A year after assuming leadership of FirstMerit Corp., Paul G. Greig is talking optimistically about moving past the ugly credit-quality situation he inherited.
The $10.3 billion-asset Akron company is in the "final stages" of repairing its loan book, Mr. Greig, its chairman, chief executive, and president, said in an interview last week. It sold $81 million of troubled loans and took a large, unexpected provision for loan losses in the fourth quarter, but in the first quarter its net chargeoff rate was just 0.21% of its loans.
"There was a significant process change needed, and we've done a complete rewrite of our credit policy, and that has been rolled out to our bankers," he said. "It's going to be a much more disciplined process from the perspective of consistent standards being upheld by all of the bankers."
Mr. Greig ran Illinois operations for Royal Bank of Scotland Group PLC's Charter One Financial Inc. before joining FirstMerit.
"There really is a strong core bank, and when we get the credit completely fixed, we certainly have the opportunity to be one of the top performers in our peer group," he said. "Credit-quality improvement is the biggest driver in improving the bank."
Analysts agree that Mr. Greig has made progress in improving FirstMerit's credit quality. They also say whether that progress will be enough to preserve its independence it is still far from certain.
Mr. Greig said that FirstMerit would prefer to be on the buying end of a deal, and that it aims to expand in the population-dense markets of Cleveland, where it has 15 branches, and Columbus, where it has 13.
But FirstMerit has not made an acquisition since February 1999, when it bought Signal Corp. of Wooster, Ohio, for $473 million, and most analysts peg it as a seller.
"The endgame is that these guys are part of someone else — I would guess within five years," said Christopher M. Bingaman, a portfolio manager with Diamond Hill Capital Management Inc. "But trying to nail that timing is difficult. I probably would have said that five years ago. Sometimes these things hang around and take a lot longer than you would think.
"But in the endgame, they are not going to be independent," he said.
Assessing possible buyers, Erin Swanson, an analyst at Morningstar Inc., said, "The most likely pairing would be with somebody who already has exposure to Ohio and wants to expand their footprint."
Eight companies have a larger Ohio deposit share than FirstMerit, including National City Corp. and Fifth Third Bancorp. The $35 billion-asset Huntington Bancshares Inc. of Columbus has been the most active in-state consolidator. It bought Unizan Financial Corp. of Canton in March of last year, and its deal to buy Sky Financial Group Inc. of Bowling Green is expected to close next quarter.
Thomas E. Hoaglin, Huntington's chairman, CEO, and president, has said several times this year that his company will be a consolidator in the Midwest. A Huntington spokeswoman would not say which banking companies it might be interested in buying.
But those with regulatory problems can be radioactive, and FirstMerit is operating under a cease-and-desist order levied in November by the Office of the Comptroller of the Currency. The order requires the company to improve its training, internal controls, and oversight of compliance with the Bank Secrecy Act.
FirstMerit said it will complete a review of its past wire transfers by Wednesday and will file suspicious activity reports, as necessary.
Scott Siefers, an analyst with Sandler O'Neill & Partners LP, said FirstMerit would have no trouble finding a buyer.
"Why would anyone want northeast Ohio? It's a fair question, but people are going to continue to live there. … People there are going to continue to need banking services. It's got a nice little branch network in the Ohio market," he said. "There is always value that can be created by M&A, even if it's just increasing scale in a particular market or by reaping back-office cost savings."
However, all the changes under Mr. Greig indicate FirstMerit intends on persevering, Mr. Siefers said. "I think they'd like to earn the right to remain independent."
When Mr. Greig arrived in May of last year, FirstMerit did not have managers in any of its 160 branches, documentation for loans was being waived in some cases, and credit quality was deteriorating quickly.
He switched the company from a geographic reporting structure to a business-line hierarchy, and now he meets weekly with each business head. He consolidated the mortgage business inside its retail business. FirstMerit is training its new branch managers in originating mortgages. Right now it has 45 employees trained to offer home loans, but training the branch managers will increase that number to 200.
And Mr. Greig used incentives to renew the company's focus on not just attracting customers, but also retaining them. To stay on top of bad loans, he attends reviews of risky loans and consults with lenders who have shaky credits exceeding $100,000. Incentive compensation was revamped to reward officers for improved credit quality.
"And that goes for me, too," he said last month at an investor conference hosted by Lehman Brothers. "I have 50% of my 2007 incentive opportunity tied to credit-quality improvement."
FirstMerit's stock has yet to rally with any conviction. The day Mr. Greig took over the stock sunk 8%, to $21.80 a share, as investors viewed the hiring as a sign FirstMerit had no intention of selling. The stock rose the rest of the year but began a slide in January that continued through April. It has regained some ground since then but is still off about 14% since Mr. Greig took over.
"I think before John Cochran [FirstMerit's previous chairman and CEO] had left, there was a certain assumption among the investor community that when John retired, the exit strategy would be a sale of the company," Mr. Siefers said.
Terry J. McEvoy, an analyst at Oppenheimer & Co. Inc., said that even though he is a fan of Mr. Greig's performance to date, he does not think FirstMerit can find any companies to acquire.
"There's a limited number of banks, in terms of where they're located, that would make sense for them to go after," he said. "Revenue and earnings have been flat for quite some time. One way to supplement the organic growth, which has been their only source of growth, would be through acquisitions."
Mr. McEvoy said he had given Mr. Greig a grace period of a year and expects FirstMerit to start improving in the next 12 months.
"Progress comes in two steps when you're looking at banks," Mr. McEvoy said. "The first step is the hard part, and that's the cultural change. That first step has clearly occurred" with, among other things, the elimination of some middle management positions. "If you talk to him, it's really about accountability, which was lacking before he arrived."
The second step is a sustained improvement in financial performance, and that has not happened, he said.
In the first quarter FirstMerit earned $31.4 million, or 39 cents a share, beating the average analyst estimate by 4 cents, according to Thomson Financial. However, as a result the large, unexpected provision, it reported fourth-quarter net income of only $6.1 million, or 7 cents a share, falling short of the analyst estimate by 32 cents.
In addition to the traditional yardstick of net income, Mr. McEvoy said he would be watching deposit growth, commercial and industrial lending, and the expansion of its wealth management business.
Ms. Swanson of Morningstar said she is focusing on the income statement, specifically operating expenses and their impact on the efficiency ratio.
Mr. Greig is aware he is being watched.
"We have a changing story, and hopefully it's a continually improving story," he said.
