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FirstMerit Corporation (NASDAQ:FMER)

Q3 2010 Earnings Call

October 26, 2010 2:00 pm ET

Executives

Tom O’Malley - IR

Paul Greig - CEO

Terry Bichsel - CFO

William Richgels - Chief Credit Officer

Mark DuHamel - Treasurer and Director of Corporate Development

Analysts

Scott Siefers - Sandler O’Neill & Partners

Steven Alexopoulos - JPMorgan

Jon Arfstrom - RBC Capital Markets

Terry McEvoy - Oppenheimer & Co

Stephen Scinicariello - Macquarie Capital

Tony Davis - Stifel Nicolaus & Company

Jeff Davis - Guggenheim Securities

Andrew Marquardt - Evercore Partners

Bryce Rowe - Robert W. Baird & Co

Operator

Good afternoon. My name is Melissa and I will be your conference operator for today. At this time, I would like to welcome everyone to FirstMerit Corporation’s Third Quarter 2010 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator instructions). Mr. Tom O’Malley, you may begin your conference.

Tom O’Malley

Thank you. Good afternoon and welcome to FirstMerit’s third quarter 2010 earnings call. Joining me today are Paul Greig, our Chief Executive Officer; Terry Bichsel, our Chief Financial Officer; William Richgels, our Chief Credit Officer; and Mark DuHamel, our Treasurer and Director of Corporate Development. Following our prepared remarks, we are happy to take your questions.

Before we get started, I would like to mention that our press release we issued this morning announcing our financial results for the quarter is available on our website at www.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 third quarter 2010 earnings release.

Now, I would like to introduce Paul Greig, FirstMerit’s Chief Executive Officer. Paul?

Paul Greig

For the third quarter of 2010, FirstMerit reported earnings of the $0.27 per share compared with $0.32 per share last quarter and $0.27 per share for the year ago quarter. Our solid performance resulted in our 46th consecutive profitable quarter reflecting strong efforts and accomplishments in an economy that continues to be uncertain. Despite that, we see a number of anecdotal signs of optimism amongst our customers and our balance sheet is well-positioned to help them.

Just two of half weeks ago, shortly after we closed books on our third quarter, we successfully converted Midwest Bank and Trust, the third of our three Chicago acquisitions to the FirstMerit brand. I’m pleased to tell that less than nine months we have successfully and seamlessly completed three IT conversions in the Chicago market.

We now operate throughout the Chicago area from a solid platform of 47 locations. In less than a year, we’ve gone from having no presence in this vibrant market to being the number 14 bank in terms of deposits.

Not only are we retaining approximately 95% of our acquired Chicago deposits, we are converting many of them from CDs to core deposit products hence strengthening those relationships with us.

On the commercial side, new loan originations were $413 million up 60% which included $86 million from the Chicago market. The loan pipeline remains robust and we remain prepared to fulfill client needs as they move from the sidelines and begin to barrow.

According to the latest FED Beige Books released last week, the economies in Northeast Ohio and Chicago both shows signs of modest growth. Manufacturing is up somewhat in both markets. Business spending has increased which may provide opportunities for booking new business loans. Given that both regions remained disrupted, we continue to see opportunity to increase market share.

I’d like to review some points from the past quarter be for Bill Richgels and Terry Bichsel provide additional detail.

Our net income for the quarter was $29 million, compared with $31.5 million for the first quarter of 2010 and $23 million for the third quarter a year ago. Our linked quarter decreased to net income was due primarily to one time $4.5 million expense associated with the conversion of Midwest Bank and Trust in Chicago. It should be noted that we’ll have achieved all of the expense savings we targeted for the Midwest acquisition as of October month end.

Operating revenue in the third quarter was $181 million which was up $9.2 million or an annualized 22% over the prior quarter and 31% over the last year. Fee income excluding securities gains increased significantly up $2.5 million or an annualized 10% compared to prior quarter. While still strong our net interest margin was up slightly from the prior quarter and 3.95% compared to 4.04% in the second quarter. Over the prior year quarter, we were up from 3.61%. You will recall that we were up 32 basis points from first quarter to second quarter and historically our margin has been quite stable and predictable.

