sale, in the form of unrealized holding gains and losses, is excluded from earnings and reported net of tax as a separate component of shareholders' equity. Adjustment to fair value of securities classified as trading is included in earnings. Gains or losses on the sales of investment securities are recognized upon realization and are determined by the specific identification method.
Effective December 31, 1995, the Corporation designated the entire investment portfolio as available-for-sale. Classification as available-for-sale allows the Corporation to sell securities to fund liquidity and manage the Corporation's interest rate risk.
Prior to December 31, 1995, the Corporation had designated a portion of its investment portfolio as held-to-maturity. The Corporation does not maintain a trading account.
(d) Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand, balances on deposit with correspondent banks and checks in the process of collection.
(e) Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on the straight-line and declining balance methods over the estimated useful lives of the assets. Amortization of leasehold improvements is computed on the straight-line method based on lease terms or useful lives, whichever is less.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
(f) Loans
Impaired loans are loans for which, based on current information or events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are valued based on the present value of the loans' expected future cash flows at the loans' effective interest rates, at the loans' observable market price, or the fair value of the loan collateral.
(g) Interest and Fees on Loans
Interest income on loans is generally accrued on the principal balances of loans outstanding using the "simple-interest" method. Loan origination fees and certain direct origination costs are deferred and amortized, generally over the contractual life of the related loans using a level yield method. Interest is not accrued on loans for which circumstances indicate collection is questionable.
(h) Provision for Possible Loan Losses
The provision for possible loan losses charged to operating expenses is determined based on Management's evaluation of the loan portfolios and the adequacy of the allowance for possible loan losses under current economic conditions and such other factors which, in Management's judgement, deserve current recognition.
(i) Lease Financing
The Corporation leases equipment to customers on both a direct and leveraged lease basis. The net investment in financing leases includes the aggregate amount of lease payments to be received and the estimated residual values of the equipment, less unearned income and non-recourse debt pertaining to leveraged leases. Income from lease financing is recognized over the lives of the leases on an approximate level rate of return on the unrecovered investment. Residual values of leased assets are reviewed on an annual basis for reasonableness. Declines in residual values judged to be other than temporary are recognized in the period such determinations are made.
(j) Mortgage Servicing Fees
The Corporation generally records loan administration fees earned for servicing loans for investors as income is collected. Earned servicing fees and late fees related to delinquent loan payments are also recorded as income is collected.
(k) Federal Income Taxes
The Corporation follows the asset and liability method of accounting for income taxes. Deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect of a change in tax rates is recognized in income in the period of the enactment date.
(l) Value Ascribed to Acquired Intangibles
The value ascribed to acquired intangibles, including core deposit premiums, results from the excess of cost over fair value of net assets acquired in acquisitions of financial institutions. Such values are being amortized over periods ranging from 10 to 25 years, which represent the estimated remaining lives of the long-term interest bearing assets acquired. Amortization is generally computed on an accelerated basis based on the expected reduction in the carrying value of such acquired assets. If no significant amount of long-term interest bearing assets is acquired, such value is amortized over the estimated life of the acquired deposit base, with amortization periods ranging from 10 to 15 years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
(m) Trust Department Assets and Income
Property held by the Corporation in a fiduciary or other capacity for trust customers is not included in the accompanying consolidated financial statements, since such items are not assets of the Corporation. Trust income is reported generally on a cash basis which approximates the accrual basis of accounting.
(n) Per Share Data
The per share data is based on the weighted average number of shares of common stock and common stock equivalents outstanding during each year.
(o) Reclassifications
Certain previously reported amounts have been reclassified to conform to the current reporting presentation.
2. ACQUISITIONS
On January 31, 1995, the Corporation acquired The CIVISTA Corporation, a savings and loan holding company headquartered in Canton, Ohio ("CIVISTA"), in exchange for approximately 6,513,119 shares of the Corporation's common stock. The transaction was accounted for as a pooling of interests. As a result of CIVISTA's fiscal year which ended September 30, the Corporation made an acquisition adjustment to shareholders' equity of $614, which represented CIVISTA's net income for the three month period ended December 31, 1994. The accompanying consolidated financial statements for all periods presented have been restated to account for the acquisition.
