Acquisitions are often judged closely when announced, but FirstMerit is showing investors that sometimes a little time can deliver a nice surprise.
FirstMerit's purchase of Citizens Republic Bancorp one of the biggest deals in recent years has faced significant prejudice. Investors struggled to embrace the deal and initially punished the Akron, Ohio, company's stock as a result.
Through it all, Paul Greig, FirstMerit's chief executive, has maintained that the deal's financial benefits were compelling. Last week, Greig's team upped the ante, disclosing that Citizens' problem-loan portfolio is performing better than expected, adding that they also found more ways to cut costs.
"In addition to completing the acquisition and conversion on schedule, we also met or exceeded financial goals related to the merger," Greig said during a quarterly conference call last month.
Expectations of acquisitions are tough to gauge, especially the accounting for impaired loans, but analysts say FirstMerit's improved expectations are a sign that the deal is off to a good start.
"This is a good reminder not to judge a deal based on day one," says Terry McEvoy, an analyst at Oppenheimer. "Two or three quarters after this deal has closed, it continues to appear more favorable both on the revenue side and the cost basis."
The $23.9 billion-asset FirstMerit did not return a call for comment, but the company says it expects to trim Citizens' annual costs by 29%, about average for acquisitions and an increase from its initial expectation of 22% when the deal was announced in September 2012. Much of the added savings will come from branch closings.
The company also said its accretable yield essentially the money it expects to make on Citizens' problem loans increased by $46 million, to $137 million.
An improvement in problem assets has become an increasingly common theme for those who bought banks with credit problems, and is most pronounced in failed-bank acquisitions. At least part of the better-than-expected performance is a result of conservative marks made by the acquirers, though.
"The trend for banks that have done deals for banks with problems has been that performance has largely come out better than expected," says John Rodis, an analyst at FIG Partners. "It is not that surprising to me. Knowing what Citizens had already done on its own and, pairing that with the pretty conservative mark FirstMerit took, there was room for better performance."
Still, a sign that problem loans are performing better than expected could be a boost of confidence for buyers looking at targets that still have some lingering credit issues. "This is an example that buyers can still find value in banks that still have some credit challenges," McEvoy says.
The extra $46 million in accretable yield should add 20 cents to FirstMerit's earnings per share over the life of the once-troubled Citizens' loans, McEvoy wrote in a note to clients. In comparison, the company earned 33 cents a share in the fourth quarter and $1.18 a share in 2013.
Since the accretable yield balance is based on legacy assets, it trends down as time passes even if it can grow when various loans improve. In other words, the accretable yield is financially attractive for the buyer early on, but is not a sustainable form of revenue.
In that regard, analysts say the added benefit is attractive but they are waiting for the strategic elements of the transaction to materialize, such as loan growth. The strategic benefits will ultimately determine if the deal was a good one or not, they say.
"This is a positive, but the story is still developing," says Stephen Geyen, an analyst at D.A. Davidson. "They need to generate organic loan growth from the deal and do it at a good yield and it is going to take a few more quarters."