1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997 COMMISSION FILE NUMBER 0-10161 FIRSTMERIT CORPORATION (Exact name of registrant as specified in its charter) OHIO 34-1339938 (State or other jurisdiction of (IRS Employer Identification incorporation or organization) Number) III CASCADE PLAZA, 7TH FLOOR, AKRON, OHIO 44308-1103 (Address of principal Executive Offices) (330) 996-6300 (Telephone Number) OUTSTANDING SHARES OF COMMON STOCK, AS OF JUNE 30, 1997 31,194,611 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO 2 FIRSTMERIT CORPORATION PART I - FINANCIAL STATEMENTS ITEM 1. FINANCIAL STATEMENTS - - - ----------------------------- The following statements included in the quarterly unaudited report to shareholders are incorporated by reference: Consolidated Balance Sheets as of June 30, 1997, December 31, 1996 and June 30, 1996 Consolidated Statements of Income for the three-month and six-month periods ended June 30, 1997 and 1996 Consolidated Statements of Changes in Shareholders' Equity for the year ended December 31, 1996 and for the six months ended June 30, 1997 Consolidated Statements of Cash Flows for the six months ended June 30, 1997 and 1996 Notes to Consolidated Financial Statements as of June 30, 1997, December 31, 1996, and June 30, 1996 Management's Discussion and Analysis of Financial Conditions as of June 30, 1997, December 31, 1996 and June 30, 1996 and Results of Operations for the quarter and six months ended June 30, 1997 and 1996 and for the year ended December 31, 1996. 3 FIRSTMERIT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - - - --------------------------------------- (In thousands) -------------------------------------------------------------- (Unaudited) (Unaudited) June 30 December 31 June 30 -------------------------------------------------------------- 1997 1996 1996 - - - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS Investment securities $ 1,072,734 1,187,524 1,274,464 Federal funds sold 3,590 15,550 7,098 Commercial loans 1,508,604 1,373,806 1,350,506 Mortgage loans 931,530 944,887 1,242,316 Installment loans 1,183,530 1,072,921 1,008,166 Bankcard loans 89,426 90,028 84,210 Tax-free loans 12,908 15,119 18,154 Leases 151,687 159,237 152,545 ---------------------------------------------------------- Loans less unearned income 3,877,685 3,655,998 3,855,897 Less allowance for possible loan losses 50,893 49,336 47,772 ------------------------------------------------------------- Net loans 3,826,792 3,606,662 3,808,125 ------------------------------------------------------------- Total earning assets 4,903,116 4,809,736 5,089,687 Cash and due from banks 203,276 222,164 253,292 Premises and equipment, net 100,320 102,139 104,013 Accrued interest receivable and other assets 110,406 93,941 89,724 ------------------------------------------------------------- $ 5,317,118 5,227,980 5,536,716 ============================================================= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand-non-interest bearing $ 747,964 799,771 758,965 Demand-interest bearing 448,137 450,187 458,053 Savings 1,285,563 1,309,275 1,413,676 Certificates and other time deposits 1,721,152 1,645,642 1,740,398 ------------------------------------------------------------- Total deposits 4,202,816 4,204,875 4,371,092 Securities sold under agreements to repurchase and other borrowings 514,680 423,701 577,848 ------------------------------------------------------------- Total funds 4,717,496 4,628,576 4,948,940 Accrued taxes, expenses, and other liabilities 82,462 75,697 61,917 ------------------------------------------------------------- Total liabilities 4,799,958 4,704,273 5,010,857 Shareholders' equity: Series preferred stock, without par value: authorized and unissued 7,000,000 shares - - - Common stock, without par value: authorized 80,000,000 shares; issued 33,970,672 33,859,875 and 33,680,544 shares, respectively 109,752 107,343 104,808 Treasury stock, 2,776,061, 1,903,482 and 1,073,324 shares, respectively (90,956) (59,258) (30,153) Net unrealized holding gains (losses) on available for sale securities (2,143) (2,217) (12,853) Retained earnings 500,507 477,839 464,057 ------------------------------------------------------------- Total shareholders' equity 517,160 523,707 525,859 ------------------------------------------------------------- $ 5,317,118 5,227,980 5,536,716 ============================================================= See accompanying notes to consolidated financial statements. 4 FIRSTMERIT CORPORATION AND SUBSIDIARIES AVERAGE CONSOLIDATED BALANCE SHEETS - - - ------------------------------------ (In thousands except ratios) (Unaudited) Quarters ----------------------------------------------------------------------------------- 1997 1996 ----------------------------------------------------------------------------------- 2nd 1st 4th 3rd 2nd - - - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS Investment securities $ 1,091,932 1,148,175 1,271,617 1,279,273 1,313,661 Federal funds sold 686 7,404 36,692 7,844 13,735 Loans less unearned income 3,818,378 3,692,250 3,797,123 3,858,654 3,829,106 Less allowance for possible loan losses 50,471 49,666 46,563 47,476 48,151 -------------------------------------------------------------------------------- Net loans 3,767,907 3,642,584 3,750,560 3,811,178 3,780,955 -------------------------------------------------------------------------------- Total earning assets 4,860,525 4,798,163 5,058,869 5,098,295 5,108,351 Cash and due from banks 172,099 183,034 201,148 202,548 217,967 Premises and equipment, net 100,487 101,606 104,875 104,442 101,933 Accrued interest receivable and other assets 101,854 79,602 74,989 83,146 78,603 -------------------------------------------------------------------------------- $ 5,234,965 5,162,405 5,439,881 5,488,431 5,506,854 ================================================================================ LIABILITIES Deposits: Demand-non-interest bearing $ 731,273 711,995 759,224 747,318 768,507 Demand-interest bearing 447,398 446,893 453,654 448,771 453,118 Savings 1,283,787 1,288,069 1,353,270 1,388,472 1,423,458 Certificates