1
Exhibit 99
FirstMerit LOGO
III Cascade Plaza
Akron, Ohio 44308
March 17, 1999
To Our Shareholders:
The merger of Signal Corp into FirstMerit Corporation occurred on February
12, 1999. We are providing you with the following Supplemental Consolidated
Financial Statements of the combined companies for year-end 1998 as required by
Section 14 of the Securities Exchange Act of 1934.
These statements include the results of FirstMerit, as reported in the 1998
Annual Report, combined with the historical results of Signal Corp, for the
periods presented. Included in these results are significant one-time costs
related to First Shenango Bancorp, Inc.'s merger into Signal Corp, as well as
other expenses associated with manufactured housing loans and securities.
Because these statements are historical in nature, they do not reflect any
efficiencies or increased revenue opportunities that might be realized due to
recent acquisitions.
We are excited about the prospects of the combined companies in 1999 and
beyond. We hope you will be also.
Sincerely,
/s/ John R. Cochran
John R. Cochran, Chairman
and Chief Executive Officer
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SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEAR-ENDS,
------------------------
1998 1997
---------- ----------
(IN THOUSANDS)
ASSETS
Investment securities (at market value)................... $1,878,266 1,556,088
Federal funds sold and other interest-earning assets...... 31,739 69,291
Commercial loans.......................................... 2,613,838 2,073,855
Mortgage loans............................................ 1,648,346 1,839,201
Installment loans......................................... 1,270,014 1,145,004
Home equity loans......................................... 306,358 275,819
Credit card loans......................................... 99,541 103,041
Manufactured housing loans................................ 289,308 110,827
Leases.................................................... 171,040 185,867
---------- ----------
Total earning assets................................... 8,308,450 7,358,993
---------- ----------
Allowance for possible loan losses........................ (96,149) (67,736)
Cash and due from banks................................... 327,997 211,138
Premises and equipment, net............................... 140,841 129,372
Accrued interest receivable and other assets.............. 344,885 193,663
---------- ----------
Total assets........................................... $9,026,024 7,825,430
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand-non-interest bearing............................ $1,026,377 842,059
Demand-interest bearing................................ 917,765 728,455
Savings................................................ 1,810,340 1,574,527
Certificates and other time deposits................... 3,091,496 2,875,223
---------- ----------
Total deposits......................................... 6,845,978 6,020,264
---------- ----------
Securities sold under agreements to repurchase and other
borrowings............................................. 1,123,204 941,830
Accrued taxes, expenses, and other liabilities............ 117,714 115,659
---------- ----------
Total liabilities...................................... 8,086,896 7,077,753
---------- ----------
Mandatorily redeemable preferred securities............... 32,472 --
---------- ----------
Commitments and contingencies............................. -- --
Shareholders' equity:
Preferred stock, without par value: authorized
7,000,000 shares...................................... -- --
Preferred stock, Series A, without par value:
designated 700,000 shares; none outstanding......... -- --
Convertible preferred stock, Series B, without par
value: designated 500,000 shares; 403,232 and
429,892 shares outstanding at year-ends 1998 and
1997, respectively.................................. 9,299 9,917
Common stock, without par value: authorized 160,000,000
shares; issued 91,161,362 and 91,495,444 shares,
respectively.......................................... 122,387 119,893
Capital surplus........................................ 117,845 80,297
Accumulated other comprehensive income................. 5,858 4,603
Retained earnings...................................... 668,837 651,907
Treasury stock, at cost, 1,166,604 and 7,321,885
shares, respectively.................................. (17,570) (118,940)
---------- ----------
Total shareholders' equity............................. 906,656 747,677
---------- ----------
Total liabilities and shareholders' equity............. $9,026,024 $7,825,430
========== ==========
See accompanying notes to supplemental consolidated financial statements.
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SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEARS ENDED
------------------------------
1998 1997 1996
-------- ------- -------
(IN THOUSANDS
EXCEPT PER SHARE DATA)
Interest income:
Interest and fees on loans................................ $532,066 479,249 452,642
Interest and dividends on investment securities:
Taxable................................................. 103,354 97,417 102,668
Exempt from federal income taxes........................ 4,737 4,346 5,004
-------- ------- -------
108,091.. 101,763 107,672
Interest on federal funds sold............................ 2,400 3,498 1,838
-------- ------- -------
Total interest income................................... 642,557 584,510 562,152
-------- ------- -------
Interest expense:
Interest on deposits:
Demand-interest bearing................................. 13,222 12,575 12,485
Savings................................................. 44,077 40,564 41,816
Certificates and other time deposits.................... 165,198 146,097 141,512
Interest on securities sold under agreements to repurchase
and other borrowings.................................... 63,879 59,211 53,530
-------- ------- -------
Total interest expense.................................. 286,376 258,447 249,343
-------- ------- -------
Net interest income..................................... 356,181 326,063 312,809
Provision for possible loan losses.......................... 40,921 23,518 19,333
-------- ------- -------
Net interest income after provision for possible loan
losses................................................ 315,260 302,545 293,476
-------- ------- -------
Other income:
Trust department.......................................... 16,147 13,442 12,182
Service charges on deposits............................... 39,883 33,279 28,547
Credit card fees.......................................... 20,064 14,355 11,415
Service fees -- other..................................... 10,493 7,337 6,184
Investment securities gains (losses), net................. 6,785 3,114 (1,192)
Manufactured housing income............................... 7,630 14,684 11,580
Loan sales and servicing.................................. 16,900 11,177 8,378
Other operating income.................................... 22,246 16,706 25,997
-------- ------- -------
Total other income...................................... 140,148 114,094 103,091
-------- ------- -------
Other expenses:
Salaries, wages, pension and employee benefits............ 143,865 117,093 114,207
Net occupancy expense..................................... 23,002 22,592 22,277
Equipment expense......................................... 15,882 12,717 12,894
Loss on sale of subsidiary................................ 8,410 0 0
Intangible amortization expense........................... 8,926 3,771 4,374
Other operating expenses.................................. 144,944 89,692 106,610
-------- ------- -------
Total other expenses.................................... 345,029 245,865 260,362
-------- ------- -------
Income before federal income taxes...................... 110,379 170,774 136,205
Federal income taxes........................................ 37,862 56,066 45,995
-------- ------- -------
Net income.............................................. $ 72,517 114,708 90,210
======== ======= =======
Other comprehensive income, net of tax
Unrealized gains (losses) on available-for-sale
securities:
Unrealized holding gains, net of tax expense, arising
during period......................................... 5,828 10,492 (1,617)
Less: reclassification adjustment for gains realized in
net income, net of tax expense (benefit).............. 4,573 2,493 (1,772)
-------- ------- -------
Net unrealized gains (losses), net of tax expense
(benefit)............................................... 1,255 7,999 (3,389)
-------- ------- -------
Comprehensive income.................................... $ 73,772 122,707 86,821
======== ======= =======
Net income applicable to common shares...................... $ 71,826 113,124 88,514
======== ======= =======
Weighted average number of common shares
outstanding -- basic...................................... 86,377 81,352 83,243
======== ======= =======
Weighted average number of common shares
outstanding -- diluted.................................... 87,984 87,297 88,783
======== ======= =======
Per share data based on average number of shares
outstanding:
Basic net income per share.................................. $ 0.83 1.39 1.06
======== ======= =======
Diluted net income per share................................ $ 0.82 1.32 1.02
======== ======= =======
See accompanying notes to supplemental consolidated financial statements.
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SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEARS ENDED 1998, 1997 AND 1996
-----------------------------------------------------------------------------------
ACCUMULATED
OTHER TOTAL
PREFERRED COMMON CAPITAL COMPREHENSIVE RETAINED TREASURY SHAREHOLDERS'
STOCK STOCK SURPLUS INCOME EARNINGS STOCK EQUITY
--------- ------- ------- ------------- -------- -------- -------------
(IN THOUSANDS EXCEPT PER SHARE DATA)
Balance at Year Ended 1995..... $24,132 110,018 50,660 (7) 543,721 (7,106) 721,418
Net income................... -- -- -- -- 90,210 -- 90,210
Cash dividends -- common
stock ($0.55 per share).... -- -- -- -- (41,256) -- (41,256)
Stock options
exercised/debentures or
preferred stock
converted.................. (459) 3,483 660 -- -- 497 4,181
Shares
issued -- acquisition...... -- 279 5,309 -- -- -- 5,588
Treasury shares purchased.... -- -- -- -- -- (62,612) (62,612)
Stock dividends.............. -- 369 8,654 -- (9,023) -- --
Market adjustment investment
securities................. -- -- -- (3,389) -- -- (3,389)
Other........................ (980) (821) -- (1,133) 277 (2,657)
------- ------- ------- ------ ------- -------- -------
Balance at Year Ended 1996..... 22,693 114,149 64,462 (3,396) 582,519 (68,944) 711,483
Net income................... -- -- -- -- 114,708 -- 114,708
Cash dividends -- common
stock ($0.61 per share).... -- -- -- -- (44,136) -- (44,136)
Stock options
exercised/debentures or
preferred stock
converted.................. (12,776) 4,182 11,738 -- (1,428) 1,616 3,332
Shares
issued -- acquisition...... -- 549 4,911 -- 1,499 -- 6,959
Treasury shares purchased.... -- -- -- -- -- (51,869) (51,869)
Stock dividends.............. -- 1,013 (1,013) -- (5) -- (5)
Market adjustment investment
securities................. -- -- -- 7,999 -- -- 7,999
Other........................ -- -- 199 -- (1,250) 257 (794)
------- ------- ------- ------ ------- -------- -------
Balance at Year Ended 1997..... 9,917 119,893 80,297 4,603 651,907 (118,940) 747,677
Net income................... -- -- -- -- 72,517 -- 72,517
Cash dividends -- common
stock ($0.66 per share).... -- -- -- -- (50,525) -- (50,525)
Acquisition adjustment of
fiscal year................ -- -- -- -- (1,857) -- (1,857)
Stock options
exercised/debentures or
preferred stock
converted.................. (618) 400 3,717 -- (2,607) 12,111 13,003
Treasury shares purchased.... -- -- -- -- -- (25,703) (25,703)
Treasury shares reissued --
acquisition................ -- -- 25,919 -- -- 89,286 115,205
Treasury shares
reissued -- public
offering................... -- -- 6,518 -- -- 20,806 27,324
Stock dividends.............. -- 1,929 (1,929) -- -- -- --
Market adjustment investment
securities................. -- -- -- 1,255 -- -- 1,255
Other........................ -- 165 3,323 -- (598) 4,870 7,760
------- ------- ------- ------ ------- -------- -------
Balance at December 31, 1998... $ 9,299 122,387 117,845 5,858 668,837 (17,570) 906,656
======= ======= ======= ====== ======= ======== =======
See accompanying notes to supplemental consolidated financial statements.
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SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEARS ENDED,
-----------------------------------
1998 1997 1996
----------- -------- --------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income.................................................. $ 72,517 114,708 90,210
Adjustments to reconcile net income to net cash provided by
operating activities:
Loss on sale of subsidiary.............................. 8,410 -- --
Provision for loan losses............................... 40,921 23,518 19,333
Provision for depreciation and amortization............. 19,714 17,407 14,056
Amortization of investment securities premiums, net..... 1,413 2,908 5,031
Amortization of income for lease financing.............. (11,360) (13,436) (12,656)
(Gains) losses on sales of investment securities, net... (6,785) (3,114) 1,192
Gain on sale of affiliate branches...................... -- -- (13,210)
Deferred federal income taxes........................... (12,355) (293) 20,364
(Increase) decrease in interest receivables............. (5,051) 504 2,091
Increase in interest payable............................ 1,451 1,395 768
Amortization of values ascribed to acquired
intangibles.......................................... 8,926 3,771 4,374
Other increases (decreases)............................. (41,479) (137,790) (22,843)
----------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES................... 76,322 9,578 108,710
----------- -------- --------
INVESTING ACTIVITIES
Dispositions of investment securities:
Available-for-sale -- sales............................... 687,720 309,451 420,384
Available-for-sale -- maturities.......................... 589,722 341,138 418,682
Purchases of investment securities available-for-sale....... (1,616,554) (600,921) (624,909)
Net (increase) decrease in federal funds sold............... 37,552 (25,845) 1,021
Net increase in loans and leases, except sales.............. (1,224,699) (719,902) (570,156)
Sales of loans.............................................. 518,951 323,192 381,189
Purchases of premises and equipment......................... (32,240) (20,970) (27,623)
Sales of premises and equipment............................. 3,359 5,542 4,304
Sales of affiliate branches................................. -- -- 13,210
Payment for purchase of CoBancorp, Inc., net of cash
acquired.................................................. (50,000) -- --
----------- -------- --------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES............ (1,086,189) (388,315) 16,102
----------- -------- --------
FINANCING ACTIVITIES
Net increase (decrease) in demand, NOW and savings
deposits.................................................. 609,441 96,274 (79,521)
Net increase (decrease) in time deposits.................... 216,273 334,395 (73,827)
Net increase (decrease) in securities sold under repurchase
agreements and other borrowings........................... 221,708 (2,800) 67,902
Cash dividends.............................................. (50,525) (44,136) (41,256)
Purchase of treasury shares................................. (25,703) (51,869) (62,612)
Treasury shares reissued -- acquisition..................... 115,205 -- --
Treasury shares reissued -- public offering................. 27,324 -- --
Proceeds from exercise of stock options..................... 13,003 3,332 4,181
----------- -------- --------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES............ 1,126,726 335,196 (185,133)
Increase (decrease) in cash and cash equivalents............ 116,859 (43,541) (60,321)
Cash and cash equivalents at beginning of year.............. 211,138 254,679 315,000
----------- -------- --------
Cash and cash equivalents at end of year.................... $ 327,997 211,138 254,679
=========== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Cash paid during the year for:
Interest, net of amounts capitalized........................ $ 202,374 183,567 178,685
Income taxes................................................ $ 60,454 54,317 28,867
=========== ======== ========
See accompanying notes to supplemental consolidated financial statements.
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NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEAR-ENDS AND FOR THE YEARS ENDED 1998, 1997 AND 1996
(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 following
is a description of the more significant accounting policies.
(a) Principles of Consolidation and Presentation
The supplemental consolidated financial statements of
FirstMerit Corporation and its subsidiaries have been
prepared to give retroactive effect to the merger with
Signal Corp on February 12, 1999. Generally accepted
accounting principles proscribe giving effect to a
consummated business combination accounted for by the
pooling-of-interests method in financial statements that do
not include the date of consummation and, therefore, these
financial statements do not include costs associated with
the merger of the Corporation and Signal Corp. These
financial statements do not extend through the date of
consummation; however, they will become the historical
statements of the Corporation after statements covering the
date of consummation are issued.
The consolidated financial statements of the Corporation
include the accounts of FirstMerit Corporation (the Parent
Company) and its direct subsidiaries: FirstMerit Bank, N.
A., Citizens Investment Corporation, Citizens Savings
Corporation of Stark County, FirstMerit Community
Development Corporation, FirstMerit Credit Life Insurance
Company, SF Development Corp., FirstMerit Capital Trust I
and Mobile Consultants, Inc.
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 comprehensive income.
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.
The Corporation's investment portfolio is designated 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. The
Corporation does maintain a relatively small trading account
that is used as a hedge against variations in deferred
compensation expense.
(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.
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NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
(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.
(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 of mortgage loans 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.
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NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
(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 a
straight-line 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.
(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
Basic earnings per share is computed by dividing net income
by the weighted average number of common shares outstanding
during the period. Diluted earnings per share is computed by
dividing net income by the weighted average number of common
shares plus common stock equivalents computed using the
Treasury Share method. All earnings per share disclosures
appearing in these financial statements are computed
assuming dilution unless otherwise indicated.
(o) Reclassifications
Certain previously reported amounts have been reclassified
to conform to the current reporting presentation.
(p) Comprehensive Income
In 1998, the Corporation adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), "Reporting
Comprehensive Income." SFAS 130 requires additional
disclosure of items that affect comprehensive income but not
net income. Items relevant to the Corporation include
unrealized holding gains and losses on securities available
for sale. The additional disclosures can be found on the
face of the Supplemental Consolidated Statements of Income.
