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FirstMerit Corporation (NASDAQ:FMER)

Q1 2014 Earnings Conference Call

April 22, 2014 11:00 am ET

Executives

Thomas O'Malley - Director, Investor Relations

Paul G. Greig - Chairman, Chief Executive Officer

William P. Richgels - Chief Credit Officer and Senior Executive Vice President

Terrence E. Bichsel - Chief Financial Officer, Senior Executive Vice President

Mark N. DuHamel - Executive Vice President and Treasurer

Analysts

Steven A. Alexopoulos - JP Morgan

Jon G. Arfstrom - RBC Capital Markets

Matthew J. Keating - Barclays Capital

R. Scott Siefers - Sandler O'Neill

Stephen Scinicariello – UBS

Christopher McGratty - Keefe, Bruyette, & Woods, Inc.

Stephen Geyen - D.A. Davidson & Co.

Operator

Good morning. My name is Angie, and I will be your conference operator today. At this time, I would like to welcome everyone to the FirstMerit 2014 First Quarter Earnings Conference Call. (Operator Instructions) I would now like to turn the conference over to Mr. Tom O'Malley, Director of Investor Relations. Please go ahead sir.

Thomas O'Malley

Thank you, Angie. Good morning. Welcome, and thanks for joining us on our first quarter 2014 earnings call. On the call today, we have Paul Greig, our Chief Executive Officer; Terry Bichsel, our Chief Financial Officer; Bill Richgels, our Chief Credit Officer; and Mark DuHamel, our Treasurer and Director of Corporate Development. We are happy to take your questions following our prepared remarks.

Please note that the press release issued this morning regarding our financial results, along with supplemental slides, are available on our website at firstmerit.com under the Investor Relations section. I would like to remind you that our comments today may contain forward-looking statements that are subject to certain risks and uncertainties that could cause the company's actual future results to materially differ from those discussed.

Please refer to the forward-looking statement disclosure contained in the first quarter ‘14 earnings release materials and our SEC filings for a full discussion of the company's risk factors. Also, please note that our comments and supplemental slide deck reference non-GAAP financial measures. Reconciliation of all non-GAAP reference measures can be found in the supplemental deck.

I would now turn the call over to Paul Greig.

Paul G. Greig

Thank you, Tom. I’m pleased with the momentum displayed this quarter in our loan growth, which was prevalent throughout the entire expanded footprint. We have been an active lender throughout the economic cycle, and we continue to grow our loan portfolio today. We’re also increasing deposits with an emphasis on core deposits.

The economy continues to show steady signs of recovery and the financial health of our customers continues to improve. In the first quarter, period-end loans increased $308 million or an annualized 8.6% over the prior quarter.

We generated solid growth despite a combined run-off of almost $190 million from our covered and acquired portfolios. For the quarter, originated loans increased $614 million or 24% annualized. Of that growth, approximately $490 million or 19% annualized came from new production.

This quarter’s loan portfolio growth reflects our success competing across our footprint, particularly in the small business and middle market segments. Consistent with our business strategy, we invested in the hiring of commercial bankers, particularly in Michigan and Wisconsin in the second half of 2013.

Hiring highly experienced bankers with deep ties to their markets is a major factor in our success. These are sophisticated professionals who spent the majority of their careers at large regional banks and were known by our executive management in each region prior to hiring. Staying true to our strategy not only positioned us well in past years to make the acquisitions that expanded our geography, it continues to provide the solid foundation that allows us to successfully grow organically.

While our investments are already paying off, we expect to see our new bankers achieve greater productivity over the rest of this year. The balance sheet will begin to reflect the fuller impact of our new production as the volume of managed exits in our covered loan portfolio slows over the remainder of 2014. Today, we reported $53.5 million in net income for the first quarter of 2014 or $0.31 per share. Total revenue for the first quarter was $265 million.

First quarter 2014 results include $1 million in pre-tax one-time merger-related expense. Adjusting for those costs, return on average assets was 91 basis points and return on average equity was 8.02% for the quarter. During the first quarter of 2014, average deposits were $19.6 billion, an increase of $119 million or 2.4% annualized over the prior quarter.

