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First Niagara’s decision to sell was driven by bad decisions and bad timing

Gary Crosby calls it a “marriage made in heaven,” but he and his company had to go through hell to get there.

About a month after word leaked out that First Niagara Financial Group had hired an investment banker to seek out a buyer, the bank agreed Friday to be acquired by rival powerhouse KeyCorp of Cleveland.

The $4.1 billion deal unites the No. 2 and No. 3 banks in Western New York, forming a strong competitor to market leader M&T Bank Corp. It also creates the 13th largest U.S.-based bank, with $135 billion in assets and 1,366 branches in 15 states, from Maine to Alaska.

Driving First Niagara’s decision to sell itself, according to First Niagara CEO Crosby and others, was a combination of bad decisions and bad timing. First Niagara overpaid on its $1 billion purchase of HSBC Bank USA’s upstate New York branch network. But the bank might have survived that mistake if not for the continued softness in the U.S. economy, which has kept the Federal Reserve Board from raising interest rates.

“The tipping point was that there was no letup in sight for the interest-rate environment,” said Crosby, in a joint telephone interview Friday with KeyCorp CEO Beth Mooney. “It is very difficult for a bank like First Niagara to meet shareholder expectations in this kind of rate environment. And notwithstanding the talk that the Fed is sooner or later going to raise rates, they’re not going to raise them very much or very quickly.”

Crosby was put in charge of First Niagara in March 2013, nearly two years after the HSBC purchase was announced, and after the board ousted longtime CEO John R. Koelmel. First Niagara, formerly Lockport Savings Bank, had grown rapidly in the decade before Crosby took charge, quadrupling in size through a series of mergers that extended its franchise first across New York State, and then into Pennsylvania, Connecticut and Massachusetts.

Crosby put a halt on any further expansion and refocused the bank internally on its customers and operations, seeking to deliver the results by improving and selling more products and services. He launched a $250 million technology investment effort, spread out over several years, to upgrade the bank’s systems and capabilities to better compete with rivals.

The investments were paying off and achieving their goals, Crosby said as recently as last month, although there was still more to do.

But like all banks, First Niagara was still battling a hostile banking climate. Sustained record low interest rates reduce banks’ core income from taking deposits and making loans. First Niagara didn’t have enough fees and other revenue to offset that challenge, as many of its much larger competitors do. And it was already trying to rein in expenses, to limited avail.

Hopes were still high in late summer for the Federal Reserve to start raising interest rates, although slowly. But when the Federal Reserve delayed its long-awaited rate hikes in September, First Niagara’s board – dominated almost completely by non-Buffalonians who joined the bank through past acquisitions with the expectation of much better returns – essentially threw in the towel.

The board, weary of excuses, decided it was time for a change.

Wooing suitors

The bank turned to JPMorgan Chase & Co.’s investment bank for help in evaluating its strategic options – which meant it was putting itself up for sale. “This is something that evolved out of our ongoing strategic planning process,” Crosby said. “We, the board and management, were in agreement that it was time to critically evaluate that particular strategic alternative.

“So we started to look at merging with a company that had a strong currency for our shareholders and a company that had a lot of upside in its currency,” Crosby said, referring to an acquirer’s stock. “And the reality is that Key popped up on the radar screen immediately.”

JPMorgan reached out to Key, as well as to other potential buyers. Crosby would not name any others, but analysts have cited Canada’s Toronto-Dominion Bank, BB&T Corp. of Winston-Salem, N.C., New York Community Bancorp and Huntington Bancshares of Columbus as likely candidates based on their ability, proximity and perceived interest in expansion. However, BB&T is already busy digesting a pair of acquisitions, with another one pending, while New York Community just agreed to buy rival Astoria Financial Corp. for $2 billion.

“Once you make a decision to critically explore the alternatives, your thoughts immediately turn to who would be the best partner,” he said. “We were very fortunate with the amount of interest that we had. We’re just very, very fortunate that Key and First Niagara are coming together.”

300 worked on deal

As talks progressed, more than 300 employees from both banks were engaged in due diligence, going over First Niagara’s books and examining operations. KeyCorp officials reviewed the loan files for over 1,100 borrowers, representing half of First Niagara’s loan commitments, so it could evaluate the smaller bank’s lending practices and quality.

Officials also evaluated First Niagara’s other systems and operations, including its recent write-downs and the mysterious “process issue related to certain deposit accounts” that the bank had previously disclosed and set aside $22 million to cover.

“We went through the due diligence process and were very thorough in that and the review of credit processes, and we believe we’ll be well-positioned,” said Key Chief Financial Officer Don Kimble. “If you look back historically at First Niagara, their credit performance in the last cycle was very strong.”

The agreement itself “came together very smoothly and relatively quickly,” particularly at the end, Crosby said.

KeyCorp takes heat

Crosby and Mooney cited the two banks’ shared culture as critical to making the deal work. “Our cultures are incredibly aligned around doing what’s best for our stakeholders,” Crosby said. “Beth and I have very similar styles and values. Our teams really grew to like one another and then we both bring strengths to the table, to our shareholders, that are very, very complementary.”

Mooney agreed. “While we have always admired First Niagara, our respect has grown as we have gotten to know them,” she said. “Gary Crosby and his team operate with similar values to Key. We look forward to welcoming them to Key.”

The deal isn’t a gangbuster for First Niagara shareholders. Five years ago, on Oct. 29, 2010, the stock closed at $11.85. It peaked at an all-time high of $18.90 in September 2008, but then sank as low as $7.20 in July 2012. The KeyCorp sale is priced at $11.40 per share.

Still, Crosby said he was “not disappointed in the least.”

“It’s a very fair price. It’s fair to both sets of shareholders,” he said. “You also have to look forward and think about what could the respective prices be going forward. I firmly believe our shareholders are better off holding Key stock going forward than they are holding First Niagara stock.”

KeyCorp also took some heat about the deal on Friday from Wall Street analysts, who questioned why the bank – which has been more focused on growing its commercial and institutional businesses – would choose to buy a retail bank like First Niagara. Mooney acknowledged that the deal was unexpected since “Key has not been acquisitive,” but noted that Key is very familiar and comfortable with the upstate markets, and saw the deal as a special opportunity.

“They have a strong franchise and a commitment to their communities and we look forward to building on that,” Mooney said. “The strategic opportunity to combine with First Niagara is compelling. Key’s franchise will be forever stronger and we look forward to working with our new teammates to deliver strong results.”