(q) Segment Reporting
In 1998, the Corporation adopted Statement of Financial
Accounting Standards No. 131 ("SFAS 131"), "Disclosures
about Segments of an Enterprise and related information."
SFAS 131 requires disclosure of the internal organizational
units used by management for making operating decisions and
assessing performance. SFAS 131 also requires disclosures
about products and services, geographic areas and major
customers. The adoption of SFAS 131 did not affect results
of operations or financial position but did affect the
disclosure of segment information. See Note 17 to the
Supplemental Consolidated Financial Statements for further
details.
2. ACQUISITIONS AND MERGER-RELATED EXPENSES
On May 22, 1998, the Corporation completed the acquisition of CoBancorp,
Inc., a bank holding company headquartered in Elyria, Ohio with consolidated
assets of approximately $666.0 million. CoBancorp, Inc. ("CoBancorp") was merged
with and into the Corporation and accounted for under "purchase" accounting
requirements. At the time of the merger, the value of the transaction was $174.1
million.
In connection with the merger, the Corporation issued 3.9 million shares of
its Common Stock (valued at $29.375/share), paid approximately $50.0 million in
cash, and assumed merger-related liabilities of approximately $9.6 million. The
transaction created goodwill of approximately $136.5 million that will be
amortized primarily over 25 years.
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NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
The proforma combined unaudited operating results assuming the companies
had combined at the beginning of each period is as follows:
PERIOD AND DESCRIPTION FIRSTMERIT COBANCORP ADJUSTMENTS COMBINED
---------------------- ---------- --------- ----------- --------
Year ended December 31, 1998 (FirstMerit) and 3
months ended March 31, 1998 (CoBancorp):
Pro forma interest income......................... $642,557 11,942 211 654,710
Net interest income............................... 356,181 7,295 (944) 362,532
Net income available to common shareholders'...... 71,826 1,307 (1,394) 71,739
Adjusted income for diluted EPS calculation....... 72,032 1,307 (1,394) 71,945
Weighted-average diluted shares................... 87,984 3,485 92,241
Earnings per diluted share........................ 0.82 0.37 0.78
======== ====== =======
Year ended December 31, 1997:
Pro forma interest income......................... 584,510 48,141 844 633,495
Net interest income............................... 326,063 29,054 (3,776) 351,341
Net income available to common shareholders....... 113,124 4,800 (5,577) 112,347
Adjusted income for diluted EPS calculation....... 115,042 4,800 (5,577) 114,265
Weighted-average diluted shares................... 87,297 3,498 91,570
Earnings per diluted share........................ $ 1.32 1.37 1.25
======== ====== =======
The unaudited proforma operating results of each separate company have been
adjusted to reflect their new accounting basis' recognized to record the
purchase combination. Figures shown for CoBancorp include extraordinary merger
costs, net of tax, of $164.0 for the 1998 three-month period and $724.0 for
1997.
On September 14, 1998, FirstMerit closed a secondary underwritten public
offering of 1.38 million common shares of FirstMerit Common Stock. The
reissuance of these shares was necessary to allow the Corporation to treat the
Security First Corp. merger as a pooling-of-interests.
On October 23, 1998, the Corporation completed the acquisition of Security
First Corp., a $678.0 million bank holding company headquartered in Mayfield
Heights, Ohio. Subsidiaries of Security First Corp. ("Security First") included
Security Federal Savings and Loan Association of Cleveland and First Federal
Savings Bank of Kent. These subsidiaries were merged with and into FirstMerit
Bank, N. A. Under terms of the merger agreement, Security First Corp. was merged
with and into the Corporation. The transaction was structured with a fixed
exchange ratio of 0.8855 shares of FirstMerit Common Stock for each common share
of Security First. At the time of the merger, the pooling-of-interests
transaction was valued at $22.58 per share or approximately $199.0 million. The
accompanying consolidated financial statements for all periods presented have
been restated to account for the acquisition. The information presented for 1997
and prior periods coincides with the fiscal year-ends of each entity, which were
December 31 for FirstMerit and March 31 for Security First. For example,
information as of year-end 1997 combines FirstMerit's balances at December 31,
1997 with Security First's balances at March 31, 1998. As a result of this
difference in fiscal year ends, the Corporation made an adjustment to
shareholders' equity of $1,841 which represents Security First's net income and
cash dividends paid for the three months ended March 31, 1998.
In conjunction with the Security First acquisition, the Corporation
incurred merger-related expenses of approximately $17.2 million, before taxes.
The components of the costs are as follows: severance and employee-related
expenses of $1.7 million, occupancy and equipment charges of $2.0 million,
conversion and contract termination costs of $1.5 million, professional services
and other costs of $4.7 million and conforming adjustment to the provision for
possible loan losses of $7.3 million. On an after tax basis, the merger-related
expenses totaled approximately $12.8 million, or $0.18 per diluted share.
8
10
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
On February 12, 1999, the Corporation completed the acquisition of Signal
Corp, a $1.9 billion bank holding company headquartered in Wooster, Ohio.
Principal subsidiaries of Signal Corp ("Signal") included Signal Bank, N.A.,
Summit Bank, N.A., First Federal Savings Bank of New Castle (Pennsylvania),
Signal Capital Trust I, and Mobile Consultants, Inc. Under terms of the
agreement, the fixed exchange ratio is 1.32 shares of FirstMerit common stock
for each share of Signal common stock and one share of FirstMerit preferred
stock for each share of Signal preferred stock. Based on an estimated closing
price of $25.00 per common share and $71.00 per preferred share, the value of
the transaction is approximately $436.0 million. The transaction will be
accounted for as a pooling-of-interests. In conjunction with this merger, the
Corporation anticipates incurring merger-related expenses of $30.8 million and
conforming accounting policy changes totaling $9.5 million. The components are
as follows: $7.8 million severance and employee related benefits; $5.8 million
occupancy and equipment charges; $6.9 million conversion and contract
termination expense; $10.3 million professional services and other costs; and a
conforming accounting entry to the provision for possible loan losses of $9.5
million.
The following information is not necessarily indicative of the results
which actually would have been obtained if the Signal and Security First mergers
had been consummated in the past or which may be obtained in the future.
FIRSTMERIT SECURITY
PERIOD AND DESCRIPTION CORPORATION FIRST SIGNAL CORP COMBINED
---------------------- ----------- -------- ------------ ----------
Year ended 1998:
Interest income................................. $459,934 43,163 139,460 642,557
Net interest income............................. 284,681 20,765 50,735 356,181
Net income (loss) available to common
shareholders.................................. 89,658 7,820 (25,652) 71,826
Adjusted income (loss) for diluted EPS
calculations.................................. 89,689 7,995 (25,652) 72,032
Weighted-average diluted shares................. 65,028 8,666 11,577 87,984
Earnings per diluted share...................... $ 1.38 0.92 (2.22) 0.82
======== ====== ========== ==========
Year ended 1997:
Interest income................................. 407,825 55,715 120,970 584,510
Net interest income............................. 255,456 26,149 44,458 326,063
Net income available to common shareholders..... 86,363 9,311 17,450 113,124
Adjusted income for diluted EPS calculations.... 86,363 9,645 19,034 115,042
Weighted-average diluted shares................. 63,538 8,718 12,151 87,297
Earnings per diluted share...................... 1.36 1.11 1.57 1.32
======== ====== ========== ==========
Year ended 1996:
Interest income................................. 411,745 49,178 101,229 562,152
Net interest income............................. 250,972 23,615 38,222 312,809
Net income available to common shareholders..... 70,940 6,410 11,164 88,514
Adjusted income for diluted EPS calculations.... 70,940 6,801 12,860 90,601
Weighted-average diluted shares................. 65,470 8,695 11,828 88,782
Earnings per diluted share...................... 1.08 0.78 1.09 1.02
======== ====== ========== ==========
9
11
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
3. INVESTMENT SECURITIES
Investment securities are composed of:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ---------
Year-end 1998
Available for sale:
U.S. Treasury securities and U.S. Government
agency obligations............................. $ 692,242 3,981 2,284 693,939
Obligations of state and political
subdivisions................................... 137,129 3,048 -- 140,177
Mortgage-backed securities....................... 743,753 5,019 417 748,355
Other securities................................. 296,147 2,308 2,660 295,795
---------- ------ ----- ---------
$1,869,271 14,356 5,361 1,878,266
========== ====== ===== =========
Year-end 1997
Available for sale:
U.S. Treasury securities and U.S. Government
agency obligations............................. $ 648,009 2,705 2,354 648,360
Obligations of state and political
subdivisions................................... 116,113 1,838 206 117,745
Mortgage-backed securities....................... 616,148 5,271 1,823 619,596
Other securities................................. 168,783 1,786 182 170,387
---------- ------ ----- ---------
$1,549,053 11,600 4,565 1,556,088
========== ====== ===== =========
The amortized cost and market value of investment securities including
mortgage-backed securities at December 31, 1998, 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.
AMORTIZED MARKET
COST VALUE
---------- ---------
Due in one year or less..................................... $ 116,558 117,191
Due after one year through five years....................... 348,600 348,843
Due after five years through ten years...................... 355,581 357,504
Due after ten years......................................... $1,048,532 1,054,728
---------- ---------
$1,869,271 1,878,266
========== =========
Proceeds from sales of investment securities during the years 1998, 1997
and 1996 were $621,827, $306,331 and $420,384, respectively. Gross gains of
$6,823, $3,771 and $2,981 and gross losses of $1,728, $657 and $4,173 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
$1,180,126 and $960,107 at December 31, 1998 and December 31, 1997,
respectively.
10
12
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
4. LOANS
Loans consist of the following:
YEARS ENDED,
------------------------------------
1998 1997 1996
---------- --------- ---------
Commercial, financial and agricultural................... $1,308,127 952,507 780,772
Loans to individuals, net of unearned income............. 1,334,138 1,157,940 1,026,012
Loans secured by real estate............................. 3,585,282 3,437,303 3,286,610
Lease financing.......................................... 170,898 185,864 159,237
---------- --------- ---------
$6,398,445 5,733,614 5,252,631
========== ========= =========
The Corporation grants loans principally to customers located within the
State of Ohio.
Information with respect to impaired loans is as follows:
YEAR ENDS
-----------------
1998 1997
------- ------
Impaired Loans.............................................. $10,968 12,218
Allowance for Possible Loan Losses.......................... 3,735 4,457
Interest Recognized......................................... 427 460
======= ======
Earned interest on impaired loans is recognized as income is collected.
The Corporation makes loans to officers on the same terms and conditions as
made available to all employees and to 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, 1998 and 1997 is
summarized as follows:
1998 1997
------- -------
Aggregate amount at beginning of year....................... $35,306 41,702
Additions (deductions):
New loans................................................. 20,650 9,124
Repayments................................................ (16,472) (16,944)
Changes in directors and their affiliations............... (13,402) 1,424
------- -------
Aggregate amount at end of year............................. $26,082 35,306
======= =======
5. ALLOWANCE FOR POSSIBLE LOAN LOSSES
Transactions in the allowance for possible loan losses are summarized as
follows:
YEARS ENDED,
-----------------------------
1998 1997 1996
------- ------- -------
Balance at beginning of year................................ $67,736 60,087 56,878
Additions (deductions):
Allowance from purchase acquisition....................... 8,215 2,511
Provision for loan losses................................. 40,921 23,518 19,333
Loans charged off......................................... (32,934) (28,684) (21,876)
Recoveries on loans previously charged off................ 12,211 10,304 6,141
Decrease from sale of subsidiary.......................... (389)
------- ------- -------
Balance at end of year...................................... $96,149 67,736 60,087
======= ======= =======
11
13
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
6. MANUFACTURED HOUSING INCOME
The Corporation, through its subsidiary Mobile Consultants, Inc. ("MCi"),
has sold certain manufactured housing finance contracts (MHF contracts) to
various financial institutions while retaining the collection and recovery
aspects of servicing. The amount of MHF contracts serviced as just described
totaled $396.2 million and $430.1 million at December 31, 1998 and 1997,
respectively. At the time MCi sells an MHF contract to an unaffiliated financial
institution, approximately one-third of the fee collected is recorded as a
"manufactured housing brokerage fee" and the remaining two-thirds of the fee is
deposited into escrow accounts and is available to offset potential prepayment
or credit losses (collectively, "MCi reserves"). The MCi reserves are recognized
as "servicing income on brokered MHF contracts" ratably over the MHF contract
life based on the present value of the future cash flows of the MCi reserves
utilizing assumptions for prepayment and credit losses and a discount rate. As a
result of the assumptions used at December 31, 1998, which were based on current
experience, the deferred asset which had resulted from income previously
recorded was written down by $7.4 million to $1.6 million. The undiscounted
balance of the MCi reserves was $34.7 million and $46.4 million as of December
31, 1998 and 1997, respectively.
The Corporation's subsidiary, FirstMerit Bank, N.A., purchases MHF
contracts from MCi, a portion of which are packaged in asset-backed
securitizations ("ABS pools") and sold to investors. Sales and securitizations
of MHF contracts totaled $100 million in 1998 and $150.0 million in 1997.
At the time of sale, the Corporation records an asset, "retained interest
in securitized asset," representing the discounted future cash flows to be
received by the Corporation for (1) servicing income from the ABS pool, (2)
principal and interest payments on MHF contracts contributed to the ABS pools as
a credit enhancement, referred to as "over-collateralization," and (3) excess
interest spread. Excess interest spread represents the difference between
interest collected from the MHF contract borrowers and interest paid to
investors in the ABS pool net of estimated future credit losses and further
reduced by the impact of estimated future prepayments. Future credit loss
assumptions are derived by analyzing historical experience and estimating future
loss probabilities. Future credit losses are measured using Constant Default
Rates, or "CDR", which is an annualized measure of credit losses applied on a
monthly basis. Additionally, estimated future credit losses are impacted by
repossession recovery rates, or the amount of a loan's current outstanding
balance that is satisfied upon the sale of repossessed collateral. Prepayment
assumptions are based on historical experience and industry-wide trends. Future
prepayments are estimated using Manufactured Housing Prepayment, or "MHP", the
manufactured housing industry standard index for prepayment. As of December 31,
1998 the Corporation valued the retained interest in securitized assets using a
discount rate of 10%, a prepayment estimate of 200 MHP, a credit loss estimate
of 3.0% CDR and, a repossession recovery rate of 50%. Based on these
assumptions, the retained interest in securitized assets was written down by
$18.0 million to $26.2 million.
Cash flows from the ABS pools are subject to volatility that could
materially affect operating results. Prepayments resulting from increased
competition, obligor mobility, general and regional economic conditions, and
prevailing interest rates, as well as actual losses incurred, may vary from the
performance the Corporation expects. Actual cash flows from the Corporation's
six ABS pools have been less than originally expected. At December 31, 1998
management determined there was impairment, based on the assumptions above, and,
therefore, adjusted the carrying value of the retained interest in securitized
assets. Management reviews the cash flows and actual performance of the ABS
pools on a quarterly basis. The aggregate amount of ABS pools serviced by the
Corporation totaled $255.8 million and $186.2 million at December 31, 1998 and
1997, respectively, and such amounts are not included in the accompanying
Consolidated Financial Statements.
The Corporation classifies the retained interest in securitized assets in
two components of the Consolidated Balance Sheet, (1) securities available for
sale and, (2) excess servicing, a component of accrued interest receivable and
other assets. Total retained interest in securitized assets and excess servicing
were $26.2 million and $27.0 million at December 31, 1998 and 1997,
respectively.
12
14
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
The components of manufactured housing income were as follows:
1998 1997 1996
------ ------ ------
(DOLLARS IN THOUSANDS)
Gain on sale of ABS pools................................... $2,650 5,734 1,574
Manufactured housing brokerage fees......................... 2,464 3,151 6,726
Servicing income on brokered MHF contracts.................. 1,666 4,400 3,200
Servicing income on ABS pools............................... 850 1,399 80
------ ------ ------
Total manufactured housing income................. $7,630 14,684 11,580
====== ====== ======
7. MORTGAGE SERVICING RIGHTS AND MORTGAGE SERVICING
In accordance with Statement of Financial Accounting Standards No. 122,
"Accounting for Mortgage Servicing Rights," and Statement No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities," 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 net cash flow method.