Details of the results of operations of the previously separate corporations including CIVISTA operating results for its fiscal year ended September 30, 1994 are as follows:
The Corporation incurred a one-time charge of approximately $16.2 million ($0.48 per share) in the first quarter of 1995 related to the loss of certain tax benefits as a result of converting CIVISTA's thrift operations to national bank operations as well as other expenses related to the merger.
Great Northern Financial Corporation, a savings and loan holding company located in Barberton, Ohio, was acquired on April 22, 1994, in exchange for approximately 1,882,440 shares of the Corporation's common stock. The transaction was accounted for as a pooling of interests. The accompanying consolidated financial statements for all periods presented have been restated to account for the acquisition.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
3. INVESTMENT SECURITIES
Investment securities are composed of:
Effective December 31, 1995, the Corporation transferred all held-to-maturity investments to available-for-sale. As a result of this transfer, unrealized holding losses on available-for-sale securities were reduced by the after-tax amount of $1.2 million.
The amortized cost and market value of investment securities including mortgage-backed securities at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities based on the issuers' rights to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of investment securities during the years December 31, 1996 and 1995 were $343,600 and $98,688, respectively. Gross gains of $2,003 and $1,384 and gross losses of $3,779 and $845 were realized on these sales, respectively.
The carrying value of investment securities pledged to secure trust and public deposits and for purposes required or permitted by law amounted to $724,886 and $741,185 at December 31, 1996 and 1995, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
4. LOANS
Loans consist of the following:
The Corporation grants loans principally to customers located within the State of Ohio.
Information with respect to impaired loans is as follows:
Earned interest on impaired loans is recognized as income is collected.
The Corporation makes loans to officers and directors on substantially the same terms and conditions as transactions with other parties. An analysis of loan activity with related parties for the years ended December 31, 1996 and 1995 is summarized as follows:
5. ALLOWANCE FOR POSSIBLE LOAN LOSSES
Transactions in the allowance for possible loan losses are summarized as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
6. MORTGAGE SERVICING RIGHTS AND MORTGAGE SERVICING
In accordance with Statement of Financial Accounting Standards No. 122 "Accounting for Mortgage Servicing Rights," when the Corporation intends to sell originated or purchased loans and retain the related servicing rights, it allocates a portion of the total costs of the loans to the servicing rights based on estimated fair value. Fair value is estimated based on market prices, when available, or the present value of future net servicing income, adjusted for such factors as discount rates and prepayments. Servicing rights are amortized over the average life of the loans using the straight-line method.
The components of mortgage servicing rights are as follows:
In 1996, the Corporation's income before federal income taxes was increased by approximately $2.3 million as a result of the adoption of SFAS No. 122. The consolidated financial statements for 1995 and 1994 were prepared in accordance with Statement of Financial Accounting Standards No. 65 "Accounting for Certain Mortgage Banking Activities," which provided for servicing rights to be recorded on purchased loans, but not originated loans.
SFAS No. 122 also requires the Corporation to assess its capitalized servicing rights for impairment based on their current fair value. As permitted by SFAS No. 122, the Corporation disaggregates its servicing rights portfolio based on loan type and interest rate which are the predominant risk characteristics of the underlying loans. If any impairment results after current market assumptions are applied, the value of the servicing rights is reduced through the use of a valuation allowance.
At December 31, 1996 and 1995, the Corporation serviced for others approximately $871 million and $717 million, respectively. The following table provides servicing information for 1996:
7. RESTRICTIONS ON CASH AND DIVIDENDS
The average balance on deposit with the Federal Reserve Bank to satisfy reserve requirements amounted to $7,306 during 1996. The level of this balance is based upon amounts and types of customers' deposits held by the banking subsidiaries of the Corporation. In addition, deposits are maintained with other banks at levels determined by Management based upon the volumes of activity and prevailing interest rates to compensate for check-clearing, safekeeping, collection and other bank services performed by these banks. At December 31, 1996, cash and due from banks included $5,155 deposited with the Federal Reserve Bank and other banks for these reasons.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
Dividends paid by the subsidiaries are the principal source of funds to enable the payment of dividends by the Corporation to its shareholders. These payments by the subsidiaries in 1997 are restricted by the regulatory agencies principally to the total of 1997 net income. Regulatory approval must be obtained for the payment of dividends of any greater amount.