We increased core deposits by $268 million or an annualized 6% over last quarter. At the end of the first quarter 2014, core deposits account for 88% of total deposits, up from 87% in the prior quarter. The core deposit customer generates higher profitability and provides a stickier client relationship. It is also a major factor in our overall low deposit cost of 18 basis points this quarter, down 1 basis point from last quarter.

We continue to execute on our strategy of growing loans. Our plan is to grow the loan book at a rate that will outpace the run-off of the covered book, the declining accretion from the acquired book, and the competitive market dynamics.

Our low deposit costs and improving investment portfolio yields offset net interest margin pressure from acquired and covered loan attrition. Despite the competition for new and existing business, we maintain a disciplined process to ensure our customer relationships provide appropriate returns relative to structure and pricing.

In the first quarter, a singular credit resulted in higher-than-expected net charge-offs for the period. Bill Richgels will provide more color in his remarks. Despite that one charge-off, our metrics remained solid with net charge-offs at 31 basis points for the quarter. Recall that our credit metrics have outperformed each year over the past seven years.

Non-performing assets remained at absolute lows in the quarter as well. Non-performing assets continued to run at levels approximately one half of peers. Non-interest income decreased $5.2 million or 7% from the prior quarter. Drivers of this change are seasonality and the severe weather our footprint experienced in the quarter.

With the arrival of more typical seasonal weather, we’re seeing a return to historic levels of underlying customer activity. Capitalizing on revenue synergy opportunities in our expanded markets is a priority for us in 2014. Overall, expense trends were favorable despite higher-than-usual snow removal and utility costs due to the severe weather across the entire footprint.

Adjusting for $966,000 in the merger-related costs this quarter, non-interest expense was $168 million, down $4.3 million or 2.5% off last quarter’s base. We remain on pace to achieve the additional $18 million in cost saving guidance we provided on last quarter’s call. Our bankers are seizing opportunities to lend and build long-lasting relationships through our aggressive calling program. As I travel with our bankers and meet with customers, I note rising confidence as their businesses continue to improve.

Even with the high level of commercial loan growth in the first quarter, our commercial pipeline has grown to record high levels. We are leveraging our strong balance sheet, high liquidity and solid reputation to generate new business. We remain committed to our disciplined pricing practices, keeping the focus on profitable loans and growing the value of the company.

I’ll now turn the call over to Bill Richgels for a discussion on credit. Bill?

William P. Richgels

Thank you, Paul, and good morning, everyone. Our results include non-covered net charge-offs at an annualized 31 basis points of average loans, an increase of 18 basis points from last quarter. The originated commercial net charge-offs were $4.1 million for the quarter, compared to net recoveries in the two preceding quarters. The increased charge-off level this quarter was the direct result of a $3.5 million charge taken on one credit, a manufacturer who failed to execute on a turnaround and is in a liquidation mode.

There are currently an investigation around potential financial irregularities associated with this situation. From our history, you know we are quick to react and charge down. We have not seen a change in the broader credit trends of our portfolio.

Our non-covered criticized and classified book was $399 million or 4.36% of total commercial loans, compared with $476 million or 5.34% of total commercial loans at year end. We are pleased with the continuing improvement of the Michigan portfolio. Commercial delinquencies also decreased this quarter from 90 basis points to 78 basis points. Non-performing assets increased moderately $2.5 million, representing 58 basis points of period-end loans, plus other real estate, excluding acquired loans.

Within the consumer portion of the loan portfolio, non-covered charge-offs were roughly $4 million, down $1 million from linked quarter. Our consumer loan book had average home equity utilization rates of 46%, stable with prior periods. FICO scores within the consumer book are consistent with prior periods and represent a high-quality portfolio currently running at credit scores of 773 for commercial real estate and 741 for installment credits.

Average FICO outstanding of the acquired indirect marine and RV book at quarter end is 752. And average FICO of new production in this specific book has been consistent at 762. Our strong performance reflects our discipline in originating at the high end of prime FICO scores.

First quarter bankcard net charge-offs totaled $1 million or 283 basis points, superior in comparison to industry bankcard performance. Bankcard delinquencies were low at 1.21%, down 9 basis points from linked quarter.

Within our portfolio, we have a $5.3 million increase in originated TDRs from the linked quarter to $84.8 million, of which $63 million are accruing and performing, $22 million are classified as non-accruing, of which, $11.3 million are current on contractual payments but remain classified as non-accrual.

With that, I would now turn the call over to Terry Bichsel. Terry?