The components of mortgage servicing rights are as follows:
1998 1997
------- ------
Balance at beginning of year, net........................... $ 6,669 3,899
Additions................................................... 7,259 3,943
Scheduled amortization...................................... (2,495) (1,173)
Less: allowance for impairment.............................. (168) --
------- ------
Balance at end of year, net................................. $11,265 6,669
======= ======
In 1998, 1997 and 1996, the Corporation's income before federal income
taxes was increased by approximately $4.6 million, $2.7 million and $3.8
million, respectively, as a result of compliance with the accounting Statements
mentioned previously.
Accounting regulations also require the Corporation to assess its
capitalized servicing rights for impairment based on their current fair value.
As permitted by the regulations, 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.
13
15
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
At year-ends 1998 and 1997, the Corporation serviced loans for others of
approximately $1.8 billion and $1.5 billion, respectively. The following table
provides servicing information for 1998 and 1997:
1998 1997
---------- ---------
Balance, beginning of year.................................. $1,455,285 1,327,357
Additions:
Loans originated and sold to investors.................... 377,517 221,715
Existing loans sold to investors.......................... 186,034 100,670
Existing loans from acquisitions.......................... 66,868
Reductions:
Sale of servicing rights.................................. -- --
Loans sold servicing released............................. (4,842) (5,311)
Regular amortization, prepayments and foreclosures........ (277,963) (189,146)
---------- ---------
Balance, end of year........................................ $1,802,899 1,455,285
========== =========
8. RESTRICTIONS ON CASH AND DIVIDENDS
The average balance on deposit with the Federal Reserve Bank or other
governing bodies to satisfy reserve requirements amounted to $28,628 during
1998. 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, 1998, cash and due from banks included $5,355
deposited with the Federal Reserve Bank and other banks for these reasons.
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 1998 are restricted by the regulatory agencies
principally to the total of 1998 net income. Regulatory approval must be
obtained for the payment of dividends of any greater amount.
9. PREMISES AND EQUIPMENT
The components of premises and equipment are as follows:
YEAR-ENDS, ESTIMATED
------------------- USEFUL
1998 1997 LIVES
-------- ------- ---------
Land........................................................ $ 19,096 15,513 --
Buildings................................................... 112,537 108,132 10-35 yrs
Equipment................................................... 93,413 81,118 3-15 yrs
Leasehold improvements...................................... 18,486 16,707 1-20 yrs
-------- -------
243,532 221,470
Less accumulated depreciation and amortization.............. 102,691 92,098
-------- -------
$140,841 129,372
======== =======
Amounts included in other expenses for depreciation and amortization
aggregated $16,790, $14,302 and $12,384 for the years ended 1998, 1997 and 1996,
respectively.
14
16
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
At December 31, 1998, the Corporation was obligated for rental commitments
under noncancelable operating leases on branch offices and equipment as follows:
YEARS ENDING LEASE
DECEMBER 31, COMMITMENTS
- ------------ -----------
1999 $ 8,541
2000 6,549
2001 5,830
2002 4,887
2003 3,438
2004-2012 12,837
-------
$42,082
=======
Rentals paid under noncancelable operating leases amounted to $8,426,
$8,446, and $9,430 in 1998, 1997 and 1996, respectively.
10. CERTIFICATES AND OTHER TIME DEPOSITS
The aggregate amounts of certificates and other time deposits of $100 and
over at year end 1998 and 1997 were $804,806 and $710,089, respectively.
Interest expense on these certificates and time deposits amounted to $54,355 in
1998, $32,528 in 1997, and $27,047 in 1996.
11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER BORROWINGS
The average balance of securities sold under agreements to repurchase and
other borrowings for the years ended 1998, 1997 and 1996 amounted to $1,063,848,
$1,055,938 and $998,408, respectively. In 1998, the weighted average annual
interest rate amounted to 6.00%, compared to 5.61% in 1997 and 5.36% in 1996.
The maximum amount of these borrowings at any month end totaled $1,179,734
during 1998, $1,196,824 in 1997 and $1,143,553 during 1996.
At year-ends 1998, 1997 and 1996, securities sold under agreements to
repurchase totaled $489,373, $473,647, and $388,968, respectively. The average
annual interest rate for these instruments was 4.78%, compared to 4.91% in 1997
and 4.71% in 1996.
At year-ends 1998, 1997, and 1996, the Corporation had $586,117, $386,425
and $542,946, respectively, of Federal Home Loan Bank advances outstanding. The
advance balances outstanding at year-end 1998 included: $309,670 with maturities
within one year, $193,413 with maturities from one to five years and $83,034
with maturities over five years. The FHLB advances have interest rates that
range from 4.65% to 8.10%.
At year-end 1998, the Corporation had outstanding balances on lines of
credit with two financial institutions totaling $23,000 and $10,000,
respectively. As of year-end 1998, the unused portions of these lines totaled
$7,000 and $65,000, respectively. The interest rates on these lines were 6.00%
and 5.93%, respectively. At year-end 1997, $6,000 was outstanding on one of the
lines with a corresponding interest rate of 6.01% for the year. The interest
rates on these lines of credit are variable and approximate one-month LIBOR plus
37.5 basis points and one-month LIBOR plus 30.0 basis points, respectively.
At year-end 1998, 1997 and 1996, the Corporation had $6,541, $47,340 and
$8,479 respectively of convertible subordinated debentures outstanding. The
first of two sets of convertible bonds totaling $1,541 consists of 15 year,
6.25% debentures issued in a public offering in 1993 by Security First. These
bonds mature May 5, 2008 and may be redeemed by the bondholders any time prior
to maturity. The second set of bonds totaled $5,000 at year-end 1998, carry an
interest rate of 9.125%, were issued by Signal Corp, are due in 2004.
15
17
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
At year-ends 1998, 1997 and 1996, other borrowings totaled $8,173, $28,418
and $5,876, respectively. These borrowings carry interest rates ranging from
4.96% through 12.00%.
Residential mortgage loans totaling $879,175, $579,638, and $760,418 at
year-end 1998, 1997 and 1996, respectively, were pledged to secure Federal Home
Loan Bank ("FHLB") advances. FANNIE MAE ("FNMA") Preferred Stock of
approximately $28.2 million and preferred stock of another financial institution
totaling $4.3 million were pledged against the line of credit outstanding of
$23.0 million at year-end 1998. FNMA Preferred Stock of $16.0 million was
pledged to secure the $6.0 million outstanding on the line at year-end 1997.
12. SIGNAL CAPITAL TRUST SECURITIES
During 1998, Signal Capital Trust I ("Signal Trust") was formed (1) to
issue and sell $50.0 million of 8.67% Capital Securities, Series A, ("Series A
Securities") (2) to issue common securities, (3) to invest the proceeds in the
8.67% Junior Subordinated Deferrable Interest Debentures, Series A
("Debentures") and (4) to engage in certain other limited activities. The Series
A Securities were issued and sold to investors in a private placement exempt
from the Securities Act of 1933 on February 10, 1998. In an exchange offer,
Signal Trust exchanged the outstanding Series A Securities for 8.67% Capital
Securities, Series B which were registered with the Securities and Exchange
Commission in June 1998. The Common Securities are owned solely by the
Corporation's wholly-owned subsidiary, FirstMerit Bank, N. A.
Distributions on the Capital Securities are guaranteed, are cumulative, and
began accumulating on February 13, 1998. The distributions are payable
semi-annually in arrears on February 15 and August 15 of each year, commencing
August 15, 1998 at the annual rate of 8.67% of the liquidation amount of $1,000
per security. The interest payment schedule of the Debentures is identical to
that of the Capital Securities, except that so long as the distributions of the
Debentures are not in default, as defined in the governing indenture, deferment
of the interest payment on the Debentures at any time and from time to time (for
an extension period not exceeding ten consecutive semi-annual periods) is
permitted. During any extension period, certain actions, including declaring or
paying any dividends or distributions, or redeeming or purchasing any capital
stock, is prohibited.
Prior to December 31, 1998, and consummation of the Signal Merger, the
Corporation acquired approximately $17.5 million of the Series B Capital
Securities in the open market. The result of this acquisition was appropriately
eliminated in the consolidated financial statements and notes thereto.
13. FEDERAL INCOME TAXES
Federal income taxes are comprised of the following:
YEARS ENDED,
----------------------------
1998 1997 1996
-------- ------ ------
Taxes currently payable..................................... 50,217 56,359 25,631
Deferred expense (benefit).................................. (12,355) (293) 20,364
-------- ------ ------
$ 37,862 56,066 45,995
======== ====== ======
16
18
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
Actual Federal income tax expense differs from expected Federal income tax
as shown below:
YEARS ENDED,
---------------------
1998 1997 1996
----- ---- ----
Statutory rate.............................................. 35.0% 35.0% 35.0%
Increase (decrease) in rate due to:
Interest income on tax-exempt securities and tax-free
loans, net............................................. -1.6% -1.3% -1.6%
State and local income taxes, net......................... 0.1% 0.3% 0.3%
Goodwill amortization..................................... 1.0% 0.3% 1.2%
Reduction to excess tax reserves.......................... -1.7% -0.8% -1.1%
Exercise of options at acquisition........................ -0.6% -0.1% --
Merger expenses at acquisition............................ 1.2% 0.1% --
Sale of subsidiary........................................ 1.4% -- --
Other..................................................... -0.5% -0.7% --
----- ---- ----
Effective tax rates......................................... 34.3% 32.8% 33.8%
===== ==== ====
For 1998, 1997 and 1996, 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:
YEARS ENDED
------------------------------
1998 1997 1996
-------- ------- -------
Loan loss provision......................................... $(12,101) (5,817) 5,500
Recapture of bad debt reserves.............................. (109) -- 654
Depreciation................................................ (18) 650 (627)
Deferred loan fees, net..................................... (1,362) 1,030 3,933
Leasing..................................................... (1,696) 293 6,708
SFAS 106 postretirement benefits............................ (1,132) (1,105) (1,057)
SFAS 87 pension expense..................................... (407) 1,333 1,678
FHLB stock dividends........................................ 1,990 1,661 1,342
SFAS 125 mortgage servicing rights.......................... 3,130 361 526
Deferred gain on sale of loans.............................. (3,857) 1,531 535
Severance costs............................................. -- -- 1,315
Valuation reserves.......................................... 147 633 675
Other....................................................... (954) (433) (1,333)
-------- ------- -------
Total deferred income tax................................... $(16,369) 137 19,849
======== ======= =======
Principal components of the Corporation's net deferred tax (liability) are
summarized as follows:
YEAR END,
-------------------
1998 1997
-------- -------
Excess of book loan provision over tax loan provision....... $ 25,840 13,739
Tax bad debt reserves over base year reserves............... (545) (654)
Excess of tax depreciation over book depreciation........... (4,345) (4,363)
Deferred loan fees tax basis income over book basis......... (1,325) (2,687)
Leasing book basis over tax basis........................... (26,611) (28,307)
Postretirement book basis expense over tax basis............ 6,157 5,025
Pension book basis expense over tax basis................... (805) (1,212)
FHLB stock book basis over tax basis........................ (9,584) (7,594)
17
19
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEAR END,
-------------------
1998 1997
-------- -------
Security portfolio tax basis over book basis................ (2,781) (2,512)
Mtg. servicing rights book basis over tax basis............. (4,017) (887)
Deferred (gain) loss on sale of loans....................... 1,791 (2,066)
Valuation reserves book basis over tax basis................ -- 147
Other....................................................... 4,674 3,720
-------- -------
Total net deferred tax (liability).......................... $(11,551) (27,651)
======== =======
14. 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 Corporation also sponsors 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 Corporations' 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 employee's 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 following table sets forth the both plans' funded status and amounts
recognized in the Corporation's consolidated financial statements. The 1998 and
1997 amounts shown reflect a change in the measurement date from December 31 to
September 30. Amounts shown for 1996 have not been restated to show the change
in the measurement date. In addition, all amounts for each year have been
restated to reflect the mergers of CoBancorp and Security First in 1998.
18
20
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
PENSION BENEFITS POSTRETIREMENT BENEFITS
----------------------------- --------------------------------
1998 1997 1996 1998 1997 1996
------- ------- ------- -------- -------- --------
CHANGE IN BENEFIT OBLIGATION
Projected Benefit Obligation
(PBO)/,
Accumulated Postretirement
Benefit
Obligation (APBO),
beginning of year...... $70,720 $70,119 $73,926 $ 27,864 $ 30,888 $ 31,198
Service Cost.............. 3,546 3,379 3,729 855 958 935
Interest Cost............. 4,988 4,880 4,978 1,872 2,157 2,133
Plan amendments........... 1,060 684 144 -- -- (2,952)
Participant
contributions.......... -- -- -- 1,390 1,554 1,575
Actuarial (gain) loss..... (2,735) (2,113) (6,054) (2,330) (5,953) (221)
Benefits Paid............. (3,890) (6,229) (6,604) (1,750) (1,740) (1,780)
------- ------- ------- -------- -------- --------
PBO/APBO, end of year....... 73,689 70,720 70,119 27,901 27,864 30,888
------- ------- ------- -------- -------- --------
CHANGE IN PLAN ASSETS
Fair Value of Plan Assets,
beginning of year......... 80,877 71,929 67,035 -- -- --
Actuarial return on plan
assets................. 2,465 9,454 3,827 -- -- --
Participant
contributions.......... -- -- -- 1,390 1,554 1,575
Employer contributions.... 1,027 5,723 7,671 360 186 205
Benefits paid............. (3,890) (6,229) (6,604) (1,750) (1,740) (1,780)
------- ------- ------- -------- -------- --------
Fair Value of Plan Assets,
end of year............... 80,479 80,877 71,929 -- -- --
------- ------- ------- -------- -------- --------
Funded Status............... 6,790 10,157 1,810 (27,901) (27,864) (30,888)
Unrecognized Transition
(asset) obligation........ (586) (792) (999) 11,488 12,308 13,129
Prior service costs......... 4,437 3,707 3,311 -- -- --
Cumulative net (gain) or
loss...................... (7,137) (8,450) (3,215) 365 1,666 6,394
------- ------- ------- -------- -------- --------
(Accrued) prepaid pension/
postretirement cost....... 3,504 4,622 907 (16,048) (13,890) (11,365)
------- ------- ------- -------- -------- --------
Amounts recognized in the
statement of financial
position consist of:
Prepaid benefit cost...... 4,250 4,632 2,073 -- -- --
Accrued benefit
liability.............. (6,362) (4,218) (3,794) (16,048) (13,890) (11,365)
Intangible asset.......... 4,940 3,556 2,628 -- -- --
Accumulated other
comprehensive income... 676 652 -- -- -- --
------- ------- ------- -------- -------- --------
Net amount recognized....... 3,504 4,622 907 (16,048) (13,890) (11,365)
------- ------- ------- -------- -------- --------
19
21
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
PENSION BENEFITS POSTRETIREMENT
-------------------- ------------------------------------
1998 1997 1996 1998 1997 1996
---- ---- ---- ------- -------- -------------
Weighted-average assumptions as
of December 31
Discount Rate................... 7.00% 7.50% 7.50% 7.00% 7.50% 7.50%
Long-term rate of return on 9.00% 9.00% 9.00% N/A N/A N/A
assets........................