8. PREMISES AND EQUIPMENT
The components of premises and equipment are as follows:
Amounts included in other expenses for depreciation and amortization aggregated $10,120, $8,862 and $8,353 for the years ended December 31, 1996, 1995 and 1994, respectively.
At December 31, 1996, the Corporation was obligated for rental commitments under noncancelable operating leases on branch offices and equipment as follows:
Rentals paid under noncancelable operating leases amounted to $8,819, $9,574 and $7,325 in 1996, 1995 and 1994, respectively.
9. CERTIFICATES AND OTHER TIME DEPOSITS
The aggregate amounts of certificates and other time deposits of $100 and over at December 31, 1996 and 1995 were $271,634 and $230,429, respectively. Interest expense on these certificates and time deposits amounted to $13,016 in 1996, $14,360 in 1995, and $9,406 in 1994.
10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER BORROWINGS
At December 31, 1996 and 1995, securities sold under agreements to repurchase totaled $368,566 and $336,083, respectively. The average balance of securities sold under agreements to repurchase and other borrowings for the years ended December 31, 1996 and 1995, amounted to $515,556 and $609,247, respectively. In 1996, the weighted average annual interest rate amounted to 4.87%, compared to 5.87% in 1995. The maximum amount of these borrowings at any month end amounted to $608,782 in 1996 and $740,586 in 1995.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
At December 31, 1996, and 1995, the Corporation had $55,135 and $75,875, respectively, of Federal Home Loan Bank ("FHLB") advances. The 1996 balance includes: $37,000 that have maturities within one year with interest rates of 5.38% to 6.15%; $12,017 with maturities over one year to five years with interest rates of 4.65% to 6.40%; and $6,118 over five years with interest rates of 4.75% to 8.10%.
Residential mortgage loans totaling $82,702 and $107,813 at December 31, 1996 and 1995, respectively, were pledged to secure FHLB advances.
11. FEDERAL INCOME TAXES
Federal income taxes are comprised of the following:
Actual Federal income tax expense differs from expected Federal income tax as shown below:
For 1996, 1995 and 1994, the deferred income tax expense results from temporary differences in the recognition of income and expense for Federal income tax and financial reporting purposes. The sources and tax effect of these temporary differences are presented below:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
Principal components of the Corporation's net deferred tax (liability) are summarized as follows:
12. BENEFIT PLANS
The Corporation has a defined benefit pension plan covering substantially all of its employees. In general, benefits are based on years of service and the employee's compensation. The Corporation's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax reporting purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.
A supplemental non-qualified, non-funded pension plan for certain officers is also maintained and is being provided for by charges to earnings sufficient to meet the projected benefit obligation. The pension cost for this plan is based on substantially the same actuarial methods and economic assumptions as those used for the defined benefit pension plan.
The following table sets forth the plans' funded status and amounts recognized in the Corporation's consolidated financial statements:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
Net pension cost consists of the following components:
The Corporation maintains a savings plan under Section 401(k) of the Internal Revenue Code, covering substantially all full-time and part-time employees after six months of continuous employment. Under the plan, employee contributions are partially matched by the Corporation. Such matching becomes vested when the employee reaches five years of credited service. Total savings plan expense was $2,108, $2,294 and $1,874 for 1996, 1995 and 1994, respectively.
13. POSTRETIREMENT MEDICAL AND LIFE INSURANCE PLAN
The Corporation has a benefit plan which presently provides postretirement medical and life insurance for retired employees. Effective January 1, 1993, the plan was changed to limit the Corporation's medical contribution to 200% of the 1993 level for employees who retire after January 1, 1993. The Corporation reserves the right to terminate or amend the plan at any time.
