FirstMerit Chief Takes on Skeptics of Citizens Republic Deal

Paul Greig has shown he can run a small bank. On Thursday he set out to prove that he can build a big one.

The chief executive of FirstMerit (FMER) sought to make the case that his $912 million all-stock agreement for a troubled Flint, Mich. bank, Citizens Republic (CRBC), is a rational bet with plenty of upside.

His argument for taking over the $9.7 billion-asset Citizens Republic was simple. FirstMerit, which has assets of $14.6 billion, wants to be a Midwestern powerhouse. That requires depleting an estimated 70 cents to 75 cents per share of investor equity to bring the largest bank based in Michigan into its fold.

Adding Citizens Republic would double the Akron, Ohio company's number of branches and provide an entrée to Michigan and Wisconsin, Greig told investors and analysts. The benefits of the pairing — including more business customers and a beefier wealth management shop — should enable FirstMerit to earn back the equity it would spend in the deal in a "reasonable" two-and-a-half years, he said.

"The financial metrics for this deal are compelling," Greig said in a conference call. "This transaction is a next step in our evolution as a premier Midwest banking institution."

Wall Street listened with skeptical ears: FirstMerit's shares fell 11% on Thursday, to $15.23. Though that is among the steeper sell-offs of a bank acquirer's share after a deal announcement in recent years, it is not necessarily damning, experts say.

"Longer term I think the deal will be fine," says Scott Siefers, managing director of equity research for Sandler O'Neill & Partners. "Financially I think they'll be able to hit their earnings accretion numbers. Having said that, the market may take a little bit back. It's a sizable transaction. You introduce interest rate risk. …There are questions about how dilutive it is."

While the deal should boost profits by an estimated 7.5% in 2014, it would consume more than 100 basis points of all-important Tier 1 capital by June 30, 2013, when the deal is expected to be completed, FirstMerit said. It can afford the hit — its estimated post-merger Tier 1 ratio will be 10.36%. Investors and regulators want banks to have a ratio of at least 10%.

FirstMerit's shares are among the most valuable in banking. This is an important reason it — not Huntington Bancshares (HBAN), KeyCorp (KEY), or Fifth Third Bancorp (FITB) — is buying Citizens Republic. Those other banks were said to be interested in Citizens Republic, but Greig can more freely afford to spend.

FirstMerit's shares closed at 166% of tangible book on Wednesday and were down to 150% tangible book as of Thursday afternoon. KeyCorp trades at roughly 93% of tangible book, and Fifth Third and Huntington each hover at roughly 130%.

A cautionary tale lies in a similar deal. Comerica (CMA) of Dallas was trading at 130% of tangible equity at the end of 2010 before announcing its acquisition of Sterling Bancshares of Houston in January 2011. Today Comerica trades at 100% of tangible book, a year after closing a heavily dilutive deal that sent investors scattering.

The math of Thursday's deal was not the only concern weighing on FirstMerit. The company pegged Chicago as its primary expansion market since acquiring two failed banks there in 2010. Analysts were surprised that it has instead opted to go into Michigan and Wisconsin. The two states have rebounding economies but staid long-term demographics.

The target has problems. Citizens Republic has made gains recovering from steep consumer and business loan losses. But it still cannot earn enough money to repay the $300 million in direct aid and $45 million in unpaid dividends owed to the Troubled Asset Relief Program. If it could raise the money selling stock at a reasonable price this deal would not be happening.

"These guys [Citizens Republic] have cleaned up a bit, but they still have a very significant chargeoff ratio," says Christopher Whalen, senior managing director of broker dealer Tangent Capital Partners. "They are rolling the dice."

Greig sought to dispel that notion in discussing the transaction with analysts.

The price is fair and reasonable, he said. FirstMerit has agreed to pay an amount equal to about 126% of Citizens' tangible book. That is well under the median 176% tangible book paid in comparable recent deals, he said.

The banks are a good fit because they court similar manufacturing customers and use the same operating software, he said. FirstMerit executives are also familiar with Citizen's Republic's territory. Greig ran what is now JPMorgan Chase's operations in Wisconsin for six years.

Greig also cited an expected internal rate of return on the deal of 18%. The combined wealth management operations will have more products and can earn more fees. FirstMerit expects to remove 22% Citizens Republic's noninterest expenses, in part because it can handle its mortgage originations in-house. Right now Citizens Republic outsources that service.

Greig will be the CEO of the combined bank, which will have 415 branches in five states and $24 billion in assets. The companies did not detail the future role of Citizens Republic CEO Cathleen Nash, who took over in 2009.