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First Niagara’s struggle to prove itself

First Niagara Financial Group has made the kind of headlines lately that stir up local anxieties.

The Buffalo-based bank recently announced a $1.1 billion accounting write-down. Separately, First Niagara said it was setting aside $45 million to deal with a “process issue,” but has not explained the origin of the problem.

Then came an announced merger that had nothing to do with First Niagara but dragged the bank’s name into the conversation. BB&T, based in North Carolina, said it would buy Pennsylvania-based Susquehanna Bancshares for about $2.5 billion. Some analysts wondered if the deal was a signal the banking industry was warming up to larger-scale deals after a long dormant stretch – and questioned whether First Niagara, among others, would be candidates for acquisition.

Whether or not that turns out to be true – and it is just analyst speculation at this point – First Niagara’s future is meaningful to the Buffalo Niagara region’s economy. The bank is based in Buffalo, meaning the big decisions are made here, in a town with very few major corporate headquarters. About 2,200 of its 5,800 employees work in Western New York. The bank has helped spur the revival of Larkinville, and its foundation supports causes here and elsewhere. If another bank acquired First Niagara, that center of gravity would most likely move elsewhere.

But investors tend to have different concerns, and First Niagara’s stubbornly low stock price has frustrated them. They have waited for the bank to capitalize on a series of acquisitions made from 2009 to 2012, including HSBC’s upstate New York branch network.

First Niagara has changed its top leadership since its buying spree. John R. Koelmel departed as chief executive officer in March 2013, and Gary M. Crosby took over on an interim basis, before being named to the job on a permanent basis a year ago. Last January, the bank said it would spend $200 million to $250 million over three to four years on strategic investment plan. And Crosby has shuffled his management team.

Market rumors

Crosby declined to comment on whether he considered First Niagara an acquisition target, saying the bank as a policy does not discuss “market rumors or speculation.”

“However, as with any public company, the board ultimately decides whether or not a company remains independent,” he said. “That decision is based on what is in the best interest of shareholders. Our board and management team recognize the value of the franchise we have built and the significant opportunity that we have in front of us. We believe that the best way to increase shareholder value is by delivering on our strategy to become a top performer among our peer group.”

Crosby is the CEO as well as a board member, and he is currently the only board member from Buffalo. Not long ago, there were two others who were from the region, but Thomas Baker retired in September, and James Boldt died in October. The board now has 10 members, including one whose appointment takes effect Jan. 1; First Niagara’s corporate governance guidelines say the bank is comfortable with nine to 13 members to carry out its goals.

“I do expect that the board will be adding a Western New York director in the near term,” Crosby said. “There’s no question in my mind that our board is committed to remaining headquartered in Western New York.”

First Niagara has operations spread across four states, the result of acquisitions that have extended the bank’s footprint far beyond its roots as Lockport Savings Bank.

While First Niagara’s local headcount is large, the bank makes an impact locally in other meaningful ways. First Niagara estimates its charitable giving in Western New York will be about $2 million, out of about $10 million donated overall. Its employees have recorded about 12,000 volunteer hours in the region (though the actual figure is likely much higher), and its Western New York donations to the United Way – counting employee contributions plus a First Niagara Foundation match – will total $376,000 this year.

Insiders buying

There is a saying in the financial services industry that “banks are sold, not bought.” In other words, in larger deals, the acquired bank is typically a willing partner, rather than the target of a hostile takeover. If that line of thinking holds true, the question becomes what First Niagara’s board prefers to do. (The Buffalo News reached out to other members of the bank’s board; those contacted either did not return messages or declined to comment on the bank’s outlook.)

Matthew Kelley, a senior research analyst with Sterne Agee, said he believes First Niagara’s board “appears to be a board that is more committed to independence than contemplating a sale at this point.” He points to factors such as the bank’s multiyear plan to upgrade technology, the top management change, and the bank’s efforts to wring out more cost savings from its acquisitions. “Over the near term, I am in the camp they will remain independent,” Kelley said.

Another reason Kelley takes that view: last month, eight First Niagara insiders, a mix of board members and officers, individually bought up a total of 88,000 shares with a combined market value of $690,000. “I would be very surprised to see a management team buying shares ahead of a sale,” he said, since such purchases would raise red flags with regulators if a deal were imminent.

Jeff K. Davis, managing director of the Financial Institutions Group at Mercer Capital, said he can’t guess at the inner workings of First Niagara’s board, but he noted the bank’s stock has under performed for the past several years. “For that reason, potentially it could be on a radar list for acquisition,” he said.

Merger draught

Working against the acquisition idea, Davis said, is the lack of large-scale banking mergers. “It’s just not a wave right now,” he said. (One factor often cited for that lull: M&T’s planned $3.7 billion purchase of Hudson City Bancorp, a deal held up by regulators.)