and other time deposits 1,696,932 1,647,357 1,784,786 1,759,320 1,746,516 -------------------------------------------------------------------------------- Total deposits 4,159,390 4,094,314 4,350,934 4,343,881 4,391,599 Securities sold under agreements to repurchase and other borrowings 478,178 454,334 488,189 553,743 520,575 -------------------------------------------------------------------------------- Total funds 4,637,568 4,548,648 4,839,123 4,897,624 4,912,174 Accrued taxes, expenses and other liabilities 85,395 87,938 78,350 65,973 65,567 -------------------------------------------------------------------------------- Total liabilities 4,722,963 4,636,586 4,917,473 4,963,597 4,977,741 SHAREHOLDERS' EQUITY 512,002 525,819 522,408 524,834 529,113 -------------------------------------------------------------------------------- $ 5,234,965 5,162,405 5,439,881 5,488,431 5,506,854 ================================================================================ RATIOS Net income as a percentage of: Average assets 1.63% 1.59% 1.39% 0.97% 1.40% Average shareholders' equity 16.70% 15.61% 14.48% 10.19% 14.61% See accompanying notes to consolidated financial statements. 5 FIRSTMERIT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME - - - ---------------------------------------------- (Unaudited) (In thousands except per share data) ------------------------------------------------------------------------- Quarters Ended Six Months Ended June 30, June 30, 1997 1996 1997 1996 - - - ------------------------------------------------------------------------------------------------------------------------------------ Interest income: Interest and fees on loans $ 85,165 82,989 165,765 163,298 Interest and dividends on securities: Taxable 15,918 18,754 32,674 38,557 Exempt from Federal income taxes 1,123 1,377 2,243 2,665 Interest on Federal funds sold 9 265 95 492 -------------------------------- ---------------------------------- Total interest income 102,215 103,385 200,777 205,012 -------------------------------- ---------------------------------- Interest expense: Interest on deposits: Demand-interest bearing 1,681 1,983 3,448 2,899 Savings 7,609 8,135 14,912 17,640 Certificates and other time deposits 22,659 23,301 44,335 47,942 Interest on securities sold under agreements to repurchase and other borrowings 6,025 6,461 11,337 12,636 -------------------------------- ---------------------------------- Total interest expense 37,974 39,880 74,032 81,117 -------------------------------- ---------------------------------- Net interest income 64,241 63,505 126,745 123,895 Provision for possible loan losses 5,033 3,170 9,194 6,127 -------------------------------- ---------------------------------- Net interest income after provision for possible loan losses 59,208 60,335 117,551 117,768 -------------------------------- ---------------------------------- Other income: Trust department income 3,288 3,227 6,399 6,191 Service charges on depositors' accounts 6,423 6,086 12,930 11,475 Credit card fees 3,633 2,994 6,593 5,487 Service fees - other 1,845 1,450 3,823 3,061 Securities gains (losses) 477 (55) 940 212 Gain on sales of loans, net 881 1,081 2,004 1,812 Other operating income 3,271 2,901 6,705 9,079 -------------------------------- ---------------------------------- Total other income 19,818 17,684 39,394 37,317 -------------------------------- ---------------------------------- 79,026 78,019 156,945 155,085 -------------------------------- ---------------------------------- Other expenses: Salaries, wages, pension and employee benefits 23,489 23,839 46,470 47,933 Net occupancy expense 3,970 4,298 8,631 8,622 Equipment expense 3,217 2,995 6,714 6,247 Other operating expense 16,903 18,208 33,511 34,787 -------------------------------- ---------------------------------- Total other expenses 47,579 49,340 95,326 97,589 -------------------------------- ---------------------------------- Income before Federal income taxes 31,447 28,679 61,619 57,496 Federal income taxes 10,128 9,458 20,067 19,022 -------------------------------- ---------------------------------- Net income $ 21,319 19,221 41,552 38,474 ================================ ================================== Per share data based on average number of shares outstanding: Net Income $ 0.67 0.59 1.31 1.17 ================================ ================================== Dividends paid $ 0.29 0.27 0.58 0.54 Weighted average number of shares outstanding 31,451,196 32,812,388 31,648,363 33,030,297 See accompanying notes to consolidated financial statements. 6 FIRSTMERIT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY - - - --------------------------------------------------------------- Year Ended December 31, 1996 and Six Months Ended June 30, 1997 (In Thousands) ----------------------------------------------------------------------------- Net unrealized holding gains (losses) on Total Common Treasury available for Retained Shareholders' Stock Stock sale securities Earnings Equity ----------- ------------ ---------------- --------- ------------- Balance at December 31, 1995 $103,861 (2,963) (1,292) 443,275 542,881 Net Income -- -- -- 70,940 70,940 Cash dividends ($1.10 per share) -- -- -- (36,376) (36,376) Stock options exercised 3,482 -- -- -- 3,482 Treasury shares purchased -- (56,295) -- -- (56,295) Market adjustment investment securities -- -- (925) -- (925) -------- -------- -------- -------- -------- Balance at December 31, 1996 107,343 (59,258) (2,217) 477,839 523,707 Net Income -- -- -- 41,552 41,552 Cash dividends ($0.58 per share) -- -- -- (18,884) (18,884) Stock options exercised 2,409 -- -- -- 2,409 Treasury shares purchased -- (31,698) -- -- (31,698) Market adjustment investment securities -- -- 74 -- 74 -------- -------- -------- -------- -------- Balance at June 30, 1997 $109,752 (90,956) (2,143) 500,507 517,160 ======== ======== ======== ======== ======== See accompanying notes to consolidated financial statements. 