FirstMerit Corporation and Subsidiaries

The Corporation’s subsidiary, FirstMerit Bank, N.A., purchases MHF contracts from MCi, a portion of which are packaged in asset-backed securitizations (ABS pools) and sold to investors. Sales and securitizations of MHF contracts totaled $100 million in 1998 and $150 million in 1997. There were no sales and securitizations of MHF contracts during 1999.

At the time of sale, the Corporation records an asset, “retained interest in securitized assets,” representing the discounted future cash flows to be received by the Corporation for (1) servicing income from the ABS pool, (2) principal and interest payments on MHF contracts contributed to the ABS pools as a credit enhancement, referred to as “over-collateralization” and, (3) excess interest spread. Excess interest spread represents the difference between interest collected from the MHF contract borrowers and interest paid to investors in the ABS pool. Future credit losses are estimated using historical experience of originated manufactured housing loans. The historical data used provides credit loss experience throughout a loan’s term or lifecycle. As a result, this vintage, or static pool, analysis reflects increasing losses in earlier years as the portfolio seasons and declining losses in later years. Prepayment assumptions used to project future cash flows are based on historical experience and industry-wide trends.

Cash flows from the ABS pools are subject to volatility that could materially affect operating results. Prepayments resulting from increased competition, borrower mobility, general and regional economic conditions, prevailing interest rates, as well as actual losses incurred, may vary from the performance the Corporation expects. Management reviews the cash flows and actual performance of the ABS pools on a quarterly basis. The aggregate amount of ABS pools serviced by the Corporation totaled $222.1 million and $255.8 million at December 31, 1999 and 1998 respectively, and such amounts are not included in the accompanying Consolidated Financial Statements.

The Corporation classifies the retained interest in securitized assets in the Consolidated Balance Sheet as securities available for sale. Total retained interest in securitized assets was approximately $26 million at year-ends 1999 and 1998.

7. Mortgage Servicing Rights and Mortgage Servicing

The Corporation allocates a portion of total costs of the loans originated or purchased that it intends to sell to servicing rights based on estimated fair value. Fair value is estimated based on market prices, when available, or the present value of future net servicing income, adjusted for such factors as discount rates and prepayments. Servicing rights are amortized over the average life of the loans using the net cash flow method.

The components of mortgage servicing rights are as follows:

In 1999, 1998 and 1997, the Corporation’s income before federal income taxes was increased by approximately $1.7 million, $4.6 million and $2.7 million, respectively, as a result of compliance with the accounting Statements mentioned previously. The Corporation assesses its capitalized servicing rights for impairment based on their current fair value and disaggregates its servicing rights portfolio based on loan type and interest rate, which are the predominant risk characteristics of the underlying loans. If any impairment results after current market assumptions are applied, the value of the servicing rights is reduced through the use of a valuation allowance.

At year-ends 1999 and 1998, the Corporation serviced loans for others of approximately $2.5 billion and $1.8 billion, respectively. The following table provides servicing information for the year-ends indicated: