Business Combinations

The Corporation completed the merger with Citizens, a Michigan corporation with approximately $9.6 billion in assets and 219 branches, in the quarter ended June 30, 2013. All of Citizens' common shareholders received 1.37 shares of the Corporation's Common Stock in exchange for one share of Citizens' common stock, resulting in the Corporation issuing 55,468,283 shares of its Common Stock. In conjunction with the completion of the merger, the Corporation fully repurchased the $300.0 million of Citizens TARP Preferred plus accumulated but unpaid dividends and interest of approximately $55.4 million previously issued to the U.S. Treasury under the Capital Purchase Program. The Corporation used the net proceeds from its February 4, 2013 public offerings, which consisted of $250 million aggregate principal amount of 4.35% subordinated notes due February 4, 2023, and $100 million 5.875% Non-Cumulative Perpetual Preferred Stock, Series A, to repurchase the Citizens TARP Preferred and pay all accrued, accumulated and unpaid dividends and interest. Additionally, a warrant issued by Citizens to the U.S. Treasury to purchase up to 1,757,812.5 shares of Citizens' common stock has been converted into a warrant issued by the Corporation to the U.S. Treasury to purchase 2,408,203 shares of FirstMerit Common Stock.

The Citizens transaction was accounted for using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the Acquisition Date. Per the applicable accounting guidance for business combinations, these fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values become available.

Preliminary goodwill of $274.8 million is calculated as the purchase premium after adjusting for the fair value of net assets acquired. None of the goodwill is deductible for income tax purposes as the merger is accounted for as a tax-free exchange. The tax-free exchange resulted in a carryover of tax attributes and tax basis to the Corporation's subsequent income tax filings. These carryovers were comprised of DTA of $312.9 million and DTL of $51.3 million for a net DTA carryover of $261.6 million. This net DTA includes $224.7 million of net operating loss and tax credit carryovers. The carryover of these tax attributes is subject to limitation as to the tax period in which they can be used to reduce future tax payments. The amounts recorded are expected to be substantially used by 2016, however, some will continue to carryover until 2032. These tax attribute benefits will also be subject to regulatory capital adjustments until fully utilized. An additional net DTA of $83.5 million was established on the Acquisition Date as a result of the purchase accounting fair market value adjustments resulting in a total net DTA on the Acquisition Date of $345.1 million.

The following table provides the preliminary purchase price calculation as of the Acquisition Date and the identifiable assets purchased and the liabilities assumed at their estimated fair value. These fair value measurements are provisional based on third-party valuations that are currently under review and are subject to refinement for up to one year after the Acquisition Date based on additional information obtained by Management that existed as of the Acquisition Date.



Purchase Price:
FirstMerit shares of Common Stock issued for Citizens' shares				55,468,283
Closing price per share of the Corporation's Common Stock on April 12, 2013				$	16.68
Consideration from Common Stock conversion (1.37 ratio)				925,211
Cash paid to the Treasury for Citizens' TARP Preferred				355,371
Cash paid in lieu of fractional shares to the former Citizens' shareholders				61
Consideration from the warrant issued to the Treasury for Citizens' TARP warrant				3,000
Total purchase price				$	1,283,643
Preliminary Statement of Net Assets Acquired at Fair Value:
ASSETS
Cash and due from banks	$	544,380
Investment Securities	3,202,577
Loans	4,624,293
Premises and equipment	138,536
Intangible assets	84,774		¹
Accrued interest receivable and other assets	678,639
Total assets	$	9,273,199
LIABILITIES
Deposits	$	7,276,754
Borrowings	908,824
Accrued taxes, expenses, and other liabilities	78,816
Total liabilities	$	8,264,394
Net identifiable assets acquired				1,008,805
Goodwill				$	274,838

1 - Intangible assets consist of core deposit intangibles of $70.8 million and trust relationships of approximately $14.0 million. The useful life for which the core deposit intangible and the trust relationships are being amortized over is 15 years and 12 years, respectively.

The estimated fair values presented in the above table reflect additional information that the Corporation obtained during the three months ended September 30, 2013, which resulted in changes to certain fair value estimates made as of the Acquisition Date. Material adjustments to acquisition date estimated fair values are recorded in the period in which the acquisition occurred and, as a result, previously recorded results have changed. After considering this additional information, the estimated fair value of loans and accrued interest receivable decreased $0.2 million, the estimated fair value of premises and equipment decreased $0.2 million, and the estimated fair value of other assets decreased $0.4 million of the Acquisition Date from that originally reported in the three months ended June 30, 2013. The estimated net deferred tax asset increased $0.3 million as a result of these revised fair values. These revised fair value estimates resulted in a net increase to goodwill of $0.5 million from that originally reported in the three months ended June 30, 2013 to $274.8 million, which is recognized in the September 30, 2013 consolidated balance sheet.

The operating results of the Corporation for the three and nine month periods ended September 30, 2013 include the operating results of the acquired assets and assumed liabilities subsequent to the Acquisition Date. The operations of the Wisconsin and Michigan geographic area, which primarily includes the acquired operations of Citizens, provided approximately $164.4 million in interest income, and approximately $31.6 million in net income for the period from the Acquisition Date to September 30, 2013. These amounts are included in the Corporation's consolidated financial statements as of and for the three and nine month periods ending September 30, 2013. Citizens' results of operations prior to the Acquisition Date are not included in the Corporation's consolidated statements of comprehensive income.