Rate of compensation increase... 4.00% 4.75% 4.75% -- -- --
Medical trend rates............. -- -- -- 5% to 8% 5% to 9% pre-65:%
6.0% to 12.4
post-65:%
6.1% to 11.8
For measurement purposes, a 9.0% annual rate increase in the per capita
cost of covered health care benefits was assumed for 1999. The rate was assumed
to decrease gradually to 6.0% in 2002 and remain at that level hereafter.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plan. A one-percent point change in assumed
health care cost trend rates would have the following effects:
1-PERCENTAGE 1-PERCENTAGE
POINT INCREASE POINT DECREASE
-------------- --------------
Effect on total of service and interest cost components..... $ 328 (285)
Effect on postretirement benefit obligation................. 2,994 (2,684)
PENSION BENEFITS POSTRETIREMENT BENEFITS
----------------------------- --------------------------
1998 1997 1996 1998 1997 1996
------- ------- ------- ------ ------ ------
Components of Net Periodic Pension/
Postretirement Cost
Service Cost..................... $ 3,546 $ 3,379 $ 3,729 $ 855 $ 958 $ 935
Interest Cost.................... 4,988 4,880 4,978 1,872 2,157 2,133
Expected return on assets........ (6,537) (6,275) (5,996) -- -- --
Amortization of unrecognized
Transition (asset)............ (207) (207) (207) 821 821 821
Prior service costs........... 331 287 277 -- -- --
Cumulative net (gain) loss....... 25 (56) (99) -- 144 323
------- ------- ------- ------ ------ ------
Net periodic
pension/postretirement cost... 2,146 2,008 2,682 3,548 4,080 4,212
------- ------- ------- ------ ------ ------
The Corporation has elected to amortize the transition obligation for both
the pension and postretirement plans by charges to income over a twenty-year
period on a straightline basis.
Accumulated Benefit Obligation for the Corporation's pension plan were
($63,211), ($55,386) and ($55,222) for the periods ended December 31, 1998, 1997
and 1996, respectively.
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, employees
contributions are partially matched by the Corporation. Such matching becomes
vested when the employee reaches five years of credited service. Total savings
plan expenses were $2,586, $2,375 and $2,232 for 1998, 1997 and 1996,
respectively. The former CoBancorp employees now working for the Corporation
were merged into the 401(k) plan during 1998 and the former Security First
employees working for the Corporation were merged into the 401(k) plan effective
January 1, 1999.
20
22
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
As part of the Signal Corp acquisition, the Corporation merged a Signal
Corp profit sharing plan into the Corporation's 401(k) plan. As of December 31,
1998, the profit sharing plan held approximately 59,400 shares of the
Corporation's Common Stock. Employer contributions to the plan were $300 in
1998, $299 in 1997 and $124 in 1996. The account balances of the former
employees of Signal Corp now working for FirstMerit will be merged into the
Corporation's 401(k) plan beginning May 1, 1999.
15. STOCK OPTIONS
The Corporation's 1982, 1992, and 1997 Stock Plans (the "Plans") provide
incentive options to certain key employees for up to 5,966,556 shares of
FirstMerit Common Stock. In addition, these Plans provide for the granting of
non-qualified stock options to certain non-employee directors of the Corporation
for which 200,000 shares of FirstMerit Common Stock have been reserved.
Outstanding options under these Plans are generally not exerciseable for at
least six months from date of grant.
Options under these Plans are granted at 100% of the fair market value of
the Corporation's Common Stock on the date of the grant. 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.
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Corporation continues to account for its stock option plans in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock issued to
Employees," and makes no charges against income with respect to options granted.
However, SFAS No. 123 does require the disclosure of the proforma 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 proforma earnings and earnings per share for 1998, 1997, and 1996 along with
significant assumptions used in determining the fair value of the compensation
amounts.
1998 1997 1996
-------------- ----------- -----------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
Proforma amounts:
Net income....................................... $ 65,131 112,981 88,922
Earnings per share (basic)....................... 0.75 1.39 1.07
Earnings per share (diluted)..................... 0.74 1.29 1.00
Assumptions:
Dividend yield................................... 0.00% 3.50% 2.70%
Expected volatility.............................. 24.94% 23.30% 24.51%
Risk free interest rate.......................... 4.55% - 5.61% 5.8% - 6.8% 5.2% - 6.7%
Expected lives................................... 5 yrs. 5 yrs. 5 yrs.
21
23
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
A summary of stock option activity for the last two years follows:
RANGE OF
AVAILABLE OUT- OPTION AVERAGE OPTION
FOR GRANT STANDING PRICE PER SHARE PRICE PER SHARE
--------- --------- --------------- ---------------
Balance
Year-end 1996......................... 582,109 2,920,231 .00 - 16.97 $11.33
New shares reserved................ 2,200,000
Canceled........................... -- (47,639) 5.41 - 25.06 12.46
Exercised.......................... -- (501,503) 5.44 - 15.44 9.54
Granted............................ (549,743) 943,833 .00 - 40.26 24.14
--------- --------- ------------ ------
Balance
Year-end 1997......................... 2,232,366 3,314,922 .00 - 40.26 15.22
Canceled........................... (85,797) 9.56 - 34.00 18.8
Exercised.......................... (876,679) 6.31 - 21.63 17.84
Granted............................ (442,346) 856,826 .00 - 43.11 34.53
--------- --------- ------------ ------
Balance
December 31, 1998..................... 1,790,020 3,209,272 .00 - 43.11 $19.46
========= ========= ============ ======
The ranges of exercise prices and the remaining contractual life of options
as of December 31, 1998 were:
$0 - $9 $10 - $18 $19 - $26 $27 - $34
RANGE OF EXERCISE PRICES -------- ---------- --------- ----------
Options outstanding:
Outstanding as of December 31, 1998.......... 393,422 1,131,342 446,277 1,238,231
Wtd-avg remaining contractual life (in
years)..................................... 6.00 6.94 8.56 9.19
Weighted-average exercise price.............. $ 4.35 $ 14.17 $ 22.21 $ 28.16
Options exerciseable:
Outstanding as of December 31, 1998.......... 297,443 627,676 202,031 957,633
Wtd-avg remaining contractual life (in
years)..................................... 5.87 6.76 8.19 8.78
Weighted-average exercise price.............. $ 4.81 $ 13.60 $ 21.03 $ 27.25
The Employee Stock Purchase Plan provides full-time and part-time employees
of the Corporation the opportunity to acquire shares of the Corporation's Common
Stock on a payroll deduction basis. Shares available under the Employee Stock
Purchase Plan are purchased at 85% of their fair market value on the business
day immediately preceding the semi-annual grant-date. Of the 625,849 shares
available under the Plan, there were 45,802, 26,770 and 12,512 shares issued in
1998, 1997 and 1996, respectively.
22
24
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
16. PARENT COMPANY
(Parent Company only) is as follows:
YEAR-ENDS,
---------------------
1998 1997
CONDENSED BALANCE SHEETS ---------- -------
ASSETS
Cash and due from banks..................................... $ 18,642 30,933
Investment securities....................................... 9,322 9,334
Loans to subsidiaries....................................... 126,336 79,551
Investment in subsidiaries, at equity in underlying value of
their net assets.......................................... 843,993 664,982
Net loans................................................... 15,375 31,568
Goodwill.................................................... -- 133
Other assets................................................ 9,133 12,016
---------- -------
$1,022,801 828,517
========== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Convertible subordinated debt............................... $ 42,041 47,340
Repurchase agreements....................................... 10,000 --
Accrued and other liabilities............................... 64,104 33,500
Shareholders' equity........................................ 906,656 747,677
---------- -------
$1,022,801 828,517
========== =======
YEARS ENDED,
-----------------------------
1998 1997 1996
CONDENSED STATEMENTS OF INCOME ------- ------- -------
Income:
Cash dividends from subsidiaries............................ $60,000 101,200 82,250
Other income................................................ 8,526 68,000 62,319
------- ------- -------
68,526 169,200 144,569
Interest and other expenses................................. 19,203 69,943 61,898
------- ------- -------
Income before federal income tax benefit and equity in
undistributed income of subsidiaries...................... 49,323 99,257 82,671
Federal income tax (benefit)................................ (6,941) (1,468) (795)
------- ------- -------
56,264 100,725 83,466
Equity in undistributed income of subsidiaries.............. 16,253 13,983 6,744
------- ------- -------
Net income.................................................. $72,517 114,708 90,210
======= ======= =======
23
25
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEARS ENDED,
--------------------------------
1998 1997 1996
CONDENSED STATEMENTS OF CASH FLOWS --------- ------- --------
Operating activities:
Net income.................................................. $ 72,517 114,708 90,210
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed income of subsidiaries.............. (16,253) (14,220) (6,744)
Gain on sale of assets -- FirstMerit Bank, N.A.............. -- -- (490)
Cash received on FirstMerit Bank, N.A. sale................. -- -- 13,060
Addition to provision for loan losses....................... 62 1,097 --
Other....................................................... (10,032) 6,675 7,535
--------- ------- --------
Net cash provided by operating activities................... 46,294 108,260 103,571
--------- ------- --------
Investing activities:
Proceeds from maturities of investment securities........... 3,378 10,982 22,402
Loans to subsidiaries....................................... (3,000) (4,211) 63,228
Payments for investments in and advances to subsidiaries.... (209,672) (48,145) (10,475)
Net increase (decrease) in loans............................ 16,131 2,346 (33,152)
Purchases of investment securities.......................... (3,049) (10,909) (15,641)
Other....................................................... 365 (468) 135
--------- ------- --------
Net cash (used) provided by investing activities............ (195,847) (50,405) 26,497
--------- ------- --------
Financing activities:
Net increase in securities sold under repurchase agreements
and other borrowings...................................... 60,000 40,500 4,000
Cash dividends.............................................. (54,651) (45,692) (42,939)
Proceeds from exercise of stock options..................... 15,087 4,323 3,928
Purchase of treasury shares................................. (25,703) (54,329) (62,612)
Purchase of preferred stock................................. (2,002)
Treasury shares reissued -- acquisition..................... 115,205 -- --
Treasury shares reissued -- public offering................. 27,324 -- --
Loans made to FirstMerit Bank, N. A......................... (17,000)
ESOP termination............................................ -- -- 456
--------- ------- --------
Net cash (used) provided by financing activities............ 137,262 (55,198) (116,169)
--------- ------- --------
Net increase (decrease) in cash and cash equivalents........ (12,291) 2,657 13,899
Cash and cash equivalents at beginning of year.............. 30,933 28,276 14,377
--------- ------- --------
Cash and cash equivalents at end of year.................... $ 18,642 30,933 28,276
========= ======= ========
17. SEGMENT INFORMATION
The Corporation provides a diversified range of banking and certain
nonbanking financial services and products through its various subsidiaries.
Management reports the results of the Corporation's operations through its major
line of business Supercommunity Banking. Parent Company and Others include
activities that are not directly attributable to Super Community Banking.
Included in this category are certain nonbanking affiliates, eliminations of
certain intercompany transactions and certain nonrecurring transactions. Also
included are portions of certain assets, capital, and support functions not
specifically identifiable with Supercommunity Banking. The Corporation's
business is conducted solely in the United States.
24
26
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
The accounting policies of the segment are the same as those described in
"Summary of Significant Accounting Policies." The Corporation evaluates
performance based on profit or loss from operations before income taxes.
The following table presents a summary of financial results and significant
performance measures for the periods depicted. Segment information prior to 1997
was not available.
1998 1997
----------------------------------------------------- -----------------------
SUPER- ADJUSTMENTS SUPER-
COMMUNITY PARENT CO. AND FIRSTMERIT COMMUNITY PARENT CO.
BANKING & OTHERS ELIMINATIONS CONSOLIDATED BANKING & OTHERS
---------- ---------- ------------ ------------ ---------- ----------
(DOLLARS IN THOUSANDS)
SUMMARY OF OPERATIONS:
Net interest income........ $ 353,429 62,756 (60,004) 356,181 $ 321,763 91,806
Provision for possible loan
losses................... 40,859 62 -- 40,921 22,421 1,097
Other income............... 138,585 1,563 (12) 140,136 115,575 75,454
Other expenses............. 341,691 3,354 (16) 345,029 244,556 65,550
Net income................. 68,713 73,127 (69,323) 72,517 103,987 96,188
AVERAGE BALANCES:
Assets..................... 7,788,204 732,371 8,520,575 6,971,999 619,937
Loans...................... 6,106,860 24,805 6,131,665 5,428,924 39,663
Earning assets............. 7,861,819 30,267 7,892,086 6,617,021 511,532
Deposits................... 6,455,209 -- 6,455,209 5,667,347 --
Shareholders' equity....... 811,414 30,451 841,865 645,552 76,852
PERFORMANCE RATIOS:
Return on average equity... 8.47% 8.61% 16.11%
Return on average assets... 0.88% 0.85% 1.49%
Efficiency ratio........... 68.09% 68.17% 54.99%
1997
---------------------------
ADJUSTMENTS
AND FIRSTMERIT
ELIMINATIONS CONSOLIDATED
------------ ------------
(DOLLARS IN THOUSANDS)
SUMMARY OF OPERATIONS:
Net interest income........ (87,506) 326,063
Provision for possible loan
losses................... -- 23,518
Other income............... (76,935) 114,094
Other expenses............. (64,241) 245,865
Net income................. (85,467) 114,708
AVERAGE BALANCES:
Assets..................... 7,591,936
Loans...................... 5,468,587
Earning assets............. 7,128,553
Deposits................... 5,667,347
Shareholders' equity....... 722,404
PERFORMANCE RATIOS:
Return on average equity... 15.88%
Return on average assets... 1.51%
Efficiency ratio........... 54.90%
The table below presents estimated revenues from external customers, by
product and service group for the periods depicted.
1998
---------------------------------------------
TRUST
RETAIL COMMERCIAL SERVICES TOTAL
-------- ---------- -------- -------
Interest and fees............................... $435,901 256,596 16,147 708,644
Service charges................................. 41,878 8,498 -- 50,376
Sales and servicing............................. 16,900 6,785 -- 23,685
-------- ------- ------ -------
$494,679 271,879 16,147 782,705
18. 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.
25
27
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
Federal funds sold -- The carrying amount is considered a reasonable
estimate of fair value.
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.
Derivative financial instruments -- The fair value of exchange-traded
derivative financial instruments was based on quoted market prices or
dealer quotes. These values represent the estimated amount the Corporation
would receive or pay to terminate the agreements, considering current
interest rates, as well as the current credit-worthiness of the
counterparties. Fair value amounts consist of unrealized gains and losses,
accrued interest receivable and payable, and premiums paid or received, and
take into account master netting agreements.
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.
26
28
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
The estimated fair values of the Corporation's financial instruments based
on the assumptions described above are as follows:
YEAR-ENDS
-------------------------------------------------
1998 1997
----------------------- ----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- --------- --------- ---------
Financial assets:
Investment securities...................... $1,878,266 1,878,266 1,555,988 1,556,088
Federal funds sold......................... 31,739 31,739 69,291 69,291
Net loans.................................. 6,310,096 6,342,269 5,665,878 5,686,906
Cash and due from banks.................... 327,997 327,997 211,138 211,138
Accrued interest receivable................ 53,119 53,119 37,219 37,219
Financial liabilities:
Deposits................................... 6,845,978 6,888,298 6,020,264 6,024,439
Securities sold under agreements to
repurchase and other borrowings......... 1,123,204 1,132,734 941,830 947,183
Accrued interest payable................... 28,788 28,788 17,291 17,291
Derivative instruments..................... -- 612 -- --
Unrecognized financial instruments:
Commitments to extend credit............... -- -- -- --
Standby letters of credit and financial
guarantees written...................... -- -- -- --
Loans sold with recourse................... -- -- -- --
19. 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
and derivative instruments.
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.
27
29
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
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.
YEARS ENDED,
-----------------------
1998 1997
---------- ---------
Commitments to extend credit................................ $2,270,082 1,583,467
========== =========
Standby letters of credit and financial guarantees
written................................................... $ 122,747 114,304
========== =========
Loans sold with recourse.................................... $ 46,627 11,378
========== =========
Interest rate swaps......................................... $ 75,000 65,500
========== =========
Purchased options........................................... $ 61,400 --
========== =========
Futures contracts sold...................................... $ 6,100 41,000
========== =========
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 $27,627 and $33,796 at December 31, 1998 and 1997, 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 certain
transactions, 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.
Derivative financial instruments include swaps, futures, forwards and
option contracts all of which derive their value from underlying interest rates,
commodity values or equity instruments. For most contracts, notional amounts are
used solely to determine cash flows to be exchanged. The notional or contract
amounts associated with the derivative instruments are not recorded as assets or
liabilities on the balance sheet and do not represent the potential for gain or
loss associated with such transactions. During 1998 the Corporation entered into
swap agreements to modify the interest sensitivity of certain liability
portfolios. Specifically, the Corporation swapped $25 million fixed rate
certificate of deposits to floating rate liabilities and swapped $50 million of
fixed rate capital securities to floating rate liabilities. At the same time,
the Corporation purchased a $50 million interest rate cap associated with the
fixed rate capital securities. The gross losses in 1998 associated with purchase
options totaled $31.0 million and the gross losses from future contracts sold
were $36.0 million.