7 FIRSTMERIT CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows Six Months Ended June 30, 1997 and 1996 (In thousands) ------------------------ 1997 1996 -------- ------- Operating Activities ---------------------------- Net income $ 41,552 38,474 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 9,194 6,127 Provision for depreciation and amortization 5,217 4,738 Amortization of investment securities premiums, net 1,826 1,606 Amortization of income for lease financing (6,560) (6,873) Gains on sales of investment securities, net (940) (212) Deferred federal income taxes 10,992 4,048 Increase in interest receivable (235) (3,396) Increase in interest payable 406 156 Amortization of values ascribed to acquired intangibles 936 1,611 Other increases (decreases) (21,836) (13,227) --------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 40,552 33,052 --------- -------- Investing Activities ---------------------------- Dispositions of investment securities: Available-for-sale - sales 100,678 27,468 Available-for-sale - maturities 116,892 166,656 Purchases of investment securities available-for-sale (103,555) (84,708) Net decrease in federal funds sold 11,960 5,477 Net increase in loans and leases (222,764) (83,853) Purchases of premises and equipment (5,682) (15,487) Sales of premises and equipment 2,284 894 --------- -------- NET CASH PROVIDED\(USED) BY INVESTING ACTIVITIES (100,187) 16,447 --------- -------- Financing Activities ---------------------------- Net decrease in demand, NOW and savings deposits (77,569) (67,539) Net increase (decrease) in time deposits 75,510 (63,294) Net increase in securities sold under repurchase agreements and other borrowings 90,979 90,890 Cash dividends (18,884) (17,692) Purchase of treasury shares (31,698) (27,190) Proceeds from exercise of stock options 2,409 947 -------- -------- NET CASH PROVIDED\(USED) BY FINANCING ACTIVITIES 40,747 (83,878) Decrease) in cash and cash equivalents (18,888) (34,379) Cash and cash equivalents at beginning of year 222,164 267,671 -------- -------- Cash and cash equivalents at end of year $203,276 253,292 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION: ---------------------------------------------------- Cash paid during the year for: Interest, net of amounts capitalized $ 74.894 46,788 Income taxes $ 20,000 15,462 ======== ======== See accompanying notes to consolidated financial statements. 8 FIRSTMERIT CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 1997, December 31, 1996 and June 30, 1996 1. FirstMerit Corporation ("Corporation"), is a bank holding company whose principal assets are the common stock of its wholly owned subsidiaries, First National Bank of Ohio, The Old Phoenix National Bank of Medina, EST National Bank, Citizens National Bank, Peoples National Bank, and Peoples Bank, N.A. In addition FirstMerit Corporation owns all of the common stock of Citizens Investment Corporation, Citizens Savings Corporation of Stark County, FirstMerit Community Development Corporation, and FirstMerit Credit Life Insurance Company. 2. In February 1997, the Financial Accounting Standards Board issued Statement No. 128 ("SFAS 128"), "Earnings per Share" ("EPS"). SFAS 128 simplifies the standards for computing earnings per share previously found in APB Opinion No. 15 ("APB 15"), "Earnings per Share," and makes the standards comparable to recently adopted international EPS guidelines. SFAS 128 replaces the presentation of "Primary" EPS with the presentation of "Basic" EPS. It also requires dual presentation of Basic and Diluted EPS on the face of the statements of income and a reconciliation of the numerator and denominator between the Basic EPS and Diluted EPS calculations. Basic EPS excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding. Diluted EPS reflects the dilution that would occur if securities or other contracts to issue common stock were exercised or converted to common stock (e.g., exercising of common stock options). SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods; earlier application is not permitted. An entity is, however, permitted to disclose pro forma Earnings per Share amounts using SFAS 128 in the notes to the financial statements in periods before adoption. After the effective date, all prior period EPS data must be restated. In the accompanying Statements of Income, net income per share calculated under existing standard APB 15 was $0.67 for the quarter ended June 30, 1997 and $1.31 for the 1997 year-to-date period. For the comparable 1996 quarter and six-month periods, APB 15 EPS was $0.59 and $1.17, respectively. Basic EPS, calculated under SFAS 128, also resulted in earnings per share totals of $0.67 for the 1997 second quarter, $1.31 for the six months ended June 30, 1997, $0.59 for the quarter ended June 30, 1996, and $1.17 for the 1996 first half. Diluted EPS for the 1997 second quarter totaled $0.67 compared to $0.58 for the same quarter last year. For the year-to-date periods, diluted EPS was $1.30 for 1997 and $1.16 for 1996. For the quarter ended June 30, 1997, under SFAS 128, the potential dilution of unexercised stock options added 306,000 shares to the existing 31,451,196 weighted-average shares outstanding. For the six months ended June 30, 1997, the potential dilution of unexercised stock options under SFAS 128 added 277,206 shares to the existing weighted-average totals of 31,648,363. If SFAS 128 had been applied to the three months ended June 30, 1996, outstanding common stock options would have added 193,099 to the existing outstanding shares total of 9 32,812,388. For the 1996 first half, SFAS 128 requirements would have increased weighted-average outstanding shares by 210,529. For all periods presented, there were no differences in the numerators for the proforma Basic and Diluted EPS computations. 3. The Corporation cautions that any forward looking statements contained in this report, in a report incorporated by reference to this report or made by management of the Corporation, involve risks and uncertainties and are subject to change based upon various factors. Actual results could differ materially from those expressed or implied. 