From an asset quality standpoint, net charge-offs continue to perform well relative to the rest of the industry totaling $19.9 million or 1.17% of the average loans for the third quarter. Early stage delinquencies continued its trend of improvement with what is now the four consecutive decline in year-over-year quarters.

Our core deposits continue to grow in the third quarter with a total of $8.1 billion to September 30, increase of $119 million or 5% from June 30 and an increase of $2.5 billion or 45% over September 30, 2009. This continued increase is a function of our Chicago acquisitions, our ability to retain new customers, convert CD customers to core deposit products and successes within our lines of business and achieving specific core deposit sales goals.

The value our customers place on our overdraft service is reflected in the fact that over 90% of our revenue base from those fees as opted in. The tangible common equity ratio at September 30 grows on an even stronger 7.53% from 7.34% at June 30. This increase to our TC as a customer to our commitment to balance sheet strength and positions us for profitable organic growth across our entire footprint. That footprint now consists of 207 branches in Ohio, Pennsylvania, and Chicago.

With Midwest now officially part of the FirstMerit brand, we are operating in three states as one culture, one team. We have talented people in place throughout the company and we continue to hire qualified experienced bankers across of our organization.

We are focused on fully integrating our corporate culture and successful super community banking model throughout our expanded company, and I’m pleased to tell you that this is being growing exceedingly well. At the same time, we continue to look at all additional M&A opportunities both traditional whole bank transitions and FDIC assisted.

We will maintain a disciplined approach with respect to the pursuit of any M&A opportunity. As we have done since we begin our Chicago expansion in the 2009, we will only undertake a transaction which can generate enhanced shareholder value. This is our philosophy in Chicago and Ohio and in any geography adjacent to our footprint where opportunities present themselves.

I would like to take a moment to address foreclosure issue that is forced the number of banks to suspend their foreclosure efforts. We feel this issue is mostly concentrated from a large mortgage debtor creator banks and not community banks like FirstMerit. Our mortgage business has been focused on lending loans locally in our markets. We’ve recently reviewed our foreclosuring processing procedures and I’m pleased to report that they are all conservative in nature and all are in (inaudible).

Each loan file is independently reviewed by two different people and then reviewed by an outside law firm. Because we do not do mortgage business behind our markets, we have not been buried by excessive paper work and have avoided faulty review procedures. In fact September 30 of the approximately 84,000 total foreclosures in the counties, in which we operate, FirstMerit was involved in only 87 for our loan book.

Our reputation as a safe, solid and stable bank plays well with customers in the disrupted markets of Northeast Ohio, and Chicago. We also find it beneficial to employ attraction as well as retention.

In summary, our performance was solid in the third quarter. Our liquidity and capital levels remain among the industry’s highest. We are well positioned for growth and intend to take advantage of opportunities that bring additional value to the company.

At this point in time I’d like to turn the call over to Bill Richgels, our Chief Credit Officer. Bill?

William Richgels

Thank you, Paul, and good afternoon. As we reported, our charge-offs for the quarter totaled $19.9 million or 117 basis points of average loans. These charge-offs are in line with our expectation and represent a continuation of moderating charge-offs which began at the beginning of the year. Our consumer retail portfolio had a $9.6 million share of the charge-offs for this quarter down $3.4 million from the link quarter.

Within this $2.7 billion consumer portfolio, the change in charge-offs for each portfolio are as follows: indirect charge-offs are down $1.3 million from $4 million, direct lending down $70,000 from $1.5 million, HELOCs down 900,000 from $2.3 million, credit card down $1.1 million from $3.4 million and mortgages are down 250,000 from $1.3 million from the quarter before.

While consumer charge-offs are elevated at these levels, the decrease in charge-offs quarter-to-quarter was inline with our expectations and it is encouraging in that all of the segments were down. While overall delinquency rates in the retail book are up slightly running 2.33% versus the 2.24% consistent with the seasonal cycle or early stage delinquencies are down slightly on a linked quarter basis and are down year-over-year.

Non-performing assets increased $5.5 million from the second quarter to $115 million or 1.7% of loans. We continue to expect non-performing loan and OREO balances to remain elevated reflecting broader economic stress, but we believe that inflows will be slowing and we are starting to see evidence of market liquidity strengthening in the later half of the third quarter and this is necessary for the NPA and NPL resolution.

