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Top Bank: FirstMerit Steers Smooth Course Through Industry Storm

JPMorgan Chase draws praise these days for having survived the U.S. banking crisis. But the financial giant has nothing on FirstMerit Corp. Who, you say? The publicly held banking company may be relatively anonymous, but it's well-known to industry analysts, not to mention contented shareholders. FirstMerit, a midsize institution with $10.7 billion in assets, is one of a handful of banks that have continued to chug profitably along while competitors great and small try not to croak.

FirstMerit, which has recorded 41 straight profitable quarters, is leaving just about every other U.S. bank in the housing-choked dust. Drawing on data from the FDIC, let's look at several key bank metrics:

  • 10.7 percent return on equity (industry average 2.2 percent)
  • 1 percent return on assets (0.2 percent)
  • 3.5 percent net interest margin (3.2 percent)
  • 1.2 percent net loan charge-off rate (1.9 percent)
  • 1.3 percent nonperforming loans (2.8 percent)
The first three bullets tell us that FirstMerit is highly profitable compared with the rest the industry, while the last two indicate that its loans are in considerably better shape.

The full-service bank does even better measured against its peers, as I learned in benchmarking it against some 70 banking companies ranging in size from $266 billion in assets (US Bancorp) to $190 million (Ohio Legacy). FirstMerit's net income growth over the last 24 months is 2.6 percent, versus an average of -5.5 percent for our sample. Its 27.4 percent Ebitda margin, another important gauge of profitability, is more than double the group average of 12.9 percent.

The number of bad loans FirstMerit carries on its books did tick up last quarter. But the company wisely boosted its tangible common equity ratio, which essentially indicates how leveraged a bank is, to 8.4 percent (5 percent and above is considered well-capitalized).

So what does FirstMerit do well that other banks don't? If I had to boil down their success, I would characterize it as prudent growth. The company has continued to expand revenue and churn out profits, but not at the expense of loosening the reins on its underwriting standards. Indeed, in the second quarter its commercial and home equity loans were up 4.7 percent and 8.1 percent, respectively, offsetting declines in mortgage and other lines of business.

Crucially, as the economy darkened FirstMerit also maintained a fat capital cushion to account for any rise in loan defaults and other deterioration in its business, avoiding the kind of financial drain that is crippling other banks. For example, the graph above charts the company's level of Tier 1 capital (in blue), a common measure of funding adequacy, against its nonperforming loans (brown) and loan charge-offs (yellow; click on chart to expand). This isn't a bank prone to throwing a bunch of mortgages at folks to see what sticks.

The banking industry is rightfully under fire these days for a host of sins. Which is why it's instructive to recognize the virtues of companies like FirstMerit.

Graph courtesy of Capital IQ.

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