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 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, as such, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the Acquisition Date. All acquired loans were also recorded at fair value. No allowance for loan losses was carried over and no allowance was created at Acquisition Date. Per the acquisition method of accounting, these fair values are preliminary and subject to refinement for up to one year after the Acquisition Date as additional information relative to closing date fair values become available.

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.



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	3,202,575
Loans	4,617,004
Premises and equipment	138,536
Intangible assets	84,774		¹
Accrued interest receivable and other assets	680,020
Total assets	$	9,267,289
LIABILITIES
Deposits	$	7,276,754
Borrowings	908,824
Accrued taxes, expenses, and other liabilities	77,843
Total liabilities	$	8,263,421
Net identifiable assets acquired				1,003,868
Goodwill				$	279,775

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

The estimated fair values presented in the above table reflect additional information that the Corporation obtained during the year ended December 31, 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 decreased $7.3 million, the estimated fair value of premises and equipment decreased $0.2 million, the estimated fair value of other assets increased $1.1 million and the estimated fair value of other liabilities decreased $1.0 million as of the Acquisition Date from that originally reported as of June 30, 2013. The estimated net deferred tax asset increased $3.4 million as a result of these revised fair values. These revised fair value estimates resulted in a net increase to goodwill of $5.4 million to $279.8 million, which is recognized in the Consolidated Balance Sheet as of December 31, 2013.

The amount of goodwill recorded reflects the increased market share and related synergies that are expected to result from the acquisition, and represents the excess purchase price over the estimated fair value of the 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 $313.0 million and DTL of $51.3 million for a net DTA carryover of $261.7 million. This net DTA includes $224.8 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 $86.5 million was established on the Acquisition Date as a result of the purchase accounting fair value adjustments resulting in a total net DTA on the Acquisition Date of $348.2 million.

The following table summarizes the provisional fair value of both acquired impaired and nonimpaired loans by product type as of the Acquisition Date.



	Acquired Impaired Loans		Acquired Nonimpaired Loans		Acquired Loans Total
Commercial
C&I	$	93,735	$	1,660,199	$	1,753,934
CRE	378,569		359,066		737,635
Construction	13,399		17,135		30,534
Total commercial	485,703		2,036,400		2,522,103
Consumer
Residential mortgages	232,291		278,404		510,695
Installment	54,108		1,165,235		1,219,343
Home equity lines	47,613		317,250		364,863
Total consumer	334,012		1,760,889		2,094,901
Total	$	819,715	$	3,797,289	$	4,617,004

The determination of estimated fair values of the acquired loans required the Corporation to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status and credit risk ratings, 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 nonimpaired). The acquired loans were further segregated into loan pools designed to facilitate the development of expected cash flows to be used in estimating fair value. Acquired loans were segregated into pools based on characteristics such as loan type, credit risk profiles, contractual interest rate and repayment terms and market area in which originated. Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed using both Citizens' historical experience and the portfolio characteristics at Acquisition Date as well as available market research. The fair value estimates for acquired loans was based on the amount and timing of expected principal, interest and other cash flows, included expected prepayments, discounted at prevailing market interest rates.

For acquired nonimpaired loans, the difference between the Acquisition Date fair value and the contractual amounts due at the Acquisition Date represents the fair value adjustment. Fair value adjustments may be discounts (or premiums) to a loan's cost basis and are accreted (or amortized) to interest income over the the loan's remaining life using the level yield method. Acquired nonimpaired loans are reported net of the unamortized fair value adjustment in the Consolidated Balance Sheet. The fair value adjustment for acquired nonimpaired loans as of the Acquisition Date is presented in the following table.



	Acquired Nonimpaired Loans
Outstanding balance	$	4,017,304
Less: Fair value adjustment	220,015
Fair value of acquired nonimpaired loans	$	3,797,289

The table below details contractually required payments, cash flows not expected to be collected and cash flows expected to be collected on acquired nonimpaired loans as of the Acquisition Date.



	Acquired Nonimpaired Loans
Contractually required payments including interest (a)	$	4,955,180
Less: Contractual cash flows not expected to be collected	680,664
Cash flows expected to be collected	$	4,274,516

(a) - Total undiscounted amounts of all uncollected contractual principal and interest, including any fees and penalties, both past due and scheduled for the future, assuming no loss or prepayment.

For acquired impaired loans, the excess of cash flows expected over the estimated fair value at the Acquisition Date represents the accretable yield and is recognized as interest income using a level yield method over the remaining life of the pooled impaired loans. Each pool of acquired impaired loans is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Acquired impaired loans in pools with an accretable yield are considered to be accruing and performing even though collection of contractual payments on loans within the pool may be in doubt, because the pool is the unit of accounting and income continues to be accreted on the pool as long as expected cash flows are reasonably estimable.

Total outstanding acquired impaired loans as of the Acquisition Date were $1.1 billion. A reconciliation of the contractual required payments to the fair value of the acquired impaired loans at the Acquisition Date is as follows:



	Acquired Impaired Loans
Contractually required payments including interest (a)	$	1,231,172
Nonaccretable difference (b)	(279,899		)
Cash flows expected to be collected (c)	951,273
Accretable yield (d)	(131,558		)
Fair value of loans acquired	$	819,715

(a) - Total undiscounted amounts of all uncollected contractual principal and interest, including any fees and penalties, both past due and scheduled for the future, assuming no loss or prepayment.

(b) - The nonaccretable difference represents, as of the Acquisition Date, the amount of contractually required payments, including interest, that are not expected to be collected based on estimated credit losses and other factors, such as prepayments.

(c) - Represents the estimate, at Acquisition Date, of the amount and timing of undiscounted principal, interest, and other cash flows expected to be collected. This estimate includes the effect of anticipated prepayments.

(d) - The accretable yield represents the excess of cash flows expected at Acquisition Date over the estimated fair value and is recognized as interest income over the remaining life of the loan using the level yield method.

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 $652.5 million, which approximated the fair value. The fair value of the two retained FHLB advances totaled $66.8 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 Sheet.

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 the Corporation and is junior in right of payment to all future senior indebtedness of the Corporation. The Corporation 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.

The operating results of the Corporation for the year ended December 31, 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 $222.7 million in interest income, and approximately $106.4 million in net income for the period from the Acquisition Date to December 31, 2013. These amounts are included in the Corporation's consolidated financial statements for the year ended December 31, 2013. Citizens' results of operations prior to the Acquisition Date are not included in the Corporation's Consolidated Statement of Income.

Merger-related charges of $75.1 million were recorded in the Consolidated Statement of Income for the year ended December 31, 2013. These costs were primarily composed of severance and retention employee benefits of $21.6 million, professional services of $20.2 million and $23.6 million in fees for early termination of existing agreements assumed from the merger (reported within bankcard, loan processing and other costs in the accompanying Consolidated Statement of Income). 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 years ended December 31, 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 $75.1 million in year to date merger-related 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.



	(Unaudited)
	Year Ended December 31,
	2013		2012
Total revenue, net of interest expense	$	1,096,960	$	1,254,594
Net income	196,744		609,259

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