In flows to NPAs totaled $19.6 million up from $4.4 million on a linked quarter basis that’s significantly below the previous linked quarter running back to September ‘09. Serially that would be $31.2 million, $34.6 million, and $24.5 million in the reference September 30, 2009 quarter.

Our OREO book decreased 70 properties at quarter end versus 77 properties the previous quarter. Roughly 24% of our commercial non-performing loans are concentrated in footprint multifamily and housing construction real estate. The total homebuilder portfolio will continue to reduce nearly 16% down to $48 million.

Finally, our commercial criticized and classified buckets increased modestly $35 million to $410 million this quarter with increased portfolio management disciplines funds and heightened awareness of macro trends, we are aggressive on recognition of stress and resultant downgrades of credit. We benefit from heightened scrutiny and restructuring opportunity and we further expect moderation of these elevated levels.

Within our commercial portfolio, we have approximately $2.5 billion of commercial real estate outstanding. Major components of that portfolio comprised that the following: Owner occupied real estate at $560 million, office medical at $440 million, multifamily at $200 million, retail at $200 million, industrial, commercial, construction at $280 million, healthcare at $270 million, industrial warehouse at $270 million as well, general income production at $250 million and our previously referenced modest homebuilder portfolio.

Remember this commercial real estate is within our footprint and, in general, this portfolio has performed to expectation and has demonstrated favorable variance to national real estate loss rates.

Within the retail consumer book, average utilization of HELOCs remained stable at 43% consistent with last quarter. Firstly, HELOCs are 48% of that portfolio and 38% of the second HELOCs have a MeritFirst Mortgage as either owner or servicer and total weighted loan-to-value is down to 68%. Weighted average FICO is at $747 with re-scores stable to slightly up. NPLs for that $760 million portfolio equals $1.7 million or 21 basis points.

Foreclosures for our book both mortgages loans and HELOC are $87 in total as Paul previously mentioned down from previous quarter. Paul mentioned and I reiterate that our documentation review and foreclosure processes have been reviewed numerous times. I do a controlled discipline in smaller (inaudible) precludes to documentation and processing irregularities other mortgage processors have experienced.

Our allowance for credit losses was $124.3 million representing a 184% of loans consistent with linked quarter. It is 1.18 times to nonperforming loans. This level is both appropriate and consistent with a loss inherent in the portfolio. While our charge-offs totaled $9.7 million and the provision was $18.1 million refunded an additional $1.1 million of provision for unfunded commitments in expense hence the consistent allowance on a link quarter basis.

Ohio-based TDRs totaled approximately $9.24 million flow and roughly $34.3 million of retail, all current in paying. In summary, early stage delinquencies in the retail brought down 12% year-over-year. HELOC and mortgage early stage delinquencies are down 26% and 22% year-over-year respectively. Consumer charge-offs have improved 13% year-over-year.

Average FICO scores are still low to up slightly year-over-year and consumer bankruptcy filings are down 6% year-over-year and a 11% on a link quarter. All of this is positive and points to a measure of improvement and stabilization of the consumer book and this stabilization should be reflected in commercial credit performance in 2011.

With that, I’ll turn the call over to Terry, our CFO. Terry?

Terry Bichsel

Financial performance for the quarter showed net interest income up $6.7 million, reflecting a full quarter of the acquired Midwest Bank & Trust balance sheet. The net interest margin declined 9 basis points to 3.95% in the quarter. The yield on earning asset declined 15 basis points offset by a 6 basis point improvement in the cost of fund. The yield on the investment portfolio was down 29 basis points from the reinvestment of maturing cash flows in to short duration investment.

In the fourth quarter $241 million of investment portfolio cash flow is expected and $909 million is expected over the next 12 months. Yield on loans including covered loans declined 14 basis points. As Paul noted, total loans including covered loans were down 1.3% from the end of June. Loan originations, while strong did not outpace the pay downs in the portfolio.

Demand deposits, interest bearing demand and savings were up 4.8% from the end of June. The plan reduction and high class CD was executed with total deposits down 2.1% and the cost of interest bearing deposits improving by 8 basis points.