20. 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
28
30
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
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.
21. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial and per share data for the years ended 1998 and 1997
are summarized as follows:
QUARTERS
-----------------------------------------
FIRST SECOND THIRD FOURTH
-------- ------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT SHARE
Total interest income...................... 1998 $150,374 158,405 167,019 166,759
==== ======== ======= ======= =======
1997 $138,107 143,823 149,149 153,431
==== ======== ======= ======= =======
Net interest income........................ 1998 $ 83,280 87,765 91,493 93,643
==== ======== ======= ======= =======
1997 $ 78,390 80,303 81,840 85,530
==== ======== ======= ======= =======
Provision for possible loan losses......... 1998 $ 6,164 8,144 5,941 20,672
==== ======== ======= ======= =======
1997 $ 4,511 5,482 6,727 6,798
==== ======== ======= ======= =======
Income (loss) before federal income
taxes.................................... 1998 $ 42,848 35,825 49,787 (18,081)
==== ======== ======= ======= =======
1997 $ 40,919 42,234 42,408 45,213
==== ======== ======= ======= =======
Net income (loss).......................... 1998 $ 29,373 24,226 33,855 (14,937)
==== ======== ======= ======= =======
1997 $ 27,126 28,526 28,753 30,303
==== ======== ======= ======= =======
Net income (loss) per share -- basic....... 1998 $ 0.35 0.28 0.38 (0.18)
==== ======== ======= ======= =======
1997 $ 0.33 0.34 0.34 0.38
==== ======== ======= ======= =======
Net income (loss) per share -- diluted..... 1998 $ 0.34 0.28 0.37 (0.17)
==== ======== ======= ======= =======
1997 $ 0.31 0.32 0.33 0.36
==== ======== ======= ======= =======
22. 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 (a "Right").
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.
29
31
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
23. EARNINGS PER SHARE
SFAS 128 requires reconciliation of the numerator and denominator used in
the basic Earnings Per Share ("EPS") calculation to the numerator and
denominator used in the diluted EPS calculation. The calculations are presented
in the table below:
YEARS ENDED,
---------------------------------------
1998 1997 1996
----------- ---------- ----------
DOLLARS IN THOUSANDS
Basic EPS:
Net income........................................... $ 72,517 114,708 90,210
Less: preferred stock dividends...................... (691) (1,584) (1,665)
Net income available to common shareholders.......... 71,826 113,124 88,545
Average common shares outstanding.................... 86,376,507 81,351,984 83,243,457
Earnings per basic common share...................... $ 0.83 1.39 1.06
Diluted EPS:
Net income available to common shareholders.......... 71,826 113,124 88,545
Add: preferred stock dividends....................... -- 1,584 1,665
Add: interest expense on convertible bonds, net...... 206 334 391
----------- ---------- ----------
Adjusted income available to common shareholder...... 72,032 115,042 90,601
Average common shares outstanding.................... 86,376,507 81,351,984 83,243,457
Add: common stock equivalents for shares issuable
under:
Stock option plans................................. 1,055,079 1,511,268 684,620
Convertible debentures/preferred securities........ 552,420 4,433,464 4,854,554
Average common and common stock equivalent shares
outstanding........................................ 87,984,006 87,296,716 88,782,631
----------- ---------- ----------
Earnings per diluted common share.................... $ 0.82 1.32 1.02
=========== ========== ==========
24. 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 judgements
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, 1998, 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 year-end 1998, 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."
30
32
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRSTMERIT CORPORATION AND SUBSIDIARIES
FOR CAPITAL
ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES: ACTION PROVISION:
---------------- --------------- ---------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- ------- ----- ------- -----
Year-end 1998:
Total Capital (to Risk $949,229 12.82% M 592,802 8.00% M 740,391 M 10.00%
Weighted Assets)......
Tier I Capital (to Risk 774,303 10.46% M 296,150 4.00% M 444,253 M 6.00%
Weighted Assets)......
Tier I Capital (to 774,303 8.91% M 260,773 3.00% M 434,655 M 5.00%
Average Assets).......
31
33
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders of FirstMerit Corporation:
In our opinion, the accompanying supplemental consolidated balance sheets
and the related supplemental consolidated statements of income and retained
earnings and of cash flows present fairly, in all material respects, the
consolidated financial position of FirstMerit Corporation and subsidiaries at
December 31, 1998 and 1997, and the consolidated results of their operations and
their cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles applicable
after financial statements are issued for a period which includes the date of
consummation of the business combination. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which 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 statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
The supplemental financial statements give retroactive effect to the merger
of FirstMerit Corporation and Signal Corp. on February 12, 1999, which has been
accounted for as a pooling of interests as described in the notes 1 and 2 to the
supplemental consolidated financial statements. Generally accepted accounting
principles proscribe giving effect to a consummated business combination
accounted for by the pooling of interests methods in financial statements that
do not include the date of consummation. These financial statements do not
extend through the date of consummation; however, they will become the
historical consolidated financial statements of FirstMerit Corporation and
subsidiaries after financial statements covering the date of consummation of the
business combination are issued.
PRICEWATERHOUSECOOPERS SIGNATURE
March 11, 1999
32
34
FINANCIAL HIGHLIGHTS
FIRSTMERIT CORPORATION AND SUBSIDIARIES
INCREASE
FOR THE YEAR ENDING (DECREASE)
----------------------- -----------------------
1998 1997 AMOUNT %
---------- --------- --------- ----------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
Interest income............................. $ 642,557 584,510 58,047 10
Interest expense............................ 286,376 258,447 27,929 11
Net interest income......................... 356,181 326,063 30,118 9
Net interest income--fully-tax equivalent
basis.................................... 359,673 329,275 30,398 9
Provision for possible loan losses*......... 40,921 23,518 17,403 74
Net income*................................. 72,517 114,708 (42,191) (37)
Net income available to common
shareholders*............................ 71,826 113,124 (41,298) (37)
Net yield on earning assets................. 8.19% 8.24% -- --
Return on assets*........................... 0.85% 1.51% -- --
Return on equity*........................... 8.61% 15.88% -- --
Efficiency ratio (excluding unusual
charges)................................. 63.55% 54.71% -- --
Dividends paid.............................. 50,525 44,136 6,389 14
Per Common Share
Net income -- diluted*...................... 0.82 1.32 (0.50) (38)
Dividends paid.............................. 0.66 0.61 0.05 8
Year end book value......................... 9.97 8.76 1.21 14
Weighted average number of shares
outstanding -- basic..................... 86,377 81,352 5,025 6
Weighted average number of shares
outstanding -- diluted................... 87,984 87,297 687 1
At Year End
Total assets................................ $9,026,024 7,825,430 1,200,594 15
Total deposits.............................. 6,845,978 6,020,264 825,714 14
Loans....................................... 6,398,445 5,733,614 664,831 12
Investment securities....................... 1,878,266 1,556,088 322,178 21
Total earning assets..................... 8,308,450 7,358,993 949,457 13
Total funds available.................... 7,969,182 6,962,094 1,007,088 14
Shareholders' equity........................ 906,656 747,677 162,879 22
Average Daily Balances For The Year
Total assets................................ $8,520,575 7,591,936 928,639 12
Total deposits.............................. 6,455,209 5,667,347 787,862 14
Loans....................................... 6,131,665 5,468,587 663,078 12
Investment securities....................... 1,715,543 1,593,224 122,319 8
Total earning assets........................ 7,892,086 7,128,553 763,533 11
Total funds available....................... 7,519,057 6,723,285 795,772 12
Shareholders' equity........................ 841,865 722,404 119,461 17
- ---------------
* The 1998 net income, provision for possible loan losses, and profitability
ratios shown include 1) merger-related expenses associated with the Security
First pooling-of-interests acquisition of $12.8 million after taxes, 2) merger
costs from Signal's acquisition of First Shenango Bancorp, Inc. ("First
Shenango") of $3.0 million after taxes, and 3) a loss from the sale of a
subsidiary of $5.5 million after taxes.
These same results restated to exclude the merger-related expenses and the
loss from the sale of the subsidiary, can be found in the "Earnings Summary"
section of "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
33
35
SELECTED FINANCIAL DATA
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEARS ENDED,
--------------------------------------------------------------
1998 1997 1996 1995 1994
---------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
Results of Operations
Interest income...................................... $ 642,557 584,510 562,152 548,929 483,136
Conversion to fully-tax equivalent................... 3,492 3,212 3,043 3,840 4,634
---------- --------- --------- --------- ---------
Interest income*..................................... 646,049 587,722 565,195 552,769 487,770
Interest expense..................................... 286,376 258,447 249,343 257,306 198,248
---------- --------- --------- --------- ---------
Net interest income*................................. 359,673 329,275 315,852 295,463 289,522
Provision for possible loan losses................... 40,921 23,518 19,333 21,058 6,008
Other income......................................... 140,148 114,094 103,091 75,349 75,793
Other expenses....................................... 345,029 245,865 260,362 260,927 224,206
---------- --------- --------- --------- ---------
Income before federal income taxes*.................. 113,871 173,986 139,248 88,827 135,101
Federal income taxes................................. 37,862 56,066 45,995 41,137 41,169
Fully-tax equivalent adjustment...................... 3,492 3,212 3,043 3,840 4,634
---------- --------- --------- --------- ---------
Federal income taxes*................................ 41,354 59,278 49,038 44,977 45,803
Income before extraordinary item..................... 72,517 114,708 90,210 43,850 89,298
Income before extraordinary item available to common
shareholders....................................... 72,517 113,124 88,514 42,064 87,934
Extraordinary item -- gain on disposition of assets
after combination (net of tax effect).............. -- -- -- 5,599 --
---------- --------- --------- --------- ---------
Net income (a)......................................... $ 72,517 114,708 90,210 49,449 89,298
---------- --------- --------- --------- ---------
Net income applicable to common stock (a).............. $ 71,826 113,124 88,514 47,663 87,934
---------- --------- --------- --------- ---------
Per common share:
Income before extraordinary item available to
common shareholders............................ $ 0.83 1.39 1.06 0.50 1.13
Extraordinary item (net of tax effect)........... -- 0.07 --
---------- --------- --------- --------- ---------
Basic net income (a)............................. $ 0.83 1.39 1.06 0.57 1.13
========== ========= ========= ========= =========
Diluted net income (a)........................... $ 0.82 1.32 1.02 0.55 1.06
========== ========= ========= ========= =========
Cash dividends................................... $ 0.66 0.61 0.55 0.51 0.49
Dividend payout ratio................................ 79.37% 43.87% 51.73% 102.08% 43.33%
Average Ratios
Return on total assets (a)........................... 0.85% 1.51% 1.21% 0.67% 1.29%
Return on shareholders' equity (a)................... 8.61% 15.88% 12.67% 7.07% 13.38%
Shareholders' equity to total assets................. 9.88% 9.51% 9.52% 9.47% 9.65%
Balance Sheet Data
Total assets (at year end)........................... $9,026,024 7,825,430 7,348,909 7,423,139 7,377,931
Daily averages:
Total assets....................................... $8,520,575 7,591,936 7,480,069 7,386,917 6,916,648
Earning assets................................... 7,892,086 7,128,553 7,061,579 6,961,821 6,518,632
Deposits and other funds......................... 7,519,057 6,723,285 6,677,686 6,608,598 6,186,966
Shareholders' equity............................. 841,865 722,204 712,044 699,603 667,637
- ---------------
* Fully-tax equivalent basis
(a) The 1998 net income, provision for possible loan losses, and profitability
ratios shown include 1) merger-related expenses associated with the Security
First pooling-of-interests acquisition of $12.8 million after taxes, 2)
merger costs from Signal's acquisition of First Shenango of $3.0 million
after taxes, and 3) a loss from the sale of a subsidiary of $5.5 million
after taxes. The results for 1996 include a one-time Savings Association
Insurance Fund ("SAIF") charge of $15.2 million before taxes or
approximately $9.9 million after taxes. In addition to the extraordinary
gain shown in the table, results for 1995 include several one-time charges
totaling $30.0 million before taxes. The charges related to the CIVISTA
acquisition, overall reengineering costs to improve operating efficiencies
and various other items.
These same results restated to exclude the merger-related expenses and the
loss from the sale of the subsidiary, can be found in the "Earnings Summary"
section of "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
34
36
AVERAGE CONSOLIDATED BALANCE SHEETS
FULLY-TAX EQUIVALENT INTEREST RATES AND INTEREST DIFFERENTIAL
FIRSTMERIT CORPORATION AND SUBSIDIARIES
YEARS ENDED
----------------------------------------------------------------------
1998 1997
--------------------------------- ---------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ------- ---------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Investment securities:
U.S. Treasury
securities and U.S.
Government agency
obligations
(taxable)........... $1,466,525 92,646 6.32% 1,404,024 90,853 6.47%
Obligations of states
and political
subdivisions
(tax-exempt)........ 98,457 7,767 7.89 86,873 7,074 8.14
Other securities...... 150,561 9,504 6.31 102,327 6,568 6.42
---------- ------- ---- ---------- ------- ----
Total investment
securities........ 1,715,543 109,917 6.41 1,593,224 104,495 6.56
Federal funds sold &
other interest-earning
assets................ 44,878 2,400 5.35 66,742 3,498 5.24
Loans................... 6,131,665 533,732 8.70 5,468,587 479,729 8.77
Total earning
assets............ 7,892,086 646,049 8.19 7,128,553 587,722 8.24
Allowance for possible
loan losses........... (69,191) (56,234)
Cash and due from
banks................. 204,353 202,600
Other assets............ 493,327 317,017
---------- ----------
Total assets........ $8,520,575 $7,591,936
========== ==========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Demand-non-interest
bearing............. $1,083,354 -- -- 773,285 -- --
Demand-interest
bearing............. 752,096 13,222 1.76 693,277 12,575 1.81
Savings............... 1,600,122 44,077 2.75 1,531,623 40,564 2.65
Certificates and other
time deposits....... 3,019,637 165,198 5.47 2,669,162 146,097 5.47
---------- ------- ---- ---------- ------- ----
Total deposits...... 6,455,209 222,497 3.45 5,667,347 199,236 3.52
Federal funds purchased,
securities sold under
agreements to
repurchase and other
borrowings............ 1,063,848 63,879 6.00 1,055,938 59,211 5.61
---------- ------- ---- ---------- ------- ----
Total interest
bearing
liabilities....... 6,435,703 286,376 4.45 5,950,000 258,447 4.34
Other liabilities....... 159,653 146,247
Shareholders' equity.... 841,865 722,404
---------- ----------
Total liabilities
and shareholders'
equity............ $8,520,575 7,591,936
========== ==========
Net yield on earning
assets................ 359,673 4.56 329,275 4.62
======= ==== ======= ====
Interest rate spread.... 3.73 3.90
==== ====
Income on tax-exempt
securities and
loans................. 5,542 5,225
======= =======
YEARS ENDED
---------------------------------
1996
---------------------------------
AVERAGE AVERAGE
BALANCE INTEREST RATE
---------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Investment securities:
U.S. Treasury
securities and U.S.