Merger-related charges of $33.4 million and $69.1 million were recorded in the consolidated statement of comprehensive income for the three and nine months ended September 30, 2013, respectively, and include incremental costs to integrate the operations of the Corporation and Citizens. Such expenses were for professional services, costs related to termination of existing contractual arrangements for various services, marketing and promotion expenses, retention and severance and incentive compensation costs, travel costs, and printing, supplies and other costs. The integration of Citizens into the Corporation continues to progress as scheduled. Core operating systems were converted as of October 20, 2013.

The following table provides the unaudited pro forma information for the results of operations for the three and nine months ended September 30, 2013 and 2012, as if the acquisition had occurred January 1 of each year. These adjustments include the impact of certain purchase accounting adjustments including accretion of loan marks, which makes up the vast majority of the adjustments, followed by intangible assets amortization, investment securities amortization, fixed assets depreciation and deposit accretion. In addition, the $69.1 million in merger expenses previously discussed are included in each period presented. The Corporation expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts. These unaudited pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the combined corporation that would have been achieved had the acquisition occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of operations.



	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Total revenue, net of interest expense	$	342,756	$	325,086	$	959,045	$	949,884
Net income	66,237		89,193		221,468		528,691

Note: 2012 net income includes approximately $276.8 million of tax benefits as a result of Citizens restoration of its DTA.

In many cases, determining the fair value of the acquired assets and assumed liabilities required the Corporation to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations relates to the valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with GAAP, there was no carry-over of Citizens' previously established ALLL.

The acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (acquired impaired), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (acquired non-impaired). In addition, the loans are further categorized into different loan pools per loan types.

The provisional fair value of loans at the Acquisition Date are presented in the following table:



	Acquired Impaired		Acquired Non-impaired		Acquired Loans Total
Commercial
C&I	$	95,188	$	1,664,912	$	1,760,100
CRE	380,039		359,066		739,105
Construction	13,399		17,135		30,534
Total commercial	488,626		2,041,113		2,529,739
Consumer
Residential mortgages	233,007		279,736		512,743
Installment	54,377		1,165,235		1,219,612
Home equity lines	48,598		313,601		362,199
Total consumer	335,982		1,758,572		2,094,554
Total	$	824,608	$	3,799,685	$	4,624,293

A reconciliation of the contractual required payments receivable to the carrying amount of acquired loans at the Acquisition Date is as follows:



	Acquired Impaired			Acquired Non-impaired			Acquired Loans Total
Contractual required payments receivable	$	1,086,503		$	4,020,812		$	5,107,315
Nonaccretable difference	(130,096		)	—			(130,096		)
Expected cash flows	956,407			4,020,812			4,977,219
Accretable yield	(131,799		)	(221,127		)	(352,926		)
Carrying balance	$	824,608		$	3,799,685		$	4,624,293

The fair value of the acquired non-impaired loans at the Acquisition Date was $3.8 billion. The gross contractually required principal and interest payments receivable for acquired non-impaired loans was $4.0 billion. The estimate of contractual cash flows not expected to be collected for acquired impaired loans is $130.1 million.

The fair value of the investment securities acquired was approximately $3.2 billion. Management's strategy to reduce prepayment and credit risk of the acquired investment securities portfolio resulted in the sale of approximately $2.2 billion in agency MBS, agency CMO, municipal securities and private label MBS investments subsequent to the close of the acquisition. During the second quarter of 2013, Management repurchased approximately $1.5 billion of agency MBS and CMO securities in accordance with the Corporation's investment polices.

As part of the merger, the Corporation assumed Citizens' FHLB advances with a fair value of $719.3 million. On April 15, 2013, in conjunction with Management's strategy to de-leverage the acquired Citizens' balance sheet, the Corporation terminated all but two assumed FHLB advances resulting in cash outlay of approximately $591.9 million in principal and approximately $60.6 million in prepayment penalty. The two retained FHLB advances totaled $60.0 million and mature on May 16, 2016. FHLB advances are reflected in the line item "Federal funds purchased and securities sold under agreements to repurchase" on the Consolidated Balance Sheets.

The Corporation also assumed obligations under junior subordinated debentures at fair value in the amount of $74.5 million, payable to two unconsolidated trusts that issued trust preferred securities. The junior subordinated debentures are the sole assets of each trust. The variable interest rate junior subordinated debenture has a maturity date of June 26, 2033 and bears interest at an annual rate equal to the three-month LIBOR plus 3.10% and adjusts on a quarterly basis not to exceed 11.75%. The junior subordinated debenture is an unsecured obligation of Citizens and is junior in right of payment to all future senior indebtedness of Citizens. Citizens has guaranteed that interest payments on the junior subordinated debenture made to the trust will be distributed by the trust to the holders of the trust preferred securities. The trust preferred securities of the special purpose trust are callable at par and must be redeemed in thirty years after issuance. Under the risk-based capital guidelines, the trust preferred securities currently qualify as Tier 1 capital, however, a final rule on Basel III, which becomes effective in January 2014, phases out trust preferred securities from qualifying as Tier 1 Capital beginning January 1, 2015 with complete elimination by January 1, 2016. The fixed 7.50% interest rate junior subordinated debenture has a maturity date of September 15, 2066 and is listed on the NYSE (NYSE symbol CTZ-PA). Interest is payable quarterly in arrears and became callable on September 15, 2011.

The Corporation also assumed long-term repurchase agreements with a fair value amount of $115.0 million. On April 15, 2013, in conjunction with Management's strategy to de-leverage the newly acquired Citizens' balance sheet, all of these these long-term repurchase agreements were terminated.