4. Management believes the interim consolidated financial statements reflect all adjustments consisting only of normal recurring accruals, necessary for fair presentation of the June 30, 1997 and June 30, 1996 statements of condition and the results of operations for the quarters and six month periods ended June 30, 1997 and 1996. 10 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Average Consolidated Balance Sheet, Fully-tax Equivalent Interest Rates and Interest Differential (Dollars in thousands) Quarter ended June 30, Year ended December 31, ------------------------------------- ------------------------------------- 1997 1996 ------------------------------------- ------------------------------------- Average Average Average Balance Interest Rate Balance Interest Rate - - - ------------------------------------------- ------------------------------------- -------------------------------------- ASSETS Investment securities 1,091,932 17,732 6.51% 1,311,188 82,903 6.32% Federal funds sold 686 9 5.26% 19,233 934 4.86% Loans, net of unearned income 3,818,378 85,293 8.96% 3,812,900 330,951 8.68% Less allowance for possible loan losses 50,471 47,392 ------------- ------------ ----------- ----------- Net loans 3,767,907 85,293 9.08% 3,765,508 330,951 8.79% Cash and due from banks 172,099 - - 207,533 - - Other assets 202,341 - - 175,020 - - ------------- ------------ ----------- ----------- Total assets 5,234,965 103,034 - 5,478,482 414,788 - ============= ============ ============ =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand- non-interest bearing 731,273 - - 745,102 - - Demand- interest bearing 447,398 1,681 1.51% 447,524 7,839 1.75% Savings 1,283,787 7,609 2.38% 1,399,011 32,446 2.32% Certificates and other time deposits 1,696,932 22,659 5.36% 1,772,150 95,379 5.38% -------------------------- ----------- ---------- Total deposits 4,159,390 31,949 3.08% 4,363,787 135,664 3.11% Federal funds purchased, securities sold under agreements to repurchase and 478,178 6,025 5.05% 515,556 25,109 4.87% other borrowings Other liabilities 85,395 - 71,240 - Shareholders' equity 512,002 - 527,899 - ------------- ------------ ----------- ------------ Total liabilities and shareholders' equity 5,234,965 37,974 - 5,478,482 160,773 - ============= ============ =========== =========== Total earning assets 4,860,525 103,034 8.50% 5,095,929 414,788 8.14% ============= ============ =========== =========== Total interest bearing liabilities 3,906,295 37,974 3.90% 4,134,241 160,773 3.89% ============= ============ =========== =========== Net yield on earning assets 65,060 5.37% 254,015 4.98% ============ ====== ========== ====== Interest rate spread 4.60% 4.25% ====== ====== Quarter ended June 30, ------------------------------------- 1996 ------------------------------------- Average Balance Interest Rate ------------------------------------- ASSETS Investment securities 1,313,661 20,740 6.35% Federal funds sold 13,735 265 7.76% Loans, net of unearned income 3,829,106 83,147 8.73% Less allowance for possible loan losses 48,151 ------------- ---------- Net loans 3,780,955 83,147 8.84% Cash and due from banks 217,967 - - Other assets 180,536 - - ------------- ---------- Total assets 5,506,854 104,152 - ============= ========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand- non-interest bearing 768,507 - - Demand- interest bearing 453,118 1,983 1.76% Savings 1,423,458 8,135 2.30% Certificates and other time deposits 1,746,516 23,301 5.37% ------------ ---------- Total deposits 4,391,599 33,419 3.06% Federal funds purchased, securities sold under agreements to repurchase and 520,575 6,461 4.99% other borrowings Other liabilities 65,567 - Shareholders' equity 529,113 - ------------ ---------- Total liabilities and shareholders' equity 5,506,854 39,880 - ============ ========== Total earning assets 5,108,351 104,152 8.20% ============ ========== Total interest bearing liabilities 4,143,667 39,880 3.87% ============ ========== Net yield on earning assets 64,272 5.06% ========== ====== Interest rate spread 4.33% ====== *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. 11 RESULTS OF OPERATIONS FirstMerit Corporation's net income for the quarter ended June 30, 1997 was $21,319,000, 11% higher than last year's second quarter income of $19,221,000. Return on average equity was 16.70% and return on average assets was 1.63%. The same profitability ratios for the 1996 second quarter were 14.61% and 1.40%, respectively. For the first half ended June 30, 1997, net income was $41,552,000, up 8% from last year's six-month earnings of $38,474,000. Return on average equity was 16.37%, and return on average assets was 1.61%. The comparable ratios for the same period last year were 14.51% and 1.41%, respectively. Fully taxable equivalent ("FTE") net interest income for the second quarter was $65,060,000, a $788,000 increase over the same period last year. FTE net interest income for the 1997 six-month period was $128,425,000, up 2% from $125,454,000 one year ago. A higher net interest margin increased net interest income for both 1997 periods even though earning assets declined since last year. Specifically, average earning assets were down 5% for the quarter and 6 % for the half. The asset decline since last year was primarily due to a planned strategy to reduce low-yielding assets through the liquidation of investment securities and sale of less profitable branches. The net interest margin for both the quarter and six-month periods was 5.37%, 31 basis points higher than last year's second quarter margin of 5.06% and an improvement of 44 basis points from 1996's year-to-date margin of 4.93%. Other income rose 12% during the quarter from $17,684,000 to $19,818,000. Increased credit card fees and service charge income accounted for $1,371,000, or 64% of the increase. Higher credit card fees and service charges also contributed to the $2,077,000 increase in total year-to-date other income that was achieved despite pre-tax branch sale gains of $3,186,000 recorded during the first quarter of 1996. Other expenses totaled $47,579,000 for the quarter, a decline of 4% from last year's level. Similarly, six-month other expenses were $95,326,000 compared to 1996's operating costs of $97,589,000. Regulatory changes that reduced