Government agency
obligations
(taxable)........... 1,518,635 96,180 6.33
Obligations of states
and political
subdivisions
(tax-exempt)........ 100,630 7,404 7.36
Other securities...... 99,977 6,489 6.49
---------- ------- ----
Total investment
securities........ 1,719,242 110,073 6.40
Federal funds sold &
other interest-earning
assets................ 37,971 1,838 4.84
Loans................... 5,304,366 453,284 8.55
Total earning
assets............ 7,061,579 565,195 8.00
Allowance for possible
loan losses........... (52,003)
Cash and due from
banks................. 231,564
Other assets............ 238,929
----------
Total assets........ 7,480,069
==========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Demand-non-interest
bearing............. 773,560 -- --
Demand-interest
bearing............. 641,607 12,485 1.95
Savings............... 1,653,279 41,816 2.53
Certificates and other
time deposits....... 2,610,832 141,512 5.42
---------- ------- ----
Total deposits...... 5,679,278 195,813 3.45
Federal funds purchased,
securities sold under
agreements to
repurchase and other
borrowings............ 998,408 53,530 5.36
---------- ------- ----
Total interest
bearing
liabilities....... 5,904,126 249,343 4.22
Other liabilities....... 90,339
Shareholders' equity.... 712,044
----------
Total liabilities
and shareholders'
equity............ 7,480,069
==========
Net yield on earning
assets................ 315,852 4.47
======= ====
Interest rate spread.... 3.78
====
Income on tax-exempt
securities and
loans................. 6,241
=======
- ---------------
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.
35
37
EARNINGS SUMMARY
FirstMerit Corporation's earnings totaled $93.8 million, or $1.06 per
share, when merger-related expenses, a conforming accounting entry to the
allowance for possible loan losses, and the loss on sale of a subsidiary are
excluded. The after-tax costs excluded totaled $21.3 million. Earnings in 1997,
excluding merger related costs of $0.8 million, were $115.5 million, or $1.33
per share. Reported net income for 1998, which includes the $21.3 million of
after-tax costs just listed, was $72.5 million, or $0.82 per share. All results
presented reflect the restatement of prior period financial information to
account for the pooling-of-interests acquisitions of Security First Corp. and
Signal Corp. Additionally, 1998 results include the earnings of CoBancorp, Inc.,
which was accounted for as a purchase transaction, from the merger date of May
23, 1998 through December 31, 1998. Because results of CoBancorp are included in
1998 totals for approximately seven months, almost all individual categories
discussed throughout the Annual Report will have unquantifiable increases over
1997 due solely to the acquisition.
Excluding the merger-related costs, the conforming accounting entry and the
loss from the sale of the subsidiary, returns on average equity ("ROE") and
average assets ("ROA") were 11.14% and 1.10% compared to 15.99% and 1.52% for
the prior year. ROE and ROA based on 1998 reported net income of $72.5 million
were 8.61% and 0.85%, respectively.
Net interest income on a fully tax-equivalent basis reached $359.7 million
for the year compared to $329.3 million for 1997, an increase of 9.2%. The
increase occurred because of earning asset volume gains of 10.7%. The net
interest margin declined from 4.62% in 1997 to 4.56% for 1998.
Adjusted net revenue for 1998 of $493.0 million represents a 12.0% increase
from its year earlier level of $440.3 million. Adjusted net revenue is defined
as net interest income on a tax-equivalent basis added to other income, less
securities gains. The growth in other income and earning assets more than
offsets the compression in the net interest margin. Excluding gains from the
sale of securities, other income was $133.4 million, or 20.2% higher than the
$111.0 million reported for 1997. Other income now accounts for 27.1% of 1998
net revenue compared with 25.2% a year ago. With the exception of manufactured
housing income, fee improvement was evident across-the-board as follows: trust
fees, up $2.7 million, or 20%; credit card fees, up $5.7 million, or 40%;
service charges, up $6.6 million, or 20%; other service fees, up $3.2 million,
or 43%; mortgage sales and servicing, up $5.7 million, or 51%, and other
operating income, up $5.5 million, or 33%.
Excluding the $9.8 million pre-tax charge related to the Security First
merger, the $4.6 million pre-tax charge related to Signal's acquisition of First
Shenango and the $8.4 million loss from the sale of a subsidiary, other expenses
totaled $322.2 million for the year compared with $245.9 million for the prior
year, an increase of 31.1%. Reported other expenses, when the merger costs and
loss from sale are included, were $339.0 million. Most 1998 expense categories
are consistent with the prior year performance when measured as a percentage of
assets for each period. The following items are included in 1998 other operating
expenses and account for a large portion of the increase in that category: a
valuation adjustment of $18 million related to securitized manufactured housing
loans; a valuation adjustment of $7.4 million related to retained servicing of
manufactured housing contracts; an adjustment of $3.2 million to recognize more
manufactured housing loan origination expenses and the establishment of a
liability of $3.3 million related to repayment of manufactured housing loans.
Amortization of intangibles resulting from the CoBancorp acquisition has risen
sharply, from $3.8 million in 1997 to $8.9 million for 1998. After adjusting for
merger-related expenses and the loss on sale of the subsidiary, the efficiency
ratio was 62.33% compared to 54.71% last year.
The provision for loan losses of $40.9 million includes a merger-related
increase of $9.1 million and a charge of $7.8 million associated with
manufactured housing and commercial loans. Net charge-offs as a percentage of
average outstanding loans totaled 0.34% at year ends 1998 and 1997. At year-end
1998, the allowance as a percentage of outstanding loans stands at 1.50%
compared to the 1997 reserve level of 1.18% of outstanding loans.
36
38
The following table summarizes the changes in earnings per share for 1998
and 1997.
CORE* AS REPORTED
1998/1997 1998/1997 1997/1996
(DOLLARS) --------- ----------- ---------
CHANGES IN EARNINGS PER SHARE
Net income per diluted share for 1997 and 1996,
respectively............................................. $1.32 $1.32 $1.02
Increases (decreases) attributable to:
Net interest income -- taxable equivalent................ 0.34 0.34 0.15
Provision for possible loan losses....................... (0.11) (0.20) (0.05)
Trust services........................................... 0.03 0.03 0.01
Service charges on deposit accounts...................... 0.07 0.07 0.06
Credit card fees......................................... 0.06 0.06 0.03
Service fees -- other.................................... 0.04 0.04 0.01
Securities gains (losses), net........................... 0.04 0.04 0.05
Manufactured housing income.............................. (0.08) (0.08) 0.04
Loan sales and servicing income.......................... 0.06 0.06 0.03
Other operating income................................... 0.06 0.06 (0.11)
Salaries and employee benefits........................... (0.27) (0.29) (0.03)
Equipment expense........................................ (0.03) (0.03) --
Intangible amortization expense.......................... (0.06) (0.06) 0.01
Other operating expenses................................. (0.48) (0.71) 0.19
Federal income taxes -- taxable equivalent............... 0.08 0.18 (0.12)
Change in share base..................................... (0.01) (0.01) 0.03
----- ----- -----
Net change in net income................................. (0.21) (0.50) 0.30
----- ----- -----
Net income per diluted share for 1998 core, 1998 reported
and 1997, respectively................................ $1.06 $0.82 $1.32
===== ===== =====
- ---------------
* The term "core" is defined as excluding merger-related expenses associated
with the Security First pooling-of-interests acquisition and merger-related
expenses associated with Signal's acquisition of First Shenango. See Note 2 to
the supplemental consolidated financial statements for further details.
SUPERCOMMUNITY BANKING RESULTS
The Corporation's operations are managed along its major line of business,
Supercommunity Banking. Note 17 to the supplemental consolidated financial
statements provides performance data for this line of business as well as
summary information by product and service group.
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,
37
39
and the growth in earning assets. The following table shows the allocation to
assets, the source of funding and their respective interest spreads.
1998
----------------------------------------------------
AVERAGE NET
EARNING ASSETS INTEREST SPREAD INTEREST INCOME
-------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
Interest-bearing liabilities...................... $6,435,703 3.73% 240,052
Non-interest-bearing liabilities and equity....... 1,456,383 8.19%* 119,621
---------- -------
$7,892,086 359,673
========== =======
1997
----------------------------------------------------
AVERAGE NET
EARNING ASSETS INTEREST SPREAD INTEREST INCOME
-------------- --------------- ---------------
Interest-bearing liabilities...................... $5,950,000 3.90% 232,050
Non-interest-bearing liabilities and equity....... 1,178,553 8.24%* 97,225
---------- -------
$7,128,553 329,275
========== =======
1996
----------------------------------------------------
AVERAGE NET
EARNING ASSETS INTEREST SPREAD INTEREST INCOME
-------------- --------------- ---------------
Interest-bearing liabilities...................... $5,904,126 3.78% 223,176
Non-interest-bearing liabilities and equity....... 1,157,453 8.01%* 92,676
---------- -------
$7,061,579 315,852
========== =======
- ---------------
* Yield on earning assets
Net interest income, on a fully-tax equivalent basis, increased $30.4
million, or 9.2%, to $359.7 million in 1998 compared to $329.3 million in 1997
and $315.9 million in 1996. The increase over 1997 occurred because the rise in
interest income more than offset the increase in interest expense. Specifically,
interest income rose $58.3 million while interest expense increased $27.9
million.
Interest income was higher than last year because average earning assets
grew 10.7% or $763.5 million. The increase in average earning assets was
attributable to the CoBancorp purchase acquisition on May 22, 1998 and strong
loan demand. Under purchase accounting rules, the results of the acquired
company are included in current year totals from the date of the acquisition
through the end of the year; corresponding prior period totals do not contain
the results of the acquired company. The average yield on earning assets
decreased 5 basis points from 8.24% in 1997 to 8.19% during 1998. In summary,
higher earning asset volumes outpaced the decline in earning asset rates
resulting in higher interest income.
Higher interest expense was both volume and rate related as deposits and
other borrowings were used to fund the earning asset growth and the cost of
funds increased 11 basis points. Similar to the asset scenario described in the
preceding paragraph, the CoBancorp acquisition played a large part in the higher
funding balances and resultant increase in interest expense. Cost of funds for
the year as a percentage of average earning assets rose from 4.34% in 1997 to
4.45% this year accounting for $5.4 million, or 19.0%, of the total rise in
interest expense of $27.9 million while increased funding volume accounted for
the remaining increase of $22.6 million, or 81.0%.
The following table illustrates the specific year-over-year impact to net
interest income based on changes in the rate and volume components of the
interest-earning assets and interest-bearing liabilities.
38
40
CHANGES IN NET INTEREST DIFFERENTIAL -- FULLY-TAX EQUIVALENT RATE/VOLUME
ANALYSIS
YEARS ENDED,
------------------------------------------------------------
1998 AND 1997 1997 AND 1996
---------------------------- --------------------------
INCREASE (DECREASE) IN INCREASE (DECREASE) IN
INTEREST INCOME/EXPENSE INTEREST INCOME/EXPENSE
---------------------------- --------------------------
YIELD/ YIELD/
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- ------- ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
INTEREST INCOME
Investment securities:
Taxable...................... $ 6,995 (2,266) 4,729 (7,260) 2,012 (5,248)
Tax-exempt................... 914 (221) 693 (1,120) 790 (330)
Loans............................. 57,718 (3,715) 54,003 14,406 12,039 26,445
Federal funds sold................ (1,169) 71 (1,098) 1,508 152 1,660
------- ------- ------ ------ ------ ------
Total interest income... 64,458 (6,131) 58,327 7,534 14,993 22,527
------- ------- ------ ------ ------ ------
INTEREST EXPENSE
Interest on deposits:
Demand-interest bearing...... 1,034 (387) 647 937 (847) 90
Savings...................... 1,887 1,626 3,513 (3,222) 1,970 (1,252)
Certificates and other time
deposits (CDs)............. 19,174 (73) 19,101 3,193 1,392 4,585
Federal funds purchased,
securities sold under agreements
to repurchase and other
borrowings...................... 475 4,193 4,668 3,226 2,455 5,681
------- ------- ------ ------ ------ ------
Total interest expense............ 22,570 5,359 27,929 4,134 4,970 9,104
------- ------- ------ ------ ------ ------
Net interest income............... $41,888 (11,490) 30,398 3,400 10,023 13,423
======= ======= ====== ====== ====== ======
- ---------------
Note: The variance created by a combination of rate and volume has been
allocated entirely to the volume column.
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 1998 was 4.56% compared to 4.62% in 1997 and
4.47% in 1996. The decline in the net interest margin compared to last year was
mainly due to falling interest rates during the year (lower interest rate
spread).
1998 1997 1996
---------- ---------- ---------
(DOLLARS IN THOUSANDS)
Net interest income................................... $ 356,181 326,063 312,809
Tax equivalent adjustment............................. 3,492 3,212 3,043
---------- ---------- ---------
Net interest income -- FTE............................ $ 359,673 $ 329,275 315,852
========== ========== =========
Average earning assets................................ $7,892,086 7,128,553 7,061,579
---------- ---------- ---------
Net interest margin................................... 4.56% 4.62% 4.47%
========== ========== =========
OTHER INCOME
Excluding securities gains, other income totaled $133.4 million in 1998, an
increase of $22.4 million or 20.2% over 1997, and $29.1 million over adjusted
1996 which also excludes prior gains of $13.7 million from the
39
41
sale of branches and a former bank affiliate. Increases in all categories below
occurred because of the 1998 CoBancorp purchase acquisition as well as continued
company emphasis on improving other income (fee income).
1998 1997 1996
-------- ------- -------
(DOLLARS IN THOUSANDS)
Trust fees.................................................. $ 16,147 13,442 12,182
Service charges on deposits................................. 39,883 33,279 28,547
Credit card fees............................................ 20,064 14,355 11,415
Service fees -- other....................................... 10,493 7,337 6,184
Securities gains (losses)................................... 6,785 3,114 (1,192)
Manufactured housing income................................. 7,630 14,684 11,580
Mortgage sales and servicing................................ 16,900 11,177 8,378
Gains from branch/subsidiary sales.......................... 473 0 13,700
Other operating income...................................... 21,773 16,706 12,297
-------- ------- -------
$140,148 114,094 103,091
======== ======= =======
Trust fees increased $2.7 million or 20.1% to $16.1 million in 1998.
Service charges on deposits rose $6.6 million or 19.8% compared to last year.
Credit card fees increased $5.7 million in 1998 partially due to increased
merchant activity and the CoBancorp acquisition. Other service fees rose $3.2
million, or 43.0% compared to last year; a major component of this category is
ATM fees. Income from mortgage sales and servicing was up $5.7 million, these
gains occur as the Corporation's mortgage company sells mortgage loans to the
secondary market. Securities gains increased $3.6 million, or 117.0% as the
Corporation sold several groups of mortgage-backed securities at gains. The
sales of the mortgage-backed securities occurred as management saw the
opportunity to take gains on sales, to reinvest the proceeds in higher yielding
commercial and consumer credits, and to sell before further "run-off" of these
loans occurred during a high refinancing period. Other operating income, as
presented in the table above, was up $5.1 million in part because of the
CoBancorp and other purchase acquisitions. See "other expenses" for more
description of the acquisitions other than CoBancorp.
Excluding gains from sales of securities, other income was $133.4 million
and now represent 27.1% of net revenue compared to 25.2 % last year. Net revenue
is defined as net interest income, on a fully-taxable equivalent basis, plus
other income, less securities gains.
FEDERAL INCOME TAX
Federal income tax expense totaled $37.9 million in 1998 compared to $56.1
million in 1997, and $46.0 in 1996. In 1998 the effective federal income tax
rate for the Corporation equaled 34.3% compared to 32.8% in 1997 and 33.8% in
1996.
OTHER EXPENSES
Core other expenses, excluding merger-related costs and a loss from the
sale of a subsidiary (Alliance Corporate Resources, Inc.) were $322.2 million in
1998 compared to $245.9 million in 1997 and $245.2 million in 1996. Totals for
1998 include (1) the results of CoBancorp for approximately 7 months and the
full-year results of several smaller acquisitions that were acquired mid-year
1997, and (2) the following expenses recorded in the other operating expenses
category: a valuation adjustment of $18.0 million related to securitized
manufactured housing loans; a valuation adjustment of $7.4 million related to
retained servicing of manufactured housing contracts; an adjustment of $3.2
million to recognize more manufactured housing loan origination expenses and the
establishment of a liability of $3.3 million related to repayment of
manufactured housing loans. In accordance with purchase accounting rules, the
results of the companies purchased are not included in results presented prior
to their purchase dates.