The cost of postretirement benefits expected to be provided to current and future retirees is accrued over those employees' service periods. Prior to 1993, postretirement benefits were accounted for on a cash basis. In addition to recognizing the cost of benefits for the current period, recognition is being provided for the cost of benefits earned in prior service periods (the transition obligation). The Corporation has elected to amortize the transition obligation by charges to income over a twenty year period on a straight line basis.
The following table sets forth the plan's status and amounts recognized in the Corporation's consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
Net postretirement benefit cost includes:
The following actuarial assumptions effect the determination of these amounts:
Shown below is the impact of a 1% increase in the medical trend rates (i.e., pre-65, 13.9% for 1996 grading down to 7.0% in 2002; post-65, 13.2% grading down to 7.1% in 2027). This information is required disclosure under SFAS No. 106.
14. STOCK OPTIONS
The 1992 Stock Option Program provides incentive and non-qualified stock options to certain key employees for up to 1,000,000 common shares of the Corporation. In addition, the 1992 Directors Stock Option Program provides for the granting of non-qualified stock options to certain non-employee directors of the Corporation for which 100,000 common shares of the Corporation have been reserved. Options under these 1992 Programs are not exercisable for at least six months from date of grant.
Options continue to be outstanding under the 1982 Incentive Stock Option Plan and these options are fully exercisable.
Options under these plans are granted at 100% of the fair market value. Options granted as incentive stock options must be exercised within ten years and options granted as non-qualified stock options have terms established by the Compensation Committee of the Board and approved by the non-employee directors of the Board. Options are cancelable within defined periods based upon the reason for termination of employment.
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." This statement defines a fair value based method of accounting for an employee stock option or similar equity instrument. The statement does, however, allow an entity to continue to measure compensation cost for those plans using the intrinsic value based
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
In 1996 the Corporation adopted provisions of SFAS No. 123 by providing disclosures of the pro forma effect on net income and earnings per share that would result if the fair value compensation element were to be recognized as expense. The following table shows the pro forma earnings and earnings per share for 1996 and 1995 along with significant assumptions used in determining the fair value of the compensation amounts.
A summary of stock option activity for the last three years follows:
The Employee Stock Purchase Plan provides full-time and part-time employees of the Corporation the opportunity to acquire common shares on a payroll deduction basis. Of the 200,000 shares available under the Plan, there were 12,512 and 12,752 shares issued in 1996 and 1995, respectively.
15. PARENT COMPANY
Condensed financial information of FirstMerit Corporation (Parent Company only) is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
16. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
Disclosures of fair value information about certain financial instruments, whether or not recognized in the consolidated balance sheets are provided as follows. Instruments for which quoted market prices are not available are valued based on estimates using present value or other valuation techniques whose results are significantly affected by the assumptions used, including discount rates and future cash flows. Accordingly, the values so derived, in many cases, may not be indicative of amounts that could be realized in immediate settlement of the instrument. Also, certain financial instruments and all non-financial instruments are excluded from these disclosure requirements. For these and other reasons, the aggregate fair value amounts presented below are not intended to represent the underlying value of the Corporation.
The following methods and assumptions were used to estimate the fair values of each class of financial instrument presented:
Investment securities -- Fair values are based on quoted prices, or for certain fixed maturity securities not actively traded estimated values are obtained from independent pricing services.
Federal funds sold -- The carrying amount is considered a reasonable estimate of fair value.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
Net loans -- Fair value for loans with interest rates that fluctuate as current rates change are generally valued at carrying amounts with an appropriate discount for any credit risk. Fair values of other types of loans are estimated by discounting the future cash flows using the current rates for which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Cash and due from banks -- The carrying amount is considered a reasonable estimate of fair value.
Accrued interest receivable -- The carrying amount is considered a reasonable estimate of fair value.
Deposits -- The carrying amount is considered a reasonable estimate of fair value for demand and savings deposits and other variable rate deposit accounts. The fair values for fixed maturity certificates of deposit and other time deposits are estimated using the rates currently offered for deposits of similar remaining maturities.
Securities sold under agreements to repurchase and other borrowings - - -- Fair values are estimated using rates currently available to the Corporation for similar types of borrowing transactions.
Accrued interest payable -- The carrying amount is considered a reasonable estimate of fair value.