In the fourth quarter, $874 million of CDs mature at a rate of 1.4% and $2.4 million mature over the next 12 months at 1.35%. Fee income was up 4.8% excluding any security transactions. The driver to the increase was mortgage revenue including loan sales and servicing net of $1 million MSR impairment and the fair value of the mortgage pipeline, which is recorded in other operating income.

Service charges on deposits impacted by Reg E implementation were down 4.8% from the prior quarter. Expenses include $4.5 million of one-time conversion and integration cost for the Midwest acquisition. Also included is a $1 million provision for unfunded commitments that Bill noted 600,000 for a cumulative FDIC expense for cash held in our subsidiary that will not recur and $2.6 million of OREO expense.

For the remainder of the year, in the highly uncertain environment, with the probability of further quantitative easing by the Federal Reserve, if loan yields remain fairly constant the question will be can the re-pricing of CDs and the remixing to core deposits offset the reinvestment risk on the cash flow from the investment portfolio.

Historically, FirstMerit has maintained a stable net interest margin. Our modeling exercises and strategies will be focusing on doing just that with expectations for the fourth quarter net interest margin plus or minus 5 basis points from the third quarter level.

The provision for loan losses is expected to between $21 million and $25 million. Non-interest income is expected within a range of $49 million to $59 million, mortgage activity being the major variable in the range.

Non-interest expenses are expected between $109 million and $117 million, having achieved the cost savings from the acquisition. We will continue to pursue cost efficiency. Near-term marketing expense might be a bit higher with introduction of our product set in to the Chicago market. The tax rate for the fourth quarter is estimated at 27.5%.

Several changes were made to the opening fair value balance sheet of the acquisition, as additional become available consistent with ASC 805. For Washington, a $5.3 million true up liability to the FDIC was recorded were almost previously recorded, reducing the day one gain recorded in the first quarter to $1 million.

Loan evaluation and revolution of one day charge-off with the FDIC resulted in reducing goodwill by $5 million for the Midwest Bank & Trust acquisition.

That’s concludes my remarks. I will now return the call to Tom O’Malley. Tom?

Tom O’Malley

At this point, we are now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes in the line of Scott Siefers.

Scott Siefers - Sandler O’Neill & Partners

Terry, first question for you just again I wanted to make sure I heard the expense guidance correct is that between $109 million and $117 million in the fourth quarter. One is that (inaudible) and two I assuming it is wider range than we typical had. I know you had suggested on the second quarter call that there might be an additional couple of million dollars of one-time expenses in there. Any light you can shed on the cost and any additional one-time expenses as well?

Terry Bichsel

Within that band we include some trailing one-time cost related to the acquisitions. I believe I noted that last quarter and the other expense that I know here is a possibility of some higher marketing costs in the fourth quarter.

Scott Siefers - Sandler O’Neill & Partners

Can you pass the detail; you have the MSR fair evaluation in the other income the dollar amount for that changes?

Terry Bichsel

Actually Scott, the MSR evaluation would be netted against the loan sales and servicing line it’s noted in our press release. The other income you’ll note that is up quarter-to-quarter and that’s were the fair value of the pipeline is recorded. The $1million is net within the revenue on the home sales and servicing, which is shown as $4 million and 6000.

Scott Siefers - Sandler O’Neill & Partners

Paul just want to ask high level question, just looking as your backend and ready to do with additional deal, what attracted to you, just from your stand point, what is the attractiveness of the things that you are seeing so far pricing, quality franchise, that are relative to back in the spring time, in the last you guys did a deal?

Paul Greig

Well, that happened in March, Scott in the market over the last 120 to 180 days, so there is not a lot to comment on. If you look at the Texas ratio, the analysis of Chicago in particular would appear that the FDIC has a quiet of bit of work to do to cleanup some institutions that we have a lot of troubled assets on the books. With the IT conversion of Midwest Bank successfully completed. We’re going to continue to look both at the FDIC assisted opportunities and any un-assist that open market opportunities that may come our way in Chicago as well as in the broader Midwest.

Operator

Your next question comes from the line of Steven Alexopoulos.