Terrence E. Bichsel

Thanks, Bill, and good morning, everyone. Before I start, let me apologize for my voice. I have a cold. Thanks, Bill, and good morning, everyone. Let me start this morning by providing additional detail on the first quarter financial statements and then update the business drivers for our financial performance for the remainder of 2014.

As noted in the press release, the first quarter included $1 million of pre-tax merger-related expense, of which $0.8 million is recorded in professional services, including this work totaling $79.1 million. On slide seven and eight of the press release supplement, the rate volume changes to the net interest margin and asset yields and liability costs are depicted.

The net interest margin in the first quarter was 3.84%, down 5 basis points from last quarter. The rate volume effects from the components are as follows; the combined effect of acquired and covered loans was a minus 9 basis points, which was offset by a positive 9 basis point effect from originated loans and investments, deposits helped the margin by a basis point, and the first quarter day count reduced the margin by 6 basis points.

This quarter, we included additional detail on acquired and covered loans on slides 18 through 21 to support my remarks on these portfolios. Acquired loan income was $66.5 million in the first quarter, compared to $69.3 million in the fourth quarter. With these amounts, the accretion of the credit mark on non-credit impaired loans was $17 million, compared to $19.9 million last quarter.

The accelerated component due to payoffs and prepayments was $6.4 million, versus $6.6 million last quarter. This detail is shown on slide 19. Without the paid-in-full and accelerated payments accretion, the net interest margin was 3.71% compared to 3.77% last quarter computed on a similar basis. First quarter tax-equivalent net interest income was $197.9 million, down $4.3 million from the prior quarter with $3.4 million attributed to the first quarter day count.

As shown on slide eight, the investment portfolio yield was up 7 basis points with reinvestments and expansion of the portfolio. The originated portfolio yield narrowed 12 basis points with commercial loan renewal and new production yields in the 3.25% range and consumer loan new production yields at 4%.

The yield on the acquired portfolio improved 44 basis points as a result of the re-estimation of cash flows on acquired credit impaired loans. The yield on covered loans is down 69 basis points, reflecting improvement in re-estimated cash flows, which required FDIC indemnification asset negative accretion to catch up by 0.9 million this quarter.

Remaining discount accretion on the credit mark on the acquired non-credit impaired loans is $136 million. The detail is shown on slide 19. The re-estimation of acquired credit impaired loans this quarter resulted in the reclassification of $19.5 million of cash flow moving from non-accretable to accretable following $46 million re-class last quarter.

At quarter end, $142 million of accretable yield remained to be recognized as interest income over the remaining life of the loans. The details are shown on slide 20. Cash flow re-estimation of the covered portfolio resulted in $6 million of additional cash flow being re-classed similar in amount to last quarter. The detail is on slide 21.

On slide four, the provisions for originated acquired and covered loans totaled $14.5 million. The provisions for originated loans at $3.7 million compares to net charge-offs at $8 million, reflecting the continued positive movement in criticized and classified loans and improved delinquency while recognizing the single credit action that Bill described.

The provision for acquired loans at $7.8 million is comprised of $5.6 million provision for non-credit impaired loans with a 9% recovery rate on these newly charged off loans. We would expect the recovery rate to improve with time.

This provision should also be viewed within the context of the $17 million accretion of the credit mark that was discussed earlier in my remarks. The other component of the acquired provision is for credit impaired loans totaling $2.2 million. This represents reductions in cash flows that are recognized immediately as a provision and addition to the reserve. Whereas improvements in cash flows will be recognized in future interest income. That is, the $19.5 million and $46 million re-class to accretable yield previously noted.

Re-estimation for the credit impaired covered loans resulted in a provision of $3.1 million, which will be offset over time by the re-class to accretable for covered loans previously described. Fee income on slide five totaled $67.3 million in the quarter, down $5.2 million from the prior quarter. Trust fees are down $500,000; service charges down $2.4 million; card fees $300,000; and other operating income down $1.8 million.

Service charges historically have been down in the first quarter from the fourth quarter by 7% to 12%. We think this year showed a greater decline given the severe weather, but customer liquidity and financial literacy may also be playing a role.

Within other operating income compared to last quarter, commercial related transaction fees were down approximately $1 million. Lower interest rate swaps fees were the contributing factor. All the other categories of miscellaneous income were down a net $800,000.