deposit insurance premiums, effective September 30, 1996, lowered the 1997 second quarter insurance expense by $616,000 and the six-month expense by $1,254,000. The continued improvement in the efficiency ratio of 55.82% for the quarter and 56.56% for the half-year period demonstrates FirstMerit's on-going commitment to expense control. Nonperforming assets were 0.27% of total loans and Other Real Estate compared to 0.30% at June 30, 1996. Net charge-offs to average loans, on an annualized basis, were 0.41% for the six-month period versus 0.27% for the same period last year. At June 30, 1997, the allowance for loan losses as a percentage of outstanding loans totaled 1.31%, up from 1.24% one year ago. The allowance to 12 nonperforming loan coverage ratio totaled 5.22 times at quarter-end and 4.47 times at June 30, 1996. Earnings per share for the second quarter were $0.67, an increase of 14% over last year's quarterly earnings of $0.59. For the six months ended June 30, 1997, earnings per share were $1.31, 12% higher than the $1.17 recorded for the 1996 first half. The components of change in per share income for the quarters and six months ended June 30, 1997 and 1996 are summarized in the following table: CHANGES IN EARNINGS PER SHARE Three months ended Six months ended June 30, June 30, 1997/1996 1997/1996 ------------------------------------------- Net income per share June 30, 1996 $0.59 1.17 Increases (decreases) due to: Net interest income - taxable equivalent 0.02 0.09 Provision for possible loan losses (0.06) (0.10) Other income 0.07 0.07 Other expenses 0.05 0.07 Federal income taxes - taxable equivalent (0.02) (0.04) Reduction in weighted-average shares outstanding due to share repurchases 0.02 0.05 ------------------------------------- Net change in net income per share 0.08 0.14 ------------------------------------- Net income per share June 30, 1997 $0.67 1.31 ===================================== NET INTEREST INCOME Net interest income, the Corporation's principal source of earnings, is the difference between the interest income generated by earning assets (primarily loans and investment securities) and the total interest paid on interest bearing funds (namely deposits and other borrowings). For the purpose of this discussion, net interest income is presented on a fully-taxable equivalent ("FTE") basis, to provide a comparison among 13 types of interest earning assets. That is, interest on tax-free securities and tax-exempt loans has been restated as if such interest were taxed at the statutory Federal income tax rate of 35%, adjusted for the non-deductible portion of interest expense incurred to acquire the tax-free assets. Net interest income FTE for the quarter ended June 30, 1997 was $65,060,000 compared to $64,272,000 for the same period one year ago, an increase of $788,000. The increase in net interest income occurred as the drop in interest paid on deposits and borrowings outpaced the decline in interest income. The lower interest income was a result of a tactic to reinvest lower yielding investment securities and mortgage loans into higher earning commercial and consumer credits. Specifically, the reduction in outstanding investment securities reduced quarterly income by $3,601,000, when compared to the same period last year, but higher loan yields recovered $2,386,000 or two-thirds of the decline. For the second quarter, the yield on average loans increased 23 basis points from 8.73% in 1996 to 8.96%. The trend of the drop in interest expense exceeding the decline in interest income, and the redeployment of maturing and sold assets into higher yielding loans was also prevalent during the 1997 six-month period. For the first half, higher yielding loans and securities recovered $5,616,000, or 60% of the drop in interest income caused by fewer securities and loans outstanding. Loan yields for the first six months averaged 8.91%, a quarter of one percent better than the 8.66% earned during last year's first half. With regard to interest bearing liabilities, declining balances contributed $2,046,000 and $7,657,000, to the quarterly and year-to-date reductions in interest expense, respectively. The average cost of funds for the quarter was 3.90%, up slightly from the 3.87% recorded one year ago. For the six-month period, cost of funds averaged 3.86% compared to 3.93% last year. The following schedule illustrates in more detail the change in net interest income FTE by rate and volume components for both interest earning assets and interest bearing liabilities. 14 CHANGES IN NET INTEREST DIFFERENTIAL - FULLY-TAX EQUIVALENT RATE/VOLUME ANALYSIS (DOLLARS IN THOUSANDS) Quarters ended Six Months Ended June 30, June 30, 1997 and 1996 1997 and 1996 ------------- ------------- Increase (Decrease) Increase (Decrease) Interest Income/Expense Interest Income/Expense ----------------------- ----------------------- Volume Yield Rate Total Volume Yield Rate Total --------------------------------------------------------------------------- INTEREST INCOME Investment Securities $(3,601) 593 (3,008) (7,345) 1,235 (6,110) Loans (240) 2,386 2,146 (1,985) 4,381 2,396 Federal funds sold (171) (85) (256) (1,299) 902 (397) --------------------------------------------------------------------------- Total interest income $(4,012) 2,894 (1,118) (10,629) 6,518 (4,111) INTEREST EXPENSE Interest on deposits: Demand-interest bearing (21) (281) (302) (2,262) 2,811 549 Savings (828) 302 (526) (1,646) (1,082) (2,728) Certificates and other time deposits (662) 20 (642) (2,684) (923) (3,607) Federal Funds Purchased, REPOs & other borrowings (534) 98 (436) (1,065) (234) (1,299) --------------------------------------------------------------------------- Total interest expense $(2,045) 139 (1,906) (7,657) 572 (7,085) --------------------------------------------------------------------------- Net interest income $(1,967) 2,755 788 (2,972) 5,946 2,974 =========================================================================== NET INTEREST MARGIN The net interest margin, net interest income FTE divided by average earning assets, is affected by changes in the level of earning assets, the proportion of earning assets funded by non-interest bearing liabilities, the interest rate spread, and changes in the corporate tax rates. A meaningful comparison of the net interest margin requires an adjustment for the changes in the statutory Federal income tax rate noted above. The schedule below shows the relationship of the tax equivalent adjustment and the net interest margin. 