40
42
REPORTED CORE*
1998 1998 1997 1996
-------- ------- ------- -------
(DOLLARS IN THOUSANDS)
OTHER EXPENSES
Salaries and wages............................ $112,087 110,474 90,201 87,390
Pension and benefits.......................... 31,778 31,702 26,892 26,817
-------- ------- ------- -------
Salaries, wages, pension and benefits......... 143,865 142,176 117,093 114,207
Net occupancy expense......................... 23,002 22,310 22,592 22,277
Equipment expense............................. 15,882 15,741 12,717 12,894
Taxes, other than federal income taxes........ 7,890 7,890 7,168 7,298
Stationery, supplies and postage.............. 10,789 10,774 9,529 11,166
Bankcard, loan processing, and other fees..... 29,575 28,059 19,126 16,321
Advertising................................... 5,416 5,183 6,298 7,303
Professional services......................... 14,332 9,882 7,191 6,505
Telephone..................................... 4,722 4,722 3,856 3,654
FDIC assessment, excluding SAIF in 1996....... 1,473 1,473 1,524 6,162
SAIF assessment............................... -- -- -- 15,211
Loss on sale of subsidiary.................... 8,410 -- -- --
Amortization of intangibles................... 8,926 8,926 3,771 4,374
Other operating expenses...................... 70,747 65,104 35,000 32,990
-------- ------- ------- -------
Total other expenses.......................... $345,029 322,240 245,865 260,362
======== ======= ======= =======
- ---------------
* Core other expenses, when compared to reported results, exclude $9.8 million
of pre-tax merger-related costs associated with the Security First
acquisition, $4.6 million of pre-tax charges related to Signal's acquisition
of First Shenango and an $8.4 million loss from the sale of a subsidiary. Also
affecting core earnings, but not other expenses, was an increase to the
provision for possible loan losses of $7.3 million and a decrease in Other
Income of $0.1 million associated with the Security First acquisition.
Adjusted salaries, wages, pension and benefits totaled $142.2 million in
1998, an increase of $25.1 million or 21.4% from 1997. The increase was
primarily due to the 1997 purchase acquisition of CoBancorp, the mid-year 1997
purchases of Alpha Equipment Group, Inc., Alliance Corporate Resources Inc.
(which was subsequently sold December 31, 1998) and Summit Bank (an immaterial
"pooling-of-interests" in which prior periods were not restated) and an
adjustment of $2.8 million to recognize more direct salary and wage expense
associated with the origination of manufactured housing loans. Salaries and
benefits in 1997 were 2.5% higher than 1996 mainly due to merit increases.
Adjusted bankcard, loan processing, and other fees increased $8.9 million
to $28.1 million in 1998. A portion of the increase is due to the activity of
the purchased companies discussed previously in this section. The Corporation's
efforts to improve the efficiency of all acquired companies will be a major goal
in 1999.
Amortization of intangible expense during 1998 was $9.0 million, up $5.2
million from 1997 and $4.6 million from 1996. The 1998 increase was due to the
CoBancorp acquisition. The decline in 1997 intangible amortization expense
compared to 1996 occurred as 1996 branch sales, many in the fourth quarter,
lessened goodwill and core deposit intangibles.
Excluding the merger-related expenses and an $8.4 million loss on a
subsidiary, the efficiency ratio for 1998 was 63.55% compared to 54.71% last
year. The "lower-is-better" efficiency ratio indicates the percentage of
operating costs that is used to generate each dollar of net revenue -- that is,
during 1998, $0.6355 cents was spent to generate $1 of net revenue. The
Corporation's goal in 1999 is to make its recent acquisitions more efficient.
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 have been classified as
available-for-sale.
41
43
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 increase fair value at year-ends 1998
and 1997 were $9.0 million and $7.0 million, respectively.
At year-end 1998, investment securities totaled $1,878.3 million compared
with $1,556.1 million one year earlier, an increase of 20.7%.
A summary of investment securities' carrying value is presented below as of
year-ends 1998, 1997 and 1996. Presented with the summary is a maturity
distribution schedule with corresponding weighted average yields.
CARRYING VALUE OF INVESTMENT SECURITIES
YEAR-ENDS,
-----------------------
1998 1997
---------- ---------
(DOLLARS IN THOUSANDS)
U.S. Treasury and Government agency obligations............. $ 693,939 648,360
Obligations of states and political subdivisions............ 140,177 117,745
Mortgage-backed securities.................................. 748,355 619,596
Other securities............................................ 295,795 170,387
---------- ---------
$1,878,266 1,556,088
========== =========
OVER ONE YEAR OVER FIVE YEARS
ONE YEAR OR LESS THROUGH FIVE YEARS THROUGH TEN YEARS OVER TEN YEARS
------------------- ------------------ ------------------ --------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
AMOUNT YIELDS AMOUNT YIELDS AMOUNT YIELDS AMOUNT YIELDS
-------- -------- ------- -------- ------- -------- --------- --------
U.S. Treasury securities.......... $ 48,339 5.85% 38,138 6.11% -- -- -- --
U.S. Government agency
obligations..................... 30,999 5.85% 142,624 5.62% 190,716 5.85% 281,789 5.76%
Obligations of states and
political subdivisions.......... 20,737 4.71%* 48,304 5.05%* 36,665 4.70%* 36,605 5.23%*
Mortgage-backed securities........ 2,866 3.99% 25,934 6.22% 87,019 6.00% 518,505 6.52%
Other securities.................. 3,588 6.04% 1,041 5.50% 50,268 4.26% 314,129 5.58%**
-------- ---- ------- ---- ------- ---- --------- ----
$106,529 5.58% 256,041 5.63% 364,668 5.55% 1,151,028 6.02%
======== ==== ======= ==== ======= ==== ========= ====
Percent of total.................. 5.67% 13.63% 19.42% 61.28%
======== ======= ======= =========
- ---------------
* Fully-taxable equivalent based upon federal income tax structure applicable
at December 31, 1998.
** Weighted-average yield does not reflect $18 million write-down of
Asset-backed securities book values and fair values due to impairment. See
notes 2, 3 and 6 to the consolidated financial statements for additional
information.
At year-end 1998, Collateralized Mortgage Obligations ("CMOs") totaled
$424.2 million, representing approximately 21.7% of the investment portfolio.
The duration of total CMOs is slightly less than the total portfolio. The
aggregate book value of all privately issued mortgage-backed securities does not
exceed 10% of shareholders' equity. CMOs which fail the Federal Financial
Institution Examination Council's ("FFIEC") high risk stress test total $6.5
million, or 1.5% of the total investment portfolio.
The yield on the portfolio was 6.41% in 1998 compared to 6.56% in 1997 and
6.40% in 1996.
LOANS
Total loans outstanding at year-end 1998 increased 11.6% compared to one
year ago or $5,733.5 million compared to $6,398.4 million. A breakdown by
category is presented below, along with a maturity summary of commercial,
financial and agricultural loans.
42
44
YEAR-ENDS,
----------------------------------------------------------------
1998 1997 1996 1995 1994
---------- --------- --------- ---------- ----------
(DOLLARS IN THOUSANDS)
Commercial, financial and
agricultural................. $1,308,127 952,507 780,772 604,883 475,692
Installments to individuals.... 1,334,138 1,157,940 1,026,012 949,207 933,445
Real estate.................... 3,585,282 3,437,303 3,286,610 3,331,332 3,195,167
Lease financing................ 170,898 185,864 159,237 179,951 158,737
---------- --------- --------- ---------- ----------
Total loans............... 6,398,445 5,733,614 5,252,631 5,065,373 4,763,041
Less allowance for possible
loan losses.................. 96,149 67,736 54,304 56,878 46,021
---------- --------- --------- ---------- ----------
Net loans................. $6,302,296 5,665,878 5,198,327 5,008,495 4,717,020
========== ========= ========= ========== ==========
YEAR-END 1998
--------------------------------------
COMMERCIAL, FINANCIAL AND AGRICULTURAL
--------------------------------------
Due in one year or less..................................... $ 787,501
Due after one year but within five years.................... 288,372
Due after five years........................................ 232,254
----------
Total.................................................. $1,308,127
==========
Loans due after one year with interest at a predetermined
fixed rate................................................ $ 167,110
Loans due after one year with interest at a floating rate... 353,516
----------
Total.................................................. $ 520,626
==========
Real estate loans at year-end 1998 totaled $3,585.3 million or 56.0% of
total loans outstanding compared to 60.0% one year ago. Residential loans (1-4
family dwellings) totaled $1,643.1 million, home equity loans $531.9 million,
construction loans $228.4 million and commercial real estate loans $1,181.9
million.
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 15.2% compared to last
year and accounted for 20.9% of total loans compared to 20.2% in 1997.
Commercial, financial, and agricultural loans increased 37.3% during 1998
and make-up 20.4% of total outstanding loans compared to 16.6% last year. The
increase in consumer and commercial loans is evidence of FirstMerit's shifting
loan portfolio.
Lease financing loans decreased 8.0% during 1998. Auto leases totaled $63.2
million with equipment leasing totaling $103.9 million, and leveraged leases
were $3.9 million at year-end 1998.
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 being repaid. Successful management of credit risk requires making
good underwriting decisions, carefully administering the loan portfolio and
diligently collecting delinquent accounts.
The Corporation's Credit Policy Division manages credit risk by
establishing common credit policies for its subsidiary banks, participating in
approval of their largest loans, conducting reviews of their loan portfolios,
43
45
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.
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 provide guidance
for determining the allowance for loan loses related to impaired loans and
illustrate the required financial statement disclosures for impaired loans.
Impaired loans are loans for which 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 (ORE) acquired through foreclosure in satisfaction of a
loan.
YEARS ENDED,
-----------------------------------------------
1998 1997 1996 1995 1994
------- ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Impaired Loans:
Non-accrual............................... $10,883 12,129 9,782 7,852 10,517
Restructured.............................. 85 89 92 1,548 2,026
------- ------ ------ ------ ------
Total impaired loans.............. 10,968 12,218 9,874 9,400 12,543
Other Loans:
Non-accrual............................... 8,456 10,210 7,104 7,765 9,186
Restructured.............................. -- -- 340 366 2,714
------- ------ ------ ------ ------
Total Other non-performing
loans........................... 8,456 10,210 7,444 8,131 11,900
------- ------ ------ ------ ------
Total non-performing loans........ 19,424 22,428 17,318 17,531 24,443
------- ------ ------ ------ ------
Other real estate (ORE)..................... 3,789 2,296 829 1,989 10,958
Total non-performing assets....... 23,213 24,724 18,147 19,520 35,401
======= ====== ====== ====== ======
Loans past due 90 days or more accruing
interest.................................. $18,911 11,327 8,463 7,795 3,847
======= ====== ====== ====== ======
Total non-performing assets as a percent of
total loans & ORE......................... 0.36% 0.43% 0.35% 0.39% 0.75%
======= ====== ====== ====== ======
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.
44
46
Non-performing assets at year end were $23.2 million, $24.7 million at
year-end 1997 and $18.1 million at year-end 1996. As a percentage of total loans
outstanding plus ORE, non-performing assets were 0.36% at year-end 1998 compared
to 0.43% in 1997 and 0.35% in 1996. The average balances of impaired loans for
the years ended 1998 and 1997 were $11.6 million and $11.0 million,
respectively.
For the year ended 1998, impaired assets earned $427,000 in interest
income. Had they not been impaired, they would have earned $1.1 million. For the
same period, total non-performing loans earned $732,000 in interest income. Had
they been paid in accordance with the payment terms in force prior to being
considered impaired, on non-accrual status, or restructured, they would have
earned $2.2 million.
In addition to non-performing loans and loans 90 days past due and still
accruing interest, Management identified potential problem loans totaling $45.6
million at year-end 1998. 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 Corporation and the Subsidiary Bank 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 growth in its manufactured housing portfolio and the continuing
shift of its portfolio out of residential mortgage loans and into commercial and
consumer loans, which historically have exhibited higher loss rates. Management
felt it was prudent to increase the allowance at year end to ensure its adequacy
for changes that have occurred in the loan portfolio.
At year-end 1998, the allowance was $96.1 million or 1.50% of loans
outstanding compared to $67.7 million or 1.18% at year-end 1997 and $60.1
million or 1.14% at year-end 1996. The allowance equaled 495.0% of non-
performing loans at year-end 1998 compared to 302.1% at year-end 1997. The
allowance for possible loan losses related to impaired loans at year-ends 1998
and 1997 was $3.7 million at year-end 1998 and $4.5 million at year-end 1997.
Net charge-offs were $20.7 million in 1998 compared to $18.4 million in
1997 and $16.1 million in 1996. As a percentage of average loans outstanding,
net charge-offs equaled 0.34% in 1998 and 1997 and 0.30% in 1996. Losses are
charged against the allowance as soon as they are identified.
45
47
A five-year summary of activity follows:
ALLOWANCE FOR POSSIBLE LOAN LOSSES
YEARS ENDED,
------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Allowance for possible loan losses at
beginning of year.................. $ 67,736 60,087 56,878 46,021 45,748
Loans charged off:
Commercial, financial and
agricultural..................... 3,894 1,838 2,665 3,145 1,479
Installment to individuals......... 26,277 24,824 17,282 9,275 6,367
Real estate........................ 1,489 728 613 1,837 1,948
Lease financing.................... 1,274 1,294 1,315 319 20
Decrease from sale of subsidiary... -- -- 389 -- --
---------- ---------- ---------- ---------- ----------
Total....................... 32,934 28,684 22,264 14,576 9,814
---------- ---------- ---------- ---------- ----------
Recoveries:
Commercial, financial and
agricultural..................... 1,930 1,121 450 569 719
Installment to individuals......... 8,285 8,584 5,283 3,537 3,169
Real estate........................ 1,464 123 202 181 171
Lease financing.................... 532 476 206 88 21
---------- ---------- ---------- ---------- ----------
Total....................... 12,211 10,304 6,141 4,375 4,080
---------- ---------- ---------- ---------- ----------
Net charge-offs...................... 20,723 18,380 16,123 10,201 5,734
---------- ---------- ---------- ---------- ----------
Increase resulting from
acquisition........................ 8,215 2,511 -- -- --
---------- ---------- ---------- ---------- ----------
Provision for possible loan losses... 40,921 23,518 19,332 21,058 6,007
---------- ---------- ---------- ---------- ----------
Allowance for possible loan losses at
end of year........................ $ 96,149 $ 67,736 $ 60,087 $ 56,878 $ 46,021
========== ========== ========== ========== ==========
Average loans outstanding............ $6,131,665 5,468,587 5,304,366 5,086,781 4,460,113
========== ========== ========== ========== ==========
Ratio to average loans:
Net charge-offs.................... 0.34% 0.34% 0.30% 0.20% 0.13%
Provision for possible loan
losses........................... 0.67% 0.43% 0.36% 0.41% 0.13%
========== ========== ========== ========== ==========
Loans outstanding at end of year..... $6,398,445 5,733,614 5,252,631 5,065,373 4,763,041
========== ========== ========== ========== ==========
Allowance for possible loan losses:
As a percent of loans outstanding
at end of year................... 1.50% 1.18% 1.14% 1.12% 0.97%
As a multiple of net charge-offs... 4.64 3.69 3.73 5.58 8.03
========== ========== ========== ========== ==========
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
AS OF YEAR-END 1998 AS OF YEAR-END 1997 AS OF YEAR-END 1996
------------------------ ------------------------ -----------------------
% OF LOANS % OF LOANS % OF LOANS
BY CATEGORY BY CATEGORY BY CATEGORY
TO TOTAL LOANS TO TOTAL LOANS TO TOTAL LOANS
AMOUNT OUTSTANDING AMOUNT OUTSTANDING AMOUNT OUTSTANDING
------- -------------- ------- -------------- ------ --------------
(DOLLARS IN THOUSANDS)
Commercial, financial, and
agricultural................ $40,457 20% $27,522 17% 15,962 15%
Installment................... 28,004 21% 19,350 20% 24,434 19%
Loans secured by real
estate...................... 25,945 56% 19,555 60% 18,236 63%
Lease financing............... 1,743 3% 1,309 3% 1,455 3%
------- --- ------- --- ------ ---
$96,149 100% $67,736 100% 60,087 100%
======= === ======= === ====== ===
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AS OF YEAR-END 1995 AS OF YEAR-END 1994
------------------------ -----------------------
% OF LOANS % OF LOANS
BY CATEGORY BY CATEGORY
TO TOTAL LOANS TO TOTAL LOANS
AMOUNT OUTSTANDING AMOUNT OUTSTANDING
------- -------------- ------ --------------
(DOLLARS IN THOUSANDS)
Commercial, financial, and agricultural............ $14,570 12% 7,091 10%
Installment........................................ 16,322 19% 15,372 20%
Loans secured by real estate....................... 24,694 66% 22,809 67%
Lease financing.................................... 1,292 3% 749 3%
------- --- ------ ---
$56,878 100% 46,021 100%
======= === ====== ===
DEPOSITS
Average deposits for 1998 totaled $6.5 billion, an increase of 13.9% and
13.7% compared to 1997 and 1996 levels, respectively. Most of the increase
occurred because of the 1998 purchase acquisition of CoBancorp Inc. Purchase
accounting application includes balances of the acquired company in the year of
acquisition but not in prior periods. The Corporation's success with its
"free-checking" product also added to the increase in average non-interest
bearing demand deposit (checking) accounts.