Steven Alexopoulos - JPMorgan

Maybe I’ll start just a follow-up on Scott’s question on the range of expenses, Terry if you takeout the one-time trailing cost from acquisitions, can you just give us what that range would look like and trying to get sense you can help us better run rate in to 2011?

Terry Bichsel

If you look at the cost that we had in the third quarter, Steve, the 120 points million minus the 4.5, I’d addition for unfunded commitments as a non-interest expense matter and it also characterize the 600,000 from the cumulative FDIC expense for cash held in our subsidiaries as a non-recurring matter that was a desktop audit with the FDIC did and it was the catch up and we have subsequently move the cash out of our subs and we will have that our lost going forward. The ORE expense it was a bit higher than our normal trend in net in that area. If you deduct those items down try to get two-third at least, but what I’d say to you is we wanted to have in our guidance a little bit of cushion for marketing expense and other cost that manifest themselves.

Steven Alexopoulos - JPMorgan

Look at the yields on where the different buckets of securities went. Can you give a little bit color on why the pressure were go much more pronounced this quarter and recent quarters this seems to be way beyond just reinvestment of cash flows and just in cooperating the MDHI securities yield so why that comedown so much and how you are below 3.5% blended, how much more downward pressures that we expect there?

Terry Bichsel

Well, I’d take the cash flows that I gave you and think about we’re reinvesting those short-term to anticipate at some point in the future, not very near future, some point in the future that interest rates would begin to rise.

Paul Greig

Steve, we would look out and Steve, as you add these numbers $478 million of cash flow maturing out of the portfolio at 3.3% that do you look at the portfolio with 72% of the portfolio in mortgage-backed securities with the products we typically are buying are way around 2% if you look at 15 years MBS, way around 2% and you can see that difference to between what we’re buying and what’s maturing and that will be largely offset by the CD their maturing. As Terry, talked about the volume in CDs that are maturing over the next 6 and 12 months, which are above 75 basis points favorable to where our current board rates are.

Steven Alexopoulos - JPMorgan

Shift a gear for a second. Could you talk about the credit performance of the performing loans you’ve bought from First Bank and I know the balance is small, but you don’t have wash care on and they are in Chicago just any color there would be helpful?

Paul Greig

First of all the high preponderance of that portfolio, Steve, is C&I, not CRE. My recollection is there was only $7 million or $8 million of CRE that was acquired and almost loans will performing at the time not only performing, but they were not criticized, not classified, not delinquent and pass credits at the time of acquisition. Bill can you give more specifics?

William Richgels

Specifically Steve, Paul get at the heart of the universe we looked at for inclusion into our purchase. We specifically avoided commercial real estate of the remaining portfolio we’ve had benefit of a loan review of the book, we are two weeks away I believe from comprehensive portfolio of the entire book there.

We have had a very modest downgrade activity only one or two remaining in C&C both restructured and performing in accordance with restructure. So, all in all, the underwriting we originally bid has held up, but Paul hit at right on the head the reason was due to C&I reverse CRE.

Steven Alexopoulos - JPMorgan

Maybe just a final question on loan pipeline, can you talk about maybe what you’re seeing in Chicago versus Ohio? I don’t know if you have any metrics, number of new customers you’re taking, but any sense of market share gains you might have seen in the quarter?

Paul Greig

We have not specifically reported numbers with customers in the past, Steve what I did talk about as we have a very robust pipeline. I mentioned that in the quarter about $86 million of new business was what in Chicago, out of about $430 million of total booking so, what we’re very pleased with that given the fact that only half of the branches had our name officially during that course of that quarter and that we are in a hiring phase for some seasonal lenders, we are very pleased with the performance we’re seeing from Chicago thus far.

Steven Alexopoulos - JPMorgan

Any update on Ohio, Paul, in terms of what you’re seeing there?

Paul Greig

We are seeing continued opportunity obviously as if the 413 was the total production for the quarter 86 of our Chicago, the balance came from Ohio so it continues to be a pretty good business market. I talked about the Fed Beige Books trends and we are seeing that from our both customers and prospects was a much more upbeat view towards business opportunities on a go forward basis.

Operator

Your next question comes from the line of Jon Arfstrom.

