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).
Beginner's Guide To CQG Integrated Client Trading Platform: This robust trading platform takes time to learn and to take full advantage of its functionality.
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.
SEE: 5 Must-Have Metrics For Value Investors
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.
SEE: The Banking System
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.
Mutual Funds & ETFsLearn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
Investing NewsWill Ferrari's shares move fast off the line only to sputter later?
Stock AnalysisHere are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
InvestingThe further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
Fundamental AnalysisOptions market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
Stock AnalysisCan these two oil stocks buck the trend?
Investing NewsAlcoa plans to split into two companies. Is this a bullish catalyst for investors?
Stock AnalysisIf you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
Investing NewsA rate hike would certainly alter the investment scene, but would it be for the better or worse?
InsuranceRead about the top life insurance companies in the United States as measured by written premiums and learn a little more about their business operations.
An insurance company can find out about driving under the influence (DUI) or driving while intoxicated (DWI) charges against ... Read Full Answer >>
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>