Commitments to extend credit -- The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar arrangements, taking into account the remaining terms of the agreements, the creditworthiness of the counterparties, and the difference, if any, between current interest rates and the committed rates.
Standby letters of credit and financial guarantees written -- Fair values are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations.
Loans sold with recourse -- Fair value is estimated based on the present value of the estimated future liability in the event of default.
The estimated fair values of the Corporation's financial instruments based on the assumptions described above are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, financial guarantees, and loans sold with recourse.
These instruments involve, to varying degrees, elements recognized in the consolidated balance sheets. The contract or notional amount of these instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments.
The Corporation's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual notional amount of those instruments. The Corporation uses the obligations as it does for on-balance-sheet instruments.
Unless noted otherwise, the Corporation does not require collateral or other security to support financial instruments with credit risk. The following table sets forth financial instruments whose contract amounts represent credit risk.
Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally are extended at the then prevailing interest rates, have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Corporation upon extension of credit is based on Management's credit evaluation of the counter party. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. Standby letters of credit and financial guarantees written are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Except for short-term guarantees of $30,965 and $35,427 at December 31, 1996 and 1995, respectively, the remaining guarantees extend in varying amounts through 2020. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies, but may include marketable securities, equipment and real estate. In recourse arrangements, the Corporation accepts 100% recourse. By accepting 100% recourse, the Corporation is assuming the entire risk of loss due to borrower default. The Corporation's exposure to credit loss, if the borrower completely failed to perform and if the collateral or other forms of credit enhancement all prove to be of no value, is represented by the notional amount less any allowance for possible loan losses. The Corporation uses the same credit policies originating loans which will be sold with recourse as it does for any other type of loan.
18. EXTRAORDINARY GAIN AND UNUSUAL CHARGES
During the third quarter, the corporation recorded a one-time Savings Association Insurance Fund ("SAIF") recapitalization charge that totaled $10.2 million. The charge was mandated by legislation passed by Congress and signed into law September 30, 1996.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
During 1995, the Corporation recognized an extraordinary gain of $5,599, net of taxes of $3,015, from the sale of several apartment complexes formerly owned by a CIVISTA subsidiary.
Other 1995 unusual charges included the following items: a) fees, expenses, and lost tax benefits of $16,214 related to the acquisitions of CIVISTA; b) an expense of $2,199 related to an early retirement program; and c) a reengineering plan that was implemented to improve the overall operating effectiveness of the Corporation, improve productivity within the branch network and centralize operational functions previously handled by affiliate banks. The charges associated with this plan totaled $17,838 on a pre-tax basis, the components of which were as follows: $6,584 in adjustments to the value of buildings, equipment and other assets; $2,875 increase to reserves; $4,688 in severance costs; and $3,691 in consulting, sales training, and merchandising expenses consistent with the launch of FirstMerit's new retail emphasis. The severance charge relates to a management and employee staff reduction of approximately 400 people. As of December 31, 1996, implementation of the reengineering plan that began in 1995 was completed.
19. CONTINGENCIES
The nature of the Corporation's business results in a certain amount of litigation. Accordingly, FirstMerit Corporation and its subsidiaries are subject to various pending and threatened lawsuits in which claims for monetary damages are asserted. Management, after consultation with legal counsel, is of the opinion that the ultimate liability of such pending matters would not have a material effect on the Corporation's financial condition or results of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
20. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial and per share data for the years ended December 31, 1996 and 1995 are summarized as follows:
21. SHAREHOLDER RIGHTS PLAN
The Corporation has in effect a shareholder rights plan ("Plan"). The Plan provides that each share of Common Stock has one right attached. Under the Plan, subject to certain conditions, the Rights would be distributed after either of the following events: (1) a person acquires 10% or more of the Common Stock of the Corporation, or (2) the commencement of a tender offer that would result in a change in the ownership of 10% or more of the Common Stock. After such an event, each Right would entitle the holder to purchase shares of Series A Preferred Stock of the Corporation. Subject to certain conditions, the Corporation may redeem the Rights for $0.01 per Right.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
22. REGULATORY MATTERS
The Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory -- and possibly additional discretionary -- actions by regulators that, if undertaken, could have a material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's capital amounts and classification are also subject to quantitative judgments by regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 1996, that the Corporation meets all capital adequacy requirements to which it is subject. The capital terms used in this note to the consolidated financial statements are defined in the regulations as well as in the "Capital Resources" section of Management's Discussion and Analysis of financial condition and results of operations.