Jon Arfstrom - RBC Capital Markets

Just a follow-up on Chicago hiring, can you give us an idea of what the plan is and where you think you are in terms of being complete in terms of having the right people on the ground?

Paul Greig

Yes, we have roughly 40 bankers in Chicago today and we have plans to several more, but as I mentioned we are clearly not going to go into a hiring spree that is going to burden the company in excessive expanses. We are going to hire several more grow into that book of bankers and then do incremental hiring as opportunity present itself.

Jon Arfstrom - RBC Capital Markets

Would you say it’s generally easier to hire in this market, or is it getting more difficult?

Paul Greig

Bankers throughout the Midwest are a difficult commodity to come by today. We have a lot of current tax and have knowledge of lot of people both in Chicago and Ohio, which may give us some advantage in hiring. Another thing to notice that we get through the First Bank transaction, acquire an asset-based lending office in Chicago as well. We really have a full cadre of lending product to offer to the Chicago marketplace today from a traditional un-levered C&I transaction to more heavily leveraged asset-based lending transaction.

Jon Arfstrom - RBC Capital Markets

I don’t know if the question’s for Paul or Bill. You touched on it a little bit, but can you give us an update on utilization, and what changes we’ve seen over the last quarter?

Paul Greig

The utilization is flat. We reported last quarter of little over a 100 basis point increase in utilization it was about 150 basis point increase in utilization and at the first quarter utilization went up to several basis points so it was relatively flat.

Jon Arfstrom - RBC Capital Markets

Bill a question for you. You talked about market liquidity improving for problem assets toward the end of the quarter. I’m curious, is that specifically to FirstMerit, or is that just a general observation?

William Richgels

No, you’re starting to see property. We have reached a value in terms of on most banks balance sheet, where the asset is being held at effectively a market value and dollars with a need for return are being utilized and we’re starting to see product move as I mentioned in my comments. So, we had roughly a 10% reduction in number of properties in OREO move this quarter and people are just starting to move off the sidelines back into economic activity in that product area.

Operator

Your next question comes from the line of Terry McEvoy.

Terry McEvoy - Oppenheimer & Co

Just getting back to loan growth, three months ago it sounded like you were more optimistic about the ability to grow loans. You provided a 4% to 5% growth target for the back half of this year. Was it just the payoffs were greater than expected? That $413 number was maybe lighter than you felt it would be three months ago, and your outlook I don’t think, Terry, discussed loan growth in Q4 in his prepared remarks, if you could comment on that as well.

Paul Greig

Yes, first of all, inventory replenishment is abated a bit in the industrial sector. Yes, we continue to see a very robust pipeline, it’s hard to predict exactly one that is going to come into the company. As far as pay down of loans there is obviously scheduled the amortization on a significant portion of our portfolio and I commented in the answer to the question just earlier that utilization rates were just dead flat this quarter versus he last quarter. We’re still bullish on the loan production that we have a very healthy pipeline throughout the footprint that pipeline did not materialize, however, in the expected loan growth that we talked about last quarter.

Terry McEvoy - Oppenheimer

The second question, the really strong growth in interest bearing demand, I know you ran through 4, 5 reason why you saw that the quarter, could just may that the top 2 variable that specifically resulted in that growth?

Terry Bichsel

For the most part what you’re seeing is liquefaction, whereby the loan assets aren’t going on to the balance sheet, the business bearing demand is where the goal and also in the demand deposit categories. The retail growth would be in the non-maturity deposit categories of our very successful reality stage product and in the reality checking but the predominant growth area there would be in reality savings.

Terry McEvoy - Oppenheimer

The expected phase of a covered loan run off may be through 2011 and have you look at that portfolio down in Q3, and any guidance about future levels would be helpful?

Terry Bichsel

We have not offered any guidance and would not be prepared to give you guidance.

Operator

Your next question comes in line of Stephen Scinicariello.

Stephen Scinicariello - Macquarie Capital

Hi, just a couple of quick question, first, looking to get a little more color what exactly drove that 5% increase in the NPAs, and just what gives you comfort in terms of you know minimal last content coming out of that stuff?