Mortgage sales and servicing income was flat with the prior quarter, a positive relative to the industry with penetration into our new markets. As noted in our press release, the expense detail on pages six reflected the early adoption of conforming our accounting treatment for projects that qualify for low income housing tax credit.

Approximately $1 million of the first quarter expense and $800,000 for each of the other presented quarters has been re-classed to the provision for income taxes. Excluding $1 million of expense from the first quarter and $6 million in the fourth quarter for one-time merger-related expenses, improvement was recorded in the following categories in millions; salaries and benefits, 2.9; equipment expense, 1.2; stationery and supplies, 0.8; advertising, 1.1; professional services, 0.7; telephone, 0.5; and other, 1.4 for total reduction of $8.6 million.

These reductions were offset by the following categories again in millions; occupancy, 2.9, principally due to higher cost for snow removal and utilities; other tax, 0.2; FDIC, 0.9; and other, 0.3 for total offsets totaling 4.3 and a net $4.3 million reduction to non-interest expense.

That concludes the review of the first quarter financials. Turning now to an update on the business drivers for the remainder of 2014. Within the investment portfolio, over the remainder of the year, $718 million of maturing cash flows are expected at a 2.09% rate. The reinvestment yield is expected to be between 2.3 and 2.5, maintaining the portfolio duration in a range of 4.1 years.

The structure of the balance sheet will remain asset sensitive, 2.2% and 4.2% for a 100 and 200 basis point increase in rates across the yield curve, respectively. With our strong first quarter loan growth, the full-year expectation is now between 5% and 6%. There is no change to our core deposit strategy.

CDs that mature over the remainder of the year totaled $1.3 billion at a cost of 71 basis points with 75% expected to renew in place at approximately 25 basis points. With the balance sheet drivers noted, the net interest margin pressure will remain as we move through the low interest rate environment over the remainder of the year.

As outlined on last quarter’s call, the aggregate provisions for organic, acquired and covered loans are expected to remain in a range around the fourth quarter level. However, as observed this quarter, acquired loan accounting re-estimations of cash flows and singular events can affect a given period.

Fee income production remains a priority. We expect to grow mortgage revenue as we enter the buying season with penetration into the expanded footprint; treasury management, business transactional fees and wealth revenue are additional areas of emphasis.

We expect to average between $70 million and $73 million per quarter in non-interest income over the remainder of the year. The start point for non-interest expense is the first quarter adjusted for the $2.9 million increase in occupancy and the $1 million in merger-related costs highlighted earlier.

Based on this run-rate, the benefits of the additional efficiency actions announced last quarter are expected to reduce the quarterly run rate by $2 million in the third quarter. Within this run rate of expense and efficiency actions, salary merit increases, investments in the business, advertising and volume-related increases are being absorbed. Given the change in accounting for low income housing tax credits, the tax rate should approximate 31% over the remainder of the year.

This concludes my remarks. I’ll now return the call to Tom O’Malley. Tom?

Thomas O'Malley

Thanks, Terry. We are now ready for any questions from our participants on the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steven Alexopoulos with JPMorgan.

Steven A. Alexopoulos - JP Morgan

Good morning, Steve. Maybe for Terry, on the expense guidance from last quarter, I guess you called for a 4% reduction, ex one-timers, looks like it's around $2 million or $3 million above that. How much of that was the weather? I know you mentioned occupancy.

Terrence E. Bichsel

Yes, Steve. I would put it between $1.5 million and $2 million.

Steven A. Alexopoulos - JP Morgan

Okay. And Terry, I hate to do this to you, I do it to you every quarter, what's the expense guidance going forward? Can you repeat it again? You went through it pretty quickly.

Terrence E. Bichsel

Yes, certainly. As we start Q2, we would be leaving Q1 at the -- at the level of non-interest expense at $169.3 million, and we would take away from that, $2.9 million for the full weather-related in the change from fourth quarter to first quarter, and then the $1 million in merger-related costs. So that would be the base start point.

Get to Q3, take $2 million off of that number and keep it at that level throughout the remainder of the year. We will recall that we set our efficiency initiatives would begin to affect the run rate of expenses in the third and fourth quarter where over the course of the full year, we were expecting $9.6 million to be resident as reductions in our cost structure over the year.