As of December 31, 1996, the most recent notification from the Office of the Comptroller of the Currency ("OCC") categorized the Corporation as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Corporation must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. In Management's opinion there are no conditions or events since the OCC's notification that have changed the Corporation's categorization as well capitalized.
MANAGEMENT'S REPORT
The management of FirstMerit Corporation is responsible for the preparation and accuracy of the financial information presented in this annual report. These consolidated financial statements were prepared in accordance with generally accepted accounting principles, based on the best estimates and judgement of management.
The Corporation maintains a system of internal controls designed to provide reasonable assurance that assets are safeguarded, that transactions are executed in accordance with the Corporation's authorization and policies, and that transactions are properly recorded so as to permit preparation of financial statements that fairly present the financial position and results of operations in conformity with generally accepted accounting principles. These systems and controls are reviewed by our internal auditors and independent auditors.
The Audit Committee of the Board of Directors is composed of only outside directors and has the responsibility for the recommendation of the independent auditors for the Corporation. The Audit Committee meets regularly with management, internal auditors and our independent auditors to review accounting, auditing and financial matters. The independent auditors and the internal auditors have free access to the Audit Committee.
/s/ JOHN R. COCHRAN /s/ JACK R. GRAVO JOHN R. COCHRAN JACK R. GRAVO President and Chief Executive Vice President Executive Officer Finance and Administration
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheets of FirstMerit Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the three year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FirstMerit Corporation and subsidiaries as of December 31, 1996 and 1995 and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1996 in conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand
Akron, OH January 16, 1997
AVERAGE CONSOLIDATED BALANCE SHEETS, FULLY-TAX EQUIVALENT INTEREST RATES AND INTEREST DIFFERENTIAL
FIRSTMERIT CORPORATION AND SUBSIDIARIES
- - ---------------
Notes: Interest income on tax-exempt securities and loans have been adjusted to a fully-taxable equivalent basis.
Non-accrual loans have been included in the average balances.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information about the Directors of FirstMerit, see "Election of Directors" on pages 1 through 5 of FirstMerit's Proxy Statement dated February 26, 1997 ("Proxy Statement"), which is incorporated herein by reference.
Information about the Executive Officers of FirstMerit appears in Part I of this report.
Disclosures by FirstMerit with respect to compliance with Section 16(a) appear on page 5 of the Proxy Statement, and are incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
See "Executive Compensation and Other Information" on pages 6 through 16 of the Proxy Statement, which is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
See "Principal Shareholders" and "Election of Directors" at page 25, and pages 1 through 5, respectively, of the Proxy Statement, which are incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See "Certain Relationships and Related Transactions" at pages 18 and 19 of the Proxy Statement, which is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following Financial Statements appear in Part II of this Report:
Consolidated Balance Sheets
December 31, 1996 and 1995
Consolidated Statements of Income
Years ended December 31, 1996, 1995 and 1994
Consolidated Statements of Changes in Shareholders' Equity
Years ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows
Years ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
Years ended December 31, 1996, 1995 and 1994
Management's Report
Independent Auditors' Report
(a)(2) Financial Statement Schedules
All schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes which appear in Part II of this report.
(a)(3) Management Contracts or Compensatory Plans or Arrangements
See those documents listed on the Exhibit Index which are marked as such.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by FirstMerit during the fourth quarter of 1996.
(c) Exhibits
See the Exhibit Index.
(d) Financial Statements
See subparagraph (a)(1) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Akron, State of Ohio, on the 26th day of February, 1997.
FirstMerit Corporation
By: /s/ John R. Cochran ---------------------------------- John R. Cochran, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on the 20th day of February, 1997 by the following persons (including a majority of the Board of Directors of the registrant) in the capacities indicated.
EXHIBIT INDEX