Paul Greig

Steve, in terms of that increase velocity remain consistent inflows and outflows in that NPL bucket we’ve 21 in and 20 out in terms of the number of credits, roughly there was one credit of size $5.5million manufacturer of retail cabinets, his business is up. We take comfort in the last content with significant impairment analysis as they come in and most importantly its really you’re looking at peak levels in the first quarter of this year and successively coming down, it will be a little a chunky quarter to quarter, but the trend is now not only its sustaining its off of most other banks as well.

Stephen Scinicariello - Macquarie Capital

Changing gears, in terms of potential capital deployment. I know you don’t always get to have a choice on this, but if you could have your choice in terms of ranking the potential opportunities that might come along, would you put organic growth ahead of FDIC-assisted deals, or non-FDIC assisted deals, and what particular markets other than what you’ve already done or just building on what you already have would you kind of put in terms of priorities?

Paul Greig

Organic growth is clearly our first priority as by far the most accretive choice shareholders. The FTIC-assisted deals albeit likely to be smaller in size may also be lost competitive in bearing, so we really need to see the FDIC get back to work in some of the markets that were carefully watching. Non-assisted deals appear to become or becoming update more prevalent, yet the non-assisted transactions we have looked at date have not been attractive and hence you see nothing announced other than the branch purchase back in November 2009 from First Bank.

As far our geography is concerned we’re looking through the greater Midwest kind of think of it as a big time turf and with clearly a focus on Chicago given our investment to date in Chicago.

Operator

(Operator Instructions). Your next question comes in the line of Tony Davis; your line is now open.

Tony Davis - Stifel Nicolaus & Company

Bill, given increase in the NPL inflows, can you give us any color on the terms, the percent of loans that were classified grade five or above at quarter-end? Do you still anticipate a material improvement in risk classifications here pretty consistently going forward?

William Richgels

The Q will have a lot of detail referencing that in terms of surprises in other words going from the past directly I don’t think there weren’t any see the general deterioration from past categories down to watch special mentioned. Off hand, I am fairly confident that there is no free flowing credited in there.

Paul Greig

Tony, we have a consistent process of portfolio reviews throughout the company that are performed on an on going basis portfolio by portfolio. While that at times can catch an unforeseen event in a borrower’s financial situation it certainly gives us the best insight to correct deterioration well in advance of something falling in to a NPA category.

Tony Davis - Stifel Nicolaus & Company

Paul, you mentioned the robust pipeline. I wondered if you could give us a number on the unfunded C&I, CRE commitments at the end of the quarter. Basically how much did that change say, since mid year?

Paul Greig

Pipeline and commitments are two different things. Many items would be on the pipeline would be entities that have an interest in banking where our commitment may not yet have been approved. As far as the actually members of commitment Bill may have the number in his finger tips and if not we can get it to you.

William Richgels

In terms of commitments related to general commercial outstandings, if you will, at the quarter ending September, Tony, roughly $1.1billion on lines available with commitment of approximately 1.2 on top of that. So, significant room for greater utilization.

Tony Davis - Stifel Nicolaus & Company

Paul, finally, just wondered what’s been the reaction in your markets to Huntington’s 24 hour grace product. Has it created much buzz in your customer base?

Paul Greig

Yeah, we actually asked our branch folks give us feedback if there had been any and to-date we got virtually no comments at all.

Operator

Your next question comes in the line of Jeff Davis, your line is open

Jeff Davis - Guggenheim Securities

My questions were covered.

Operator

Your next question comes in the line of Andrew Marquardt, your line is open

Andrew Marquardt - Evercore Partners

In terms of the credit guidance provisions of $21 million to $25 million, what’s the driver of that versus this quarter of 18? Should we assume no reserve release near term or still some modest?

Terry Bichsel

First of all, I’d like to comment on the perception of reserve release this quarter. If I look at the 18 and change that went through our provision expense line. You have to add to that an additionally almost $1.1 million that is in our non-interest expense. The allowance of loan loss and allowance for credit losses are a combined amount. So, you are upto $19 million against a $19.6 million charge off level.

So our anticipation would be that charge offs would meet provision or the other way around. Given as we have said in prior quarters that commercial charges offs from time to time can be choppy. That is the reason for the range that was given. As Bill noted, our retail charge offs performance has been trending much better quarter by quarter and would expect that continue.