So those quarterly numbers are being offset in part by the increases that I denoted by merit increases, advertising investment in the business and other volume-related increases.

Steven A. Alexopoulos - JP Morgan

And on the cost saves, what was the amount that were actually realized by the end of the first quarter? And what was left to get to the $77 million?

Terrence E. Bichsel

You’ll recall as we left the fourth quarter, the $59 million that we had relative to the acquisition we indicated that we had fully achieved that and that's part of what brought us down from all the numbers I went through on the $4.3 million, SANS the increase in occupancy costs.

And then, with that embedded in and then as we begin to move out through the year, the branch restructurings won’t really be evident into the run rate until the third quarter. And that's the biggest part of the total $9.6 million, that's $4.3 million of it. And then, we have enterprise sourcing that would represent $4.5 million of that and that's bleeding into the efficiency ratio on a run-rate basis. I would say in the first quarter that would be perhaps $500,000 to $700,000.

Steven A. Alexopoulos - JP Morgan

Okay. And maybe just a final question. Regarding the $8 million of provision expense on the acquired loans, that seems to be a pretty large number given the size of the acquired portfolio. Are you seeing just a broad weakening of the acquired portfolio, driving more acquired provision, or are credit work-outs proving more costly than you estimated when you fair value the assets? Thanks.

Terrence E. Bichsel

On the acquired non-credit impaired, what we’re seeing is the amount of the mark on any individual loan is small relative to the individual loss that you take when a loan goes to a charge-off status. And so with that, the charge-offs that we have taken have not seasoned enough for us to begin to get recoveries from those same clients.

So if you look at our legacy recoveries, they would be significant relative to the consumer book. I don't know that we would expect to reach that level, but certainly higher than 9% will begin to affect the provisioning for the non-credit impaired loans as we go forward and I pointed out that we’re showing that provision in relationship to the amortization of the credit mark, the $17 million that we took into the net-interest income this quarter.

And the basic performance of -- I’ll let Bill comment on that.

William P. Richgels

And Terry is actually noting two phenomena Steve in there, and what he is talking about is, under GAAP, recoveries that would have come from pre-acquisition portfolio get cut off, so you tend to see an outsized, if you will, charge-off number itself even though the recoveries are coming into income, if you focus just on the gross charges, it may look outsized.

But then, getting to this weather situation, we also have a conservative charge-off policy if, for example, I in the process of controlling assets, such as not necessarily foreclosures, but to control an asset, to have a car, have an RV, have a boat, I need it in my possession to effectively value. So if I don't have it in my possession, I actually charge the total amount of and then weather permits us to get control of the collateral, then we’ll value it and effectively we’ll get the benefit.

This weather, particularly for the marine and RV has caught us with an inability to control all of the collateral necessary in conjunction with our charge-off policy to describe a value to it. So, it is perhaps a seasonally outsized charge without a recovery opportunity to offset it.

Terrence E. Bichsel

And then Bill, I would like to come back to a couple of other items. The provisions that were taken on the acquired book, I think we need to look at that relative to the re-class from non-accretable to accretable, the $46 million and the $19 million, fourth quarter and first quarter, respectively.

And then, just to give you a perspective, the charge-off rate on the outstanding loans in that, between the two quarters, fourth and first, averaged 62 basis points and that's with the 9% recovery rate. So, on retail loans, that's very good when you’re thinking you're going to get some recoveries coming back on those. So that would kind of conclude our remarks around your question.

Steven A. Alexopoulos - JP Morgan

Okay. Thanks for the all the color. I appreciate it.

Operator

Your next question comes from the line of Jon Arfstrom, RBC Capital Markets.

Jon G. Arfstrom - RBC Capital Markets

Terry, not to belabor this, but just I want to make sure I got it clear, you're saying the $8 million of provision expense would be on individual credits that you have to take, and that we should look at that against the re-class, which is maybe the totality of the portfolio getting better. So even though we have an $8 million provision on individual credits, you're saying it improved by $20 million during the quarter. Is that the way to look at it?

Terrence E. Bichsel

Yes. That's a way to look at it.

Jon G. Arfstrom - RBC Capital Markets

Okay. Good. That's helpful. Paul, just on the --.

Terrence E. Bichsel

I would add that same number was $46 million in the fourth quarter.