15 NET INTEREST MARGIN (DOLLARS IN THOUSANDS) Quarters Ended Six Months Ended June 30, June 30, ---------------------------------------------------------------------- 1997 1996 1997 1996 --------------------------------- ----------------------------------- Net interest income per financial statements $64,241 63,505 126,745 123,895 Tax equivalent adjustment 819 767 1,680 1,559 --------------------------------- ----------------------------------- Net interest income - FTE $65,060 64,272 128,425 125,454 ================================= =================================== Average earning assets $4,860,525 5,108,351 4,826,540 5,115,362 ================================= =================================== Net interest margin 5.37% 5.06% 5.37% 4.93% ====================================================================== Average loans outstanding for the quarter ended June 30, 1997 were $3,818,378,000, down less than one-half of one percent from $3,829,106,000 for the same quarter last year. The decline occurred because loan sales, securitizations, and repayments over the last twelve months were slightly more than new loans originated. Similarly, for the first half of 1997, average loan outstandings totaled $3,755,597,000, down one percent from $3,800,498,000 for the prior year. Average outstanding loans for the quarter and six-month periods equaled 78.6% and 77.8% of average earning assets, respectively. Average certificates and other time deposits totaled $1,696,932 at June 30, 1997, down 2.8% from $1,746,516,000 at June 30, 1996. On a percentage basis, however, average certificates and other time deposits increased from 42.1% of total interest bearing funds at June 30, 1996 to 43.4% at June 30, 1997. Average savings deposits decreased from 34.4% of interest bearing funds at June 30, 1996 to 32.9% at June 30, 1997, while total demand deposits increased from 29.5% of total interest bearing funds at June 30, 1996 to 30.2% at June 30, 1997. Interest bearing deposits increased from 87.4% of interest bearing funds at the end of the 1996 second quarter to 87.8% at the end of the 1997 second quarter. Conversely, other borrowings decreased from 12.6% of total interest bearing funds at June 30, 1996 to 12.2% at June 30, 1997. In summary, on a percentage basis, during the twelve months ended June 30, 1997, customer deposits shifted from savings into demand deposits and certificates and other time deposits. The Corporation also used excess funds to pay down other borrowings. 16 During the second quarter 1997, interest bearing liabilities funded 80.4% of average earning assets compared to 81.1% one year ago. The decline in use of interest bearing liabilities as a loan and investment securities funding source helped keep the cost of funds rate at a level comparable with last year's second quarter. OTHER INCOME Other income for the quarter ended June 30, 1997 was $19,818,000, an increase of $2,134,000 or 12%, over the $17,684,000 earned during the same period last year. Excluding securities sales, the increase in other income was $1,602,000, or 9%. For the six-month period, other income totaled $39,394,000 compared to $37,317,000 a year ago. The sale of three branches during the 1996 first quarter, contributed $3,186,000 to last year's first half other income. The prior year gains from the branch sales were included in the "other operating income" category of the income statement. Trust department income for the second quarter was $3,288,000, up slightly from the $3,227,000 earned one year ago. Service charges on depositors' accounts increased 5.5% to $6,423,000 from $6,086,000 for last year's second quarter. Credit card fees increased 21.3% to $3,633,000 for the quarter compared to $2,994,000 for the three months ended June 30, 1996. Other service fees, including Automated Teller Machine (ATM) revenue, were $1,845,000, an increase of 27.2% over last year's second quarter total of $1,450,000. For the 1997 first half, compared to the same period last year, trust department income increased 3.4% to $6,399,000, service charges on depositors' accounts increased 12.7% to $12,930,000, credit card fees increased 20.2% to $6,593,000, and other service fees, which include ATM revenue, increased 24.9% to $3,823,000. Other income is especially important to banks as it provides a source of revenues not sensitive to the interest rate environment. To complement the increases in fee income attained during the first half of 1997, the Corporation acquired, in May 1997, Abell & Associates, Inc., a nationally known life insurance and financial consulting firm. This acquisition represents a major step for the Corporation in the creation of a single center of excellence for wealth management. Abell & Associates will concentrate on the high net worth segment of FirstMerit's customer base, providing services to executives of public corporations, professionals, and owners of closely-held companies. This acquisition along with the investment and wealth-building activities of FirstMerit Investment Services Group (which includes discount brokerage, insurance, annuities, mutual funds, and trust services) should help the Corporation continue to improve on the 1997 trend of increased fee income. 