Market share isn't everything. If a company can't take strong market share and use it as a tool to generate superior internal financial returns, shareholders will never benefit. In the case of First Niagara (Nasdaq:FNFG), management has been quite willing to launch deals to build share in its core northeastern U.S. markets, but these operations have yet to deliver truly compelling financial or share returns for investors.

The question, then, is whether First Niagara can start driving better results, or whether investors are better off with other bank companies such as M&T Bank (NYSE:MTB), PNC Financial (NYSE:PNC) or People's United (Nasdaq:PBCT).

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Sizable Share in Sizable Markets
First Niagara is far more than an also-ran in most of its targeted areas. The company is a top five shareholder in many of its operating areas, holding the No.2 spot in Buffalo, the No.3 spot in Albany, the No.5 spot in Hartford and the No.6 spot in Pittsburgh. While M&T and RBS (NYSE:RBS) (through Citizens Financial Group) are strong in upstate New York as well, First Niagara is one of the strongest franchises along I-90.

Even so, there are still solid opportunities for First Niagara to grow further. Eastern Pennsylvania has not been as fertile for the company so far, and the company has about a 1% share in Philadelphia. That's clearly an opportunity to do better in a very large market. Likewise, with the heavy development of the Marcellus Shale in Pennsylvania, there should be ongoing opportunities for First Niagara to grow a loan book that has long been weighted more heavily toward commercial lending.

But Performance Hasn't Always Been Top-Notch
From a historical perspective, First Niagara's performance has been only OK. Due in part to a higher mix of securities in its assets (as opposed to loans) and lower loan yields (due to the higher mix of commercial), First Niagara has never really been a superstar in terms of return on equity (ROE). Likewise, the bank has never accreted book value per share at an especially impressive rate.

I'm not sure that investors should automatically assume that those aspects of First Niagara will get substantially better in the future. While the company has the opportunity to build up its retail business, I expect it will continue to focus on mid-market commercial lending as its bread-and-butter. While I believe commercial lending should be more attractive in the coming years than it has historically been (more as a byproduct of retail deleveraging and new financial regulations/oversight), I'm not sure it will improve enough to lead to dramatically better returns on equity in the future.

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Still, There Are Opportunities to Do Better
While I think First Niagara may be limited in how much it can improve returns, I don't want to give the impression that the company cannot do better.

For starters, the company took a sizable hit to its tangible book value and capital ratios to do its billion-dollar deal with HSBC (NYSE:HBC). That deal will restrict the bank's ability to do more large deals and/or return substantial capital to shareholders. But I believe the bank can leverage those assets over time and generate a worthwhile IRR.

I also believe that the spread pressure hitting the industry today won't last forever. Low rates are problematic for First Niagara given its high reliance on interest-generating business (about three-quarters of the mix), as well as its higher-than-normal mix of securities. Still, while 2013 could be a challenging year in this regard, the company should also be able to lower its borrowing costs.

It's worth noting that the company's cost base is elevated right now (an efficiency ratio near 65%), and taking this down into the 50-59% range over time will certainly help returns.

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The Bottom Line
While First Niagara does trade at a discount to stated book value and has been a laggard over the past year, I'm not all that excited about the shares. I love to own lagging bank stocks underpinned by strong businesses, but I don't see First Niagara boosting its ROE to a point where the shares look substantially undervalued on a long-term basis.

With a long-term assumption of a 7.5% ROE, these shares would seem to have a fair value in the low-to-mid $8 range. Holding other inputs constant, every half-point of ROE is worth about 75 cents in fair value. But with a long-term average ROE of 6.9%, investors cannot safely assume better days are ahead for this bank, and that leaves me relatively disinterested in the shares today.

At the time of writing, Stephen D. Simpson did not own shares in any company mentioned in this article.

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