Jon G. Arfstrom - RBC Capital Markets

Okay. Good. Yes, the tables help us see that. So that helps us. Paul, in terms of the lending activity, we've talked about weather a little bit, you had good loan growth, any weather impact on borrowing activity?

Paul G. Greig

On the commercial side, we had really strong growth, we had over 11% commercial growth and that was really not weather impacted. We're starting to see borrowers reinvest in their businesses, both in working capital, carrying higher levels of inventory and receivables on their balance sheet, as well as entering into capital spending programs.

And the capital spending programs, in particular, seem to be picking up some pace, which is certainly welcomed. Another part of the strategy as it relates to loan growth was the indirect lending. We had talked initially about introducing auto indirect into Michigan and Wisconsin and on the inverse marine and RV into Illinois and Ohio.

We actually saw an annualized 13% commercial -- or excuse me indirect lending loan growth in the quarter. The 11% by the way on the commercial side that I mentioned was also annualized, not within that quarter.

The other thing that we've seen in the first quarter was utilization rates ticking up. We're little bit over 60% utilization now, which was a nice increase. It was about a 250 basis point increase from last quarter and almost 500 basis point increase from the first quarter of ‘13. So, we’re seeing some very nice momentum across the loan book, both from the consumer as well as the commercial.

Jon G. Arfstrom - RBC Capital Markets

Okay, that's helpful. And then just one more, I don't know if it's you, Paul or Bill, but you talked about the potential for slowing of the managed exits in the acquired portfolio, how extensive is that currently?

Paul G. Greig

Well, that was in the covered portfolio that we had mentioned and while we haven't disclosed specific numbers, that should slow over the course of the balance of 2014. Bill, do you have anything to add?

William P. Richgels

No. The phenomena you are describing, John, will also relate to our -- the FDIC indemnification period ending and so we got it triangulated that, the assets that we will keep beyond that have been de-risked. And but as we look forward to that ending in 2015, the bulk of our heavy lifting and the monetization of those assets have occurred and so you'll naturally just have a glide path pass down to where we are satisfied with what we have and that we don't need the indemnification asset anymore.

Jon G. Arfstrom - RBC Capital Markets

Okay. So you're saying by 2015, there is a good chance the covered loan portfolio, what's left, hangs around?

William P. Richgels

Yes.

Jon G. Arfstrom - RBC Capital Markets

Yes. Okay. Thank you.

Paul G. Greig

Thanks, John.

Operator

Your next question comes from the line of Matthew Keating with Barclays.

Matthew J. Keating - Barclays Capital

Did I hear your comments correctly that the plan for the company is to grow loans at a pace to offset loan run-off and lower accretion on the acquired loans, so is it correct interpretation on this sort of strategy that the net income will grow from this quarter's levels?

Terrence E. Bichsel

Could you restate your question again?

Matthew J. Keating - Barclays Capital

Certainly. So I guess as you guys try to grow loans at a pace to offset the run-off of the acquired loans potentially and the lower accretion that you receive on those loans over time, is it your expectation that net interest income will rise from 1Q ‘14 level going forward?

Terrence E. Bichsel

The balance sheet drivers that we gave to you in terms of the rollover of investments, CDs and the loan growth and our continual quest for core deposits would be the drivers we’re giving you in the supplement, some additional information to model those components of the covered and acquired book. And what I would say consistent with Paul's remarks is of course that is our plan is to grow loans in order to refill the rundown in the covered and acquired book.

Matthew J. Keating - Barclays Capital

Okay. My second question would be about the branch consolidation costs. The last quarter you highlighted those costs as totaling between $5 million and $6 million and obviously this consolidation is expected to occur in the first half of this year, it didn't look like any of those costs were evident in results this quarter, so we should expect -- should we expect that full amount to hit in the second quarter? Thanks.

Terrence E. Bichsel

I haven't updated that number since our conference call publicly. And so the $5 million to $6 million that we stated, I think is -- continues to be a reasonable estimate for that as we get closer in, we’ll be able to disclose that as to the amount and the timing.

Matthew J. Keating - Barclays Capital

Okay. And then my final question would be, were there any elevated expenses this quarter related to the DFAS commission, I'm sure you're glad to have that out of the way, but just curious if that showed up at all in any of the line items? Thanks.