17 OTHER EXPENSES Other expenses were $47,579,000 for the second quarter, a decline of $1,761,000 or 3.6%, over the $49,340,000 recorded during the same quarter last year. For the first half of 1997, other expenses totaled $95,326,000 versus $97,589,000 a year ago. The reduction in operating costs, coupled with higher net interest income and increased other income, reduced the efficiency ratio for the quarter from 59.20% in 1996 to 55.82% in 1997. A similar improvement in the year-to-date period was noted as the current year first half efficiency ratio was 56.56% compared to 59.10% last year. The second quarter efficiency ratio of 55.82% indicates that for every one dollar of pretax profit earned, 55.82 cents were used to cover operating costs. The continuing reduction in operating expenses demonstrates the Corporation's committment to keeping other expenses under control and in line with or better than peer results. During the quarter, salaries, wages, pension and employee benefits, the largest component of other expenses, decreased one and one-half percent to $23,489,000. For the six-month period, salaries, wages, pension and employee benefits dropped 3.1% to $46,470,000. The decline in personnel costs was attributable to continued refinement of teller staffing models and consolidation of responsibilities, where appropriate. Regulatory changes that reduced deposit insurance premiums, effective September 30, 1996, lowered 1997 second quarter insurance expense by $616,000 and the reduced the six-month expense by $1,254,000. 18 FINANCIAL CONDITIONS INVESTMENT SECURITIES All investment securities of the Corporation are classified as available for sale. The available for sale classification provides the Corporation with more flexibility to respond, through the portfolio, to changes in market interest rates, or to increases in loan demand or deposit withdrawals. The book value and market value of investment securities classified as available-for-sale are as follows: June 30, 1997 ------------- Gross Gross Book Unrealized Unrealized Market Value Gains Losses Value ---------------- ---------------- ---------------- ---------------- U.S. Treasury securities and U.S. Government agency obligations $ 605,888 1,747 5,316 602,319 Obligations of state and political subdivisions 87,236 227 248 87,215 Mortgage-backed securities 282,017 1,895 1,938 281,974 Other securities 100,885 825 484 101,226 ---------------- ---------------- ---------------- ---------------- $1,076,026 4,694 7,986 1,072,734 ================ ================ ================ ================ ---------------- ---------------- Due in one year or less $98,663 98,651 Due after one year through five years 337,116 336,730 Due after five years through ten years 159,545 159,320 Due after ten years 480,702 478,033 ---------------- ---------------- $1,076,026 1,072,734 ================ ================ The book value and market value of investment securities including mortgage-backed securities and derivatives at June 30, 1997, by contractual maturity, are shown above. Expected maturities will differ from contractual maturities based on the issuers' right to call or prepay obligations with or without call or prepayment penalties. 19 The carrying value of investment securities pledged to secure trust and public deposits and for purposes required or permitted by law amounted to approximately $689,623,000 at June 30, 1997, $724,886,000 at December 31, 1996 and $719,847,000 at June 30, 1996. Securities with remaining maturities over five years reflected in the foregoing schedule consist of mortgage and asset backed securities. These securities are purchased within an overall strategy to maximize future earnings taking into account an acceptable level of interest rate risk. While the maturities of these mortgage and asset backed securities are beyond five years, these instruments provide periodic principal payments and include securities with adjustable interest rates, reducing the interest rate risk associated with longer term investments. LOANS Total loans outstanding at June 30, 1997 amounted to $3,877,685,000 compared to $3,655,998,000 at December 31, 1996 and $3,855,897,000 at June 30, 1996. Steady demand since year end has resulted in growth of 6% through the first half, or approximately 12% on an annualized basis. At June 30, 1997, compared to the same quarter-end balances last year, commercial loans were $1,508,604,000 or 12% higher than last year's total; mortgage loans were $931,530,000, down 25%; and installment and bankcard loans (on a combined basis) were $1,272,956,000, up 17%. The shift in mix from lower yielding mortgage loans to higher earning commercial and consumer credits is clearly evident in the preceding loan category totals. The loan to funds ratio, a measure of the Corporation's liquidity, equaled 82.2% at June 30, 1997 compared to 79.0% at December 31, 1996 and 77.9% at June 30, 1996. ASSET QUALITY Total nonperforming assets (non-accrual and restructured loans and other real estate loans) amounted to $10,327,000 at June 30, 1997 or 0.27% of total loans and other real estate outstanding. At December 31, 1996, nonperforming assets totaled $10,576,000 or 0.29% of outstanding loans and other real estate compared to $11,489,000 or 0.30% of outstanding loans and other real estate at June 30, 1996. 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 illustrate the required impaired loan 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' 20 expected future cash flows at the loans' effective interest rates, at the loans' observable market prices, or the fair value of the underlying collateral. Under the Corporation's credit policies and practices, and in conjunction with provisions within Statements No. 114 and No. 118, all nonaccrual and restructured commercial, agricultural, construction, and commercial real estate loans, meet the definition of impaired loans. (Dollars in thousands) June 30, December 31, June 30, 1997 1996 1996 ----------------- ---------------- ------------------ Impaired Loans: Non-accrual $7,248 9,579 7,799 Restructured 90 92 1,367 - - - -------------------------------------------------------------------------------------------------------- Total impaired loans 7,338 9,671 9,166 ------------------ ---------------- ------------------ Other Loans: Non-accrual 2,418 787 1,528 Restructured --- --- --- - - - --------------------------------------------------------------------------------------------------------- Total other nonperforming loans 2,418 787 1,528 - - - --------------------------------------------------------------------------------------------------------- Total nonperforming loans 9,756 10,458 10,694 - - - --------------------------------------------------------------------------------------------------------- Other real estate owned 571 118 795 ------------------ ---------------- ------------------ Total nonperforming assets $10,327 10,576 11,489 ========================================================================================================= Loans past due 90 days or more accruing interest $6,222 8,380 7,806 ========================================================================================================= Total nonperforming assets as a percent of total loans 0.27% 0.29% 0.30% ========================================================================================================= <FN> N/A = Not Available 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. 