Analysts interviewed said the pool of potential acquirers that could pull off a deal for First Niagara would be limited. First Niagara has assets of about $38 billion; Susquehanna, which BB&T plans to buy, has assets of only about $18 billion.

Davis also questioned how much outside interest there would be in some of First Niagara’s markets, such as a slow-growth region like upstate New York.

But Kelley noted the bank has a low loan-and-deposit ratio that might be appealing to another bank, since it gives First Niagara an opportunity to experience more substantial growth in assets and improve profitability over the next couple of years. Some of its peers, especially in the Northeast, are in the opposite situation, with a high loan-and-deposit ratio, he said.

Costly acquisitions

First Niagara made waves in its third-quarter earnings report when it announced an $800 million accounting write-down – a total later increased to $1.1 billion – and disclosed the $45 million “process issue.”

Crosby said it was the right call to announce the goodwill write-down “sooner rather than later,” saying it reflected the bank’s transparency. “The fundamentals of the acquisitions we made continue to remain strong,” he said. But in an October interview, Crosby acknowledged that if the bank knew then what it knows now, “it may very well not have paid as much for some of those acquisitions.”

Less clear is what triggered the $45 million in restitution First Niagara may have to pay to customers, due to a problem with certain customer deposit accounts. The bank said it brought the issue to regulators’ attention. Crosby said the issue has nothing to do with cyber-security, a data breach or fraud, and First Niagara would reveal more after completing its discussions with regulators. “When we are able to disclose full details, it will be clear we did the right thing,” he said.

Separately, First Niagara is cutting 150 to 200 jobs across it territory, as it attempts to simplify its organization. Most of those job cuts affect managers.

If First Niagara were in play as an acquisition, federal regulators would have say over whether a deal goes through.

“Coming out of the financial crisis, the [modus operandi] from Washington is, maybe not quite stated is, ‘We want consolidation to continue in the industry, but we don’t want larger banks getting larger through acquisitions,’” Davis said. “‘We want the acquisition activity to occur at the lower end and maybe lower middle, with small banks combining with one another, or midsize banks buying small or smallish midsize banks.’ And that’s really what we’ve seen the last five years.”

Investor pressure

Nothing symbolizes First Niagara’s struggle more than its stock price. First Niagara traded at about $8.31 per share last week on the Nasdaq exchange, and had not closed above $9 per share since September. Its share price last week was the lowest of the 24 banks in the KBW Bank Index. So, what will it take to boost its price to a level that makes investors happy?

“What will ultimately inspire investor confidence is solid, consistent financial performance,” Crosby said. “That’s what our strategic plan is designed to achieve.” And the industry will be taking note: American Banker named Crosby one of its 10 “bankers to watch” for 2015, with the publication commenting that Crosby’s top priority will have to be “winning back the faith of investors.”

Anton V. Schutz, president and chief investment officer at Mendon Capital Advisors in Rochester, pointed out First Niagara used to trade at $16 per share, about six years ago. And he wonders if First Niagara’s $45 million “process issue” could hurt the share price, once the problem is fully explained: “Any time you don’t have full disclosure, it makes one worry.”

The stubbornly low stock price could have another effect, Schutz said: “The real question is, will shareholder activism surface here?”

“As an upstate New York resident, it’s tough watching that company under perform the way it has,” Schutz said.

Davis said the First Niagara’s stock has “definitely under performed. That creates issues for management, it creates issues therefore for the board, particularly when you have a company that has a large institutional shareholder base like First Niagara.” Institutional shareholders, such as mutual funds and pensions, make up about 73 percent of all shareholders.

Boosting stock price

What does First Niagara have to do to bolster its stock price? Simply put, generate better earnings, consistently.

Kelley said a key statistic is the bank’s return on average assets, a measure of its profitability. It essentially shows how well a bank is deploying its balance sheet. Higher-performing banks have a return on average assets in the range of 1 percent to 1.5 percent. Put another way, a bank with a 1 percent return on average assets is earning $1 on each $100 of assets.

First Niagara’s return on average assets in the third quarter was recorded as a loss due to the write-down. In the previous four quarters, it ranged from 0.64 percent to 0.85 percent. Its peers are closer to 0.90 percent, Kelley said. “If that cannot be moved closer to those peer levels of 90 to 100 basis points over the next several years, I would suggest they would be more inclined to track more toward a sale.”

But Kelley said he thinks First Niagara’s first inclination is to improve on its own.

“I think the mission here is pretty obvious,” he said. “If they can execute on that and improve overall profitability levels and grow earnings per share, they will have a more legitimate claim to remaining independent. If not, I think the board would have to consider all options. My take is, at least over the next year or two, they will make an attempt to do it on their own.”