Terrence E. Bichsel

We've had continued regulatory costs, including DFAS just as the industry has. So, our risk management practices, our stress testing, hardening our network for cyber-related network security, but to answer your question specifically, it would be about $0.5 million for stress testing resident in the fourth quarter.

Matthew J. Keating - Barclays Capital

First quarter?

Terrence E. Bichsel

Yes. Excuse me, in the first quarter.

Matthew J. Keating - Barclays Capital

Great. Thanks for the color.

Operator

Your next question comes from the line of Scott Siefers with Sandler O'Neill.

R. Scott Siefers - Sandler O'Neill

I was hoping and I apologize if I missed any part of this conversation, but I was hoping you could just talk about the weather related, and I guess just overall activity based impact on fees. You did a great job of highlighting it on the expense side. Just kind of curious if anything you saw in the first quarter, particularly in things like service charges, how much of that you would attribute to kind of beyond normal levels of seasonal weakness, how much of that you see coming back in the second quarter? In other words, have you seen anything recently that would suggest that it’s not going to rebound as robustly as you would typically see in the second quarter?

Terrence E. Bichsel

Yes. As we noted, as I went back through our history, we've had between 7% and 12% reductions as the industry would have as well between fourth quarter and first quarter. Depending on where you pick a point between that range, I cuff it at maybe $800,000 to $900,000 in the service charge bucket. And I think that also had some implications to the card-related fees, but it's harder to get a sense for that particular element.

R. Scott Siefers - Sandler O'Neill

Okay. And then more recently, like any data you have in early second quarter, whether it's kind of spending or activity trends to suggest that the pickup would be any different than what you would typically see?

Terrence E. Bichsel

Yes, we did mention in our script that we’re seeing some return to normalcy.

R. Scott Siefers - Sandler O'Neill

Okay. All right. Sorry, I missed that there, that part there. And then Paul, I just wanted to ask you, I guess more strategic question just on the M&A front, if things are, seem to be picking up in Ohio and broadly there seems to be a consensus that there are more conversations taking place at least, how are you thinking about things from an M&A standpoint, what’s -- any change in either your appetite or probably more importantly, your conversations with potential targets?

Paul G. Greig

Yes, Scott. We continue to look and have conversations. You'll recall that we've looked at over 45 potential transactions in the last few years. We continue to remain selective. There continues to be a delta between what should be paid and what the asking price is. So, a return to a robust M&A market is not something that we would envision at this point in time.

We continue to look in the Midwest and stick to the principles of looking in markets where we are today or that would be complementary to our current markets. And the conversations as they have been in the past are done with discipline and our look at any target continues with looking at financial criteria first and then complementary strategic criteria secondly. We continue to be focused on creating shareholder value.

R. Scott Siefers - Sandler O'Neill

Okay. That's good. I definitely appreciate the color.

Paul G. Greig

Thanks, Scott.

Operator

(Operator Instructions) Your next question comes from the line of Steve Scinicariello with UBS Financial.

Stephen Scinicariello - UBS

Just a couple of quick ones. Just curious given the strong loan growth, what the pipeline looked like, I think it was around $2.5 billion last quarter, just kind of curious where that might have settled out currently.

Paul G. Greig

Yes. In my prepared comments, I mentioned that despite the strong loan growth or even with the strong loan growth of the first quarter, we ended the quarter with the highest level of pipeline in our history. So we continue to be viewed as a very good choice for the commercial customer and continue to see robust activity and significant opportunities throughout all of our footprint.

Stephen Scinicariello - UBS

I was just curious if you happened to have the exact number handy?

Paul G. Greig

It was about $2.85 billion at the end of the quarter.

Stephen Scinicariello - UBS

Great.

Paul G. Greig

And that would have contrasted to, I believe, $2.5 billion was our comment the last -- the previous quarter.

Stephen Scinicariello – UBS

Great. Exactly. And then, just kind of curious, like you said, it sounds like the strength is very much broad-based, but as you kind of look at kind of risk-adjusted returns, maybe what areas, whether by type of loan or geography, are you really seeing kind of some of the best opportunities out there?

Paul G. Greig

And there is really good opportunities throughout all of the commercial lines of business. As far as risk-adjusted returns, we have a discipline within the company for all commercial credits to get appropriate risk-adjusted returns on the entirety of the relationship. So, not simply loan pricing, but all of the additional fee income, wealth management services that we can provide to the owners and/or managers of businesses, all that gets factored into our profit model as we’re looking at risk-adjusted returns.