21 ALLOWANCE FOR LOAN LOSSES The allowance for possible loan losses at June 30, 1997 totaled $50,893,000 or 1.31% of total loans outstanding compared to $49,336,000 or 1.35% and $47,772,000 or 1.24% at December 31, 1996 and June 30, 1996, respectively. (Dollars in thousands) June 30, December 31, June 30, 1997 1996 1996 ----------------- ----------------- ---------------- Balance at beginning of year $49,336 46,840 46,840 Provision charged to operating expenses 9,194 17,751 6,127 Loans charged off 13,245 21,230 7,965 Recoveries on loans previously charged off 5,608 5,975 2,770 ----------------- ----------------- ---------------- $50,893 49,336 47,772 ================= ================= ================ Net charge offs as a percent of average loans 0.40% 0.40% 0.27% Allowance for possible loan losses: As a percent of loans outstanding at end of period 1.31% 1.35% 1.24% As a multiple of annualized net charge offs 3.30X 3.23X 4.57X 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 operation 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. 22 Deposits The following schedule illustrates the change in composition of the average balances of deposits and average rates paid for the noted periods. (Dollars in Thousands) Three months and year ended -------------------------------------------------------------------------------- June 30, 1997 December 31, 1996 June 30, 1996 Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate ------------------------- ------------------------- ------------------------- Demand Deposits - non-interest bearing $731,273 - 745,102 - $768,507 - Demand Deposits - interest bearing 447,398 1.51% 447,524 1.75% 453,118 1.76% Savings Deposits 1,283,787 2.38% 1,399,011 2.32% 1,423,458 2.30% Certificates and other time deposits 1,696,932 5.36% 1,772,150 5.38% 1,746,516 5.37% --------------- -------------- -------------- $4,159,390 3.08% 4,363,787 3.11% $4,391,599 3.06% =============== ============== ============== The following table summarizes the certificates and other time deposits in amounts of $100,000 or more as of June 30, 1997 by time remaining until maturity. Amount Maturing in: (Dollars in Thousands) Under 3 months $215,808 3 to 12 months 110,702 Over 12 months 35,584 ----------------------- $362,094 ======================= 23 CAPITAL RESOURCES Shareholders' equity at June 30, 1997 totaled $517,160,000 compared to $523,707,000 at December 31, 1996 and $525,859,000 at June 30, 1996. The following table reflects the various measures of capital: As of As of As of June 30, December 31, June 30, 1997 1996 1996 (In thousands) Total equity $517,160 9.73% 523,707 10.02% 525,859 9.50% Common equity 517,160 9.73% 523,707 10.02% 525,859 9.50% Tangible common equity (a) 513,932 9.67% 519,950 9.95% 520,887 9.42% Tier 1 capital (b) 517,690 11.79% 523,911 12.63% 517,307 12.40% Total risk-based capital (c) 568,583 12.95% 573,247 13.82% 565,079 13.54% Leverage (d) 517,690 9.89% 523,911 9.63% 512,335 9.33% <FN> a) Common equity less all intangibles; computed as a ratio to total assets less intangible assets. (b) Shareholders' equity minus net unrealized holding gains on equity securities, plus or minus net unrealized holding losses or gains on available for sale debt securities, less goodwill; computed as a ratio to risk-adjusted assets, as defined in the 1992 risk-based capital guidelines. (c) Tier 1 capital plus qualifying loan loss allowance, computed as a ratio to risk-adjusted assets, as defined in the 1992 risk-based capital guidelines. (d) Tier 1 capital; computed as a ratio to the latest quarter's average assets less goodwill. The risk-based capital guidelines issued by the Federal Reserve Bank in 1988 require banks to maintain capital equal to 8% of risk-adjusted assets effective December 31, 1993. At June 30, 1997 the Corporation's risk-based capital equaled 12.95% of risk adjusted assets, far exceeding the minimum guidelines. The cash dividend of $0.29 paid in the second quarter has an indicated annual rate of $1.16 per share. 24 PART II. - OTHER INFORMATION Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On April 9, 1997, the Registrant held its Annual Meeting of Shareholders for which the Board of Directors solicited proxies. At the Annual Meeting, the shareholders adopted all proposals stated in the Proxy Statement dated February 26, 1997. The proposals voted on and approved by the shareholders are as follows: 1. The election of five Class III directors, being: For Against Abstain John C. Blickle 26,931,067 * 230,218 Robert M. Carter 26,891,860 * 269,425 Terry L. Haines 26,936,245 * 225,040 Robert G. Merzweiller 26,931,283 * 230,002 Justin T. Rogers, Jr. 26,875,670 * 285,615 All other Class I and Class II directors continued in their positions. * Proxies provide that shareholders may either cast a vote for, or abstain from voting for, directors. 2. Approval of the proposal to adopt the 1997 Stock Plan by a vote of 24,827,665 for, 1,691,225 against and 642,395 abstaining. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS None (b) FORM 8-K None 25 SIGNATURES Pursuant to the requirements 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. FIRSTMERIT CORPORATION By: /s/ JACK R. GRAVO ----------------------------------------- Jack R. Gravo, Executive Vice President Finance and Administration DATE: August 13, 1997