Increases in deposit category average balances were as follows:
noninterest-bearing demand, up $310.1 million, or 41%; interest-bearing demand,
up $58.8 million, or 8%; savings up $68.5 million, or 4%; and certificate of
deposit (CDs) accounts, up $350.5 million, or 13%. Again, the CoBancorp
acquisition accounted for a large portion of the increases in these categories.
The average rate paid on interest-bearing demand deposits decreased 5 basis
points to 1.76%; the average yield paid on savings accounts increased 10 basis
points to 2.75% and the average yield paid on CDs remained at 5.47%.
Total demand deposits comprised 28.4 % of average deposits in 1998 compared
with 25.9% last year and 24.9% in 1996. Savings accounts, including "Money
Market" products, made up 24.8% of average deposits in 1998 versus 27.0% in 1997
and 29.1% in 1996. CDs accounted for 46.8% of average deposits in 1998, 47.1% in
1997 and 46.0% in 1996. The most notable shift occurred between savings and
demand deposit (checking) accounts as checking balances provided more funds, on
average, and savings accounts less.
The average cost of deposits and other borrowings was up 11 basis points
compared to one year ago, or 4.45% in 1998 compared to 4.34% last year.
YEARS ENDED
------------------------------------------------------------------
1998 1997 1996
-------------------- ------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
---------- ------- --------- ------- --------- -------
Demand deposits-non-interest
bearing......................... $1,083,354 -- 773,285 -- 773,560 --
Demand deposits-interest
bearing......................... 752,096 1.76% 693,277 1.81% 641,607 1.95%
Savings deposits.................. 1,600,122 2.75% 1,531,623 2.65% 1,653,279 2.53%
Certificates and other time
deposits........................ 3,019,637 5.47% 2,669,162 5.47% 2,610,832 5.42%
---------- --------- ---------
$6,455,209 5,667,347 5,679,278
========== ========= =========
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The following table summarizes the certificates and other time deposits in
amounts of $0.1 million or more as of year-end 1998, by time remaining until
maturity.
AMOUNT
--------
Maturing in:
Under 3 months........................ $484,560
3 to 6 months......................... 121,342
6 to 12 months........................ 99,410
Over 12 months........................ 136,029
--------
$841,341
========
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 year-end 1998 the Corporation was in a moderate asset-sensitive position
as illustrated in the following table:
1-30 31-60 61-90 91-180 181-365 OVER 1
DAYS DAYS DAYS DAYS DAYS YEAR TOTAL
---------- -------- -------- ------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Interest Earning Assets:
Loans and leases................ $1,412,585 193,694 199,934 546,722 843,988 3,201,522 6,398,445
Investment securities........... 194,494 56,114 92,509 81,823 190,829 1,262,497 1,878,266
Federal funds sold.............. 31,739 -- -- -- -- -- 31,739
---------- -------- -------- ------- --------- --------- ---------
Total Interest Earning Assets..... $1,638,818 249,808 292,443 628,545 1,034,817 4,464,019 8,308,450
---------- -------- -------- ------- --------- --------- ---------
Interest-Bearing Liabilities:
Demand -- Interest bearing...... $ 43,416 43,416 49,853 -- -- 781,080 917,765
Savings......................... 119,810 119,810 135,348 -- -- 1,435,372 1,810,340
Certificates and other time
deposits...................... 517,599 238,202 228,673 609,039 682,540 815,443 3,091,496
Securities sold under agreement
to repurchase and other
borrowings.................... 574,540 5,379 26,475 38,272 121,986 356,552 1,123,204
---------- -------- -------- ------- --------- --------- ---------
Total Interest Bearing
Liabilities..................... $1,255,365 406,807 440,349 647,311 804,526 3,388,447 6,942,805
---------- -------- -------- ------- --------- --------- ---------
Total GAP......................... $ 383,453 (156,999) (147,906) (18,766) 230,291 1,075,572 1,365,645
========== ======== ======== ======= ========= ========= =========
Cumulative GAP.................... $ 383,453 $226,454 78,548 59,782 290,073 1,365,645
========== ======== ======== ======= ========= =========
MARKET RISK
FirstMerit is exposed to market risks in the normal course of business.
Changes in market interest rates may result in changes in the fair market value
of the Corporation's financial instruments, cash flows, and net interest income.
The corporation seeks to achieve consistent growth in net interest income and
capital while managing volatility arising from shifts in market interest rates.
The Asset and Liability Committee of the FirstMerit Bank Board of Directors
("ALCO") oversees financial risk management, establishing broad policies that
govern a variety of financial risks inherent in FirstMerit Bank's operations.
ALCO monitors FirstMerit Bank's interest rates and sets limits on allowable risk
annually.
Market risk is the potential of loss arising from adverse changes in the
fair value of financial instruments due to changes in interest rates, exchange
rates, and equity prices. FirstMerit's market risk is composed primarily of
interest rate risk. Interest rate risk on FirstMerit's balance sheet consists of
mismatches of maturity gaps and indices, and options risk. Maturity GAP
mismatches result from differences in the maturity or repricing of asset and
liability portfolios. Options risk exists in many of FirstMerit's retail
products such as prepayable mortgage
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loans and demand deposits. Options risk typically results in higher costs or
lower revenue for FirstMerit. Index mismatches occur when asset and liability
portfolios are tied to different market indices which may not move in tandem as
market interest rates change.
Interest rate risk is monitored using GAP analysis, earnings simulation and
net present value estimations. Combining the results from these separate risk
measurement processes allows a reasonably comprehensive view of short-term and
long-term interest rate risk in the Corporation. Gap analysis measures the
amount of repricing risk in the balance sheet at a point in time. Earnings
simulation involves forecasting net interest earnings under a variety of
scenarios including changes in the level of interest rates, the shape of the
yield curve, and spreads between market interest rates. ALCO also monitors the
net present value of the balance sheet, which is the discounted present value of
all asset and liability cash flows. Interest rate risk is quantified by changing
the interest rates used for discounting cash flows and comparing the net present
value to the original figure. At year-end, a 100 basis point increase in
interest rates is estimated to reduce net present value by 5.9%. Should interest
rates decrease by 100 basis points, net present value is estimated to increase
by 1.8%.
Presented below, as of December 31, 1998, is an analysis of FirstMerit's
interest rate risk for earnings simulation for instantaneous and sustained
parallel shifts in the yield curve up and down 200 basis points.
NEXT 12 MONTHS
NET INTEREST INCOME
-------------------
$ CHANGE % CHANGE
-------- --------
+200 1,133 0.30%
------ -----
+100 1,532 0.41%
------ -----
- -100 (1,930) (0.52%)
------ -----
- -200 (6,174) (1.66%)
------ -----
CAPITAL RESOURCES
Shareholders' equity at year-end 1998 totaled $910.6 million compared to
$747.7 million at December 31, 1997, an increase of 21.8%.
1998 1997 1996
----------------- ---------------- ----------------
(IN THOUSANDS)
Total equity...................... $906,656 10.04% 747,612 9.55% 694,097 9.44%
Common equity..................... 897,357 9.94% 737,695 9.43% 671,404 9.14%
Tangible common equity (a)........ 724,247 8.18% 691,809 8.89% 660,051 9.00%
Tier 1 capital (b)................ 774,303 10.46% 688,693 11.84% 680,367 12.52%
Total risk-based capital (c)...... 949,229 12.82% 792,104 13.62% 739,976 13.62%
Leverage (d)...................... 774,303 8.91% 688,693 8.84% 680,367 10.39%
- ---------------
(a) Common equity less all intangibles; computed as a ratio to total assets less
intangible assets.
(b) Shareholders' equity 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 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 year-end 1998, the
Corporation's risk-based capital equaled 12.82% of risk-adjusted assets, its
Tier I capital ratio equaled 10.46% and its leverage ratio equaled 8.91%.
The Corporation's Board of Directors declared a 2-for-1 split of the
Corporation's Common Stock on September 29, 1997. The split was paid to
shareholders of record as of September 2, 1997.
During 1998, the Corporation's Directors increased the quarterly cash
dividend, marking the seventeenth consecutive year of annual increases since the
Corporation's formation in 1981. The cash dividend of $0.18 paid
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has an indicated annual rate of $0.72 per share. Over the past five years the
dividend has increased at an annual rate of approximately 8.5%.
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 subsidiary maintains sufficient liquidity in the form of
short-term marketable investments with a short-term maturity structure, along
with cash flow from loan repayment. Asset growth is primarily funded by the
growth of core deposits.
Reliance on borrowed funds increased during the year as the investment
portfolio grew slightly. 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 Corporation, primarily cash dividends and other
corporate purposes, are met through cash, short-term investments and dividends
from the banking subsidiary.
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 3% and a leverage capital ratio of at least 4%.
Institutions with lower capital levels are deemed to be undercapitalized,
significantly undercapitalized or critically undercapitalized, depending on
their actual capital levels. The appropriate federal regulatory agency may also
downgrade an institution to the next lower capital category upon a determination
that the institution is in an unsafe or unsound practice. Institutions are
required to monitor closely their capital levels and to notify their appropriate
regulatory agency of any basis for a change in capital category. At year-end
1998, the Parent Company and its subsidiaries all exceeded the minimum capital
levels of the well 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 fractual in nature, and which relates to expectations for
future shifts in loan portfolio to consumer and commercial loans, increase in
core deposits base,
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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; interest rate fluctuations; the ability of the Corporation to realize
expected efficiencies from recent acquisitions 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.
YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define an applicable year. Any of a company's
hardware, date-driven automated equipment, or computer programs that have date
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This faulty recognition could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions or engage in normal
business activities.
To ensure the Year 2000 issue is properly addressed significant resources
continue to be used. Consulting and contract programming resources supplement
internal staff and provide specialized expertise where necessary. FirstMerit is
using newly acquired software tools and enhanced procedures to assist in code
remediation, testing, and controlling the numerous software changes. Staff
throughout the organization reviews testing results. Coordination with major
business partners is also in process.
The Corporation first contracted the services of an application
development, outsourcing and integration services firm, to perform an enterprise
wide business unit risk assessment of Year 2000 issues. By year-end 1997, the
firm had completed the enterprise wide business unit risk assessment for the
Corporation which included formal communications with all significant suppliers
to determine the extent to which the Corporation is vulnerable to those third
parties' failure to address their own Year 2000 issues.
During 1998, the Corporation contracted with a different outside consulting
firm to provide an independent assessment of our Year 2000 efforts. Results were
reported to the Corporation's Board of Directors in November 1998. Management
and the Board of Directors agreed with the findings and overall view that the
project is on track. The issues identified by the independent consultants were
already in process of being addressed. Additionally, as a nationally chartered
bank the Corporation's banking subsidiary falls under the regulatory guidelines
published by the Federal Financial Institutions Examination Council ("FFIEC").
Periodic audits of the Corporation's Year 2000 activities are performed by the
Office of the Comptroller of the Currency ("OCC") as well as the Federal Reserve
Bank.
The FFIEC considers five general Year 2000 phases: Awareness, Assessment,
Renovation, Validation and Implementation. The five phases are explained below
along with Corporation's status at December 31, 1998:
Awareness: The Awareness phase defines the Year 2000 problem, gains
executive level support and establishes an overall strategy. The Corporation
began working on the Year 2000 issue in 1996 with identification of major
vendors and their compliance status. Significant progress has been made in the
implementation of the strategy for Year 2000 compliance. Executive management
has been proactive in the management of the project and contracted with
consultants to assist in performing the assessment and formulating a strategy.
The awareness phase has expanded to include a widespread customer awareness
program to help educate customers of the Year 2000 issue and allow monitoring of
FirstMerit's progress.
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Assessment: The Assessment phase defines the size and complexity of the
problem and the magnitude of the effort to address Year 2000 issues. FirstMerit
completed the assessment phase for all mainframe and microcomputer systems
during the first quarter of 1998. FirstMerit has 82 mainframe applications of
which 30 are considered "mission critical." The majority of the applications are
vendor packages. Significant microcomputer software and hardware upgrades for
Year 2000 compliance are substantially complete. The Assessment of
non-information systems such as security systems, elevators, etc. was completed
during the second quarter of 1998.
Renovation: The purpose of the Renovation phase is to ensure all date
routines have been corrected to properly address Year 2000 dates. FirstMerit has
completed 100% of the renovation for the in-house written code for the "mission
critical" applications. Installation of vendor supplied upgrades for the other
"mission critical" applications has occurred where the software was received
timely. Late arriving vendor releases or re-releases of Year 2000 compliant
software has resulted in three of the 30 "mission critical" applications which
will not be completed until the first quarter of 1999.
Renovation and vendor software implementation is also in process for the
non-"mission critical" applications. FirstMerit is approximately 94% complete in
having all of our lines of computer code renovated. The remaining applications
are scheduled to be renovated during the first quarter 1999.
Validation: The Validation phase consists of various types of testing and
retesting. FirstMerit is deeply involved in extensive testing of both in-house
and vendor written systems as well as the various connections to other systems
(internal and external). Non-information system applications or functions such
as vaults and security systems are also in the process of being tested. Testing
guidelines have been issued to ensure consistency and completeness throughout
the organization. Integrated testing is in process to ensure the applications
work together. More than 60% of our lines of computer code were successfully
tested with various future dates as part of a major integrated test over
Columbus Day weekend in October 1998. Core systems were included such as
Certificates of Deposit, Demand Deposit, Installment Loan and Savings. Of the 30
"mission critical" applications, 26 have been successfully tested or are in the
process of being tested. Additionally, many other applications (non-mission
critical) are currently in the testing process.
Implementation: During the Implementation phase, systems are certified as
Year 2000 compliant and placed into production. FirstMerit has been placing
systems, once renovated and validated, into production throughout the project.
As the non-mission critical applications are tested, they will be implemented
into production during the first quarter of 1999.
Another FFIEC area to be addressed is contingency planning. FirstMerit is
considering alternative measures throughout the organization in event of a Year
2000-caused problem. Business areas have reviewed departmental Year 2000 risks
and are incorporating changes to their contingency plans.
The Corporation's total Year 2000 readiness project costs and estimates to
complete include the estimated costs and time associated with the impact of a
third party vendor's Year 2000 issues and are based on presently available
information. There can be no guarantees, however, that the systems and
applications of other companies on which the Corporation's systems and
applications rely will be timely converted or that a failure to convert by
another company, or a conversion that is incompatible with the Corporation's
systems and applications, would not have a material adverse effect on the
Corporation.
The total cost of the Year 2000 readiness project (operating and capital)
is estimated at $6.1 million and is being funded through operating cash flows,
which will be expensed as incurred over the next two years, and is not expected
to have a material adverse effect on the Corporation's results of operations. To
date, the Corporation has expensed approximately $2.6 million and capitalized
approximately $840,000 related to the Year 2000 project.
The costs of the Year 2000 readiness project and the date on which the
Corporation plans to complete Year 2000 remediation are based on management's
best estimates, which were derived utilizing assumptions of future events
including the continued availability of certain resources, third party vendor
remediation plans and other factors. There can be no guarantee, however, that
these estimates will be achieved and actual results could differ materially from
those plans. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of trained
programming personnel, the ability to locate and correct all relevant computer
coding, and similar uncertainties.
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