Inherent in the comments I made was the fact that the risk of the underlying borrower has declined quite a bit as businesses have been very profitable, they've been retaining earnings, many companies are more cash flush than they have been in the past.

So with a lower risk profile, some of the lower competitive rates still give appropriate return on equity to our models. On the commercial loan side, we’re seeing new origination yields of about 3.25% this past quarter, and on the consumer side, 4%. So, from our perspective in this low rate environment, those are relatively attractive yields given the lower risk profile.

Stephen Scinicariello – UBS

Perfect. Thank you so much.

Paul G. Greig

Thank you.

Operator

Your next question comes from the line of Chris McGratty with KBW.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc.

I want to ask Scott’s question on M&A a little bit differently. Your balance sheet is $24 billion, $25 billion today, obviously a lot of work goes into any deal, but is there a size in terms of smallness that you wouldn't consider? Is there anything too small for the effort and the accretion expected? How do you think about the eventual size of a deal when you look at it?

Paul G. Greig

Well, there certainly is a governor at the low end, and that would be dictated by the cost of an IT conversion and the integration cost. Anything lower than $300 million, $400 million in asset size would -- the cost of integration and conversion would make a transaction smaller than that pretty uneconomic.

Above that, it would really be a function of the nature of the to-be acquired institution. If an institution was a bit smaller in size but had a unique niche in lending that we felt that we could exploit throughout our footprint, it may be attractive.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc.

And without asking specific names, is the flow of books in the Midwest in terms of opportunity, are those more focused in several billion, or are there some sizeable transactions in maybe Chicago/Wisconsin?

Paul G. Greig

First of all, I’d say the flow of books itself is not robust. There are a limited number of opportunities at any one time that are in the market and it would really go through the size range of some a bit above $1 billion and some a bit below. I wouldn't be able to comment on a trend of being significantly more population below a billion or above a billion.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc.

Okay. Thanks.

Operator

Your final question comes from the line of Stephen Geyen with D.A. Davidson.

Stephen Geyen - D.A. Davidson & Co.

Just looking at the loan growth and just wondering if you can square up if the numbers kind of are consistent with what you saw in the quarter, but it looked like loan growth was a little bit more heavily weighted towards the end of the quarter, looking at end of period and average numbers, is that something that you kind of saw as a trend?

Paul G. Greig

That would be correct that the loan growth was heavier towards the end of the quarter.

Stephen Geyen - D.A. Davidson & Co.

Okay. And if I look at just kind of loan growth in the first quarter over the last several years it looks like first quarter loan growth has typically been one of your weaker quarters. Anything in this quarter that you saw that is substantially different than say, kind of on a macro view versus last year?

Paul G. Greig

The higher level of confidence of the business owner I think contributed to the appetite to grow lending relationships, but other than that, it really is a function of a robust calling activity and opportunities coming as they may during the course of the year with really no regard to seasonality.

The other comment that I made earlier was draws on commitments and the utilization rate had increased fairly substantially in the quarter which would have contributed to some of that loan growth.

Stephen Geyen - D.A. Davidson & Co.

And just last question, on the pipeline, you gave some numbers for the pipeline. Can you kind of give us maybe not specific break down, but how do you look at the pipeline? How was it kind of built up to a top line number?

Paul G. Greig

We really haven't talked about that publicly. We've talked about the gross pipeline, at any point in time there will be opportunities in various stages of progress in the pipeline. That's something that our commercial banking team manages on a weekly basis and is obviously managing that pipeline to see that the opportunities have the greatest ability to get to closing on our books. But beyond giving the gross amount, we have not talked much about the pipeline in the past.

Stephen Geyen - D.A. Davidson & Co.

Okay. All right. Thanks for your time.

Paul G. Greig

Thank you.

Operator

There are no further questions at this time. Mr. O'Malley, do you have any closing remarks?

Thomas O'Malley

Thanks, Angie. We'd like to thank you all for your interest in FirstMerit Corporation and participating on the call this quarter. We look forward to talking with you again in the future. Have a great afternoon.

Operator

Thank you for participating in today's FirstMerit 2014 first-quarter earnings conference call. You may now disconnect your lines.

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