Andrew Marquardt - Evercore Partners

In terms of the margin, how much was, if any, purchase accounting impacting this quarter versus last?

Terry Bichsel

We say to you on that is fully accruable income. You will recall that we had Midwest transaction from the middle of May on and George Washington on for the full quarter. We report that accretable income in the 10-Q and in accordance with the GAAP ESOP 3. Our cash levels are required to be re-estimated at the each financial statement date. So, that information on the accretable income will been shown on the 10-Q when it is filed.

Andrew Marquardt - Evercore Partners

Was that a driver to the sequential decline, though, in terms of 404 to the 395?

Terry Bichsel

What we had pointed to was we had a very substantial increase in our net interest margin from Q1 &Q2 of 32 basis points and then we backed up by 9. That’s really a combination of number of things. Without going in to basis point by basis point, while our loan originations were strong they didn’t outpace the pay down so the mix was a little bit different than we would have anticipated and as a result of that excess cash on our balance sheet and the investment portfolio cash flows reinvest in lower ranges very short.

As a third item we haven’t talked about and that being our CD interest rates were maintained a little bit higher until the data processing convergence were completed and our marketing programs could begin to really stress FirstMerit’s value proposition on our products.

Andrew Marquardt - Evercore Partners

Lastly, just on the acquisition, tweaking of the prior gain, what was that driven by? Again maybe I missed it.

Terry Bichsel

Yeah, there were a other couple of things. On that day one gain within the purchase and assumption agreement there is a true up for amount that FirstMerit would owe to the FDIC. At the end of ten years if loses are below the threshold that was established by the FDIC. We went through this the first time we didn’t record a liability. Subsequentially, we analyzed the purchase and assumption agreement and the detailed formulas and determined that there’s a possibility of a liability and that it was so recorded.

The progression there, we had $5 million day one gain moved up to a $6 million day one gain in Q2 and now back down to a million with the recording of that liability. Additionally, for Midwest as you may know, the FDIC on the acquisition date goes back and repost to a bank’s balance all of the charge offs that would have been taken 90 days prior to the acquiring institution taking it over. Because of all of the noise associated with that it’s very difficult to get that reconciliation 100% accurate. As we have to learn more information reconcile out the balances part of that $5 million improved to the goodwill is from the window charge offs about half of if, and then the other half would be from new information coming forward on a few ones that we had valued at the opening balance sheet whereby we adjusted the fair value of the loan and also the fair value of the indemnification asset associated and that also improve goodwill by an amount.

Operator

Your last question comes from the line of Bryce Rowe. Your line is now open.

Bryce Rowe - Robert W. Baird & Co

Question on the OREO expense of $2.6 million in the quarter. Can you give us a flavor for what that night have been in the second quarter and with the mix of that expenses? Is it write downs or is it just kind of procedural etc?

William Richgels

Second quarter we have roughly $142,000 in the sold OREA non-covered. This quarter we have an addition of $500,000 expense related to write down of main branch we are no longer operating. If we do an appraisal at least yearly and we still have some legacy branches we are attempting to see. So that leaked into there.

There’s also some of the covered OREO write downs the short million dollars and that refers to our portion of resizing that was even though that was covered (inaudible) portion of that. There was also the covered OREO in itself went up sum $4 million quarter to quarter and you can reference on the Q2.

Bryce Rowe - Robert W. Baird & Co

The current CD board rate you say was 75 basis points, is that correct?

William Richgels

Our one year board rate would be 35 basis points. Then we have what’s called a special and our special rates are 75 basis points. Typically, you see the line between the special rates and those that roll over the board rate is 75% special and 25% board and that could move a little bit either way but it will be somewhere just under 75 basis points would be reinvestment rate called at 60 basis points coming down from the 135 that Terry talked about.

I would also point out before we move on the volume of those CDs maturing is approximately four times the amount of securities rolling over at a lower rate.

Operator

There are no further questions at this time. Mr. O’Malley, I turn over the call back to you.

Tom O’Malley

Thanks for your interest in FirstMerit Corporation and joining us on third quarter call. Have a good afternoon.

Operator

This concludes today’s conference call. You may now disconnect.

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