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| FNFG > SEC Filings for FNFG > Form 10-Q on 8-Nov-2012 | All Recent SEC Filings |
8-Nov-2012
Quarterly Report
OVERVIEW
First Niagara Financial Group, Inc. (the "Company") is a Delaware corporation
and a bank holding company, subject to supervision and regulation by the Board
of Governors of the Federal Reserve System (the "Federal Reserve"), serving both
retail and commercial customers through our bank subsidiary, First Niagara Bank,
N.A. (the "Bank"), a national bank subject to supervision and regulation by the
Office of the Comptroller of the Currency (the "OCC"). At September 30, 2012, we
had $36 billion in assets, $28 billion in deposits, and 432 full-service branch
locations across New York, Pennsylvania, Connecticut, and Western Massachusetts.
The Company and the Bank are referred to collectively as "we" or "us" or "our."
On May 18, 2012, the Bank acquired 137 full-service branches from HSBC Bank USA,
National Association ("HSBC") and its affiliates (the "HSBC Branch Acquisition")
in the Buffalo, Rochester, Syracuse, Albany, Downstate New York and Connecticut
banking markets, as contemplated by the Purchase and Assumption Agreement, dated
July 30, 2011, as amended and restated as of May 17, 2012 (the "Purchase
Agreement") and paid a net deposit premium of $772 million. In accordance with
the Purchase Agreement, the Bank acquired cash of $7.4 billion, performing loans
with a fair value of approximately $1.6 billion, core deposit and other
intangibles of $85 million, and deposits with a fair value of approximately $9.9
billion (shortly after acquisition, we allowed $0.5 billion in municipal
deposits to one large customer run-off), resulting in goodwill of $775 million.
The cash received was used to pay down wholesale borrowings, including those
used to purchase securities in advance of the HSBC Branch Acquisition. The
goodwill is tax deductible. In addition, we acquired certain wealth management
relationships and approximately $2.5 billion of assets under management of such
relationships. At closing, the Bank did not receive any loans greater than 60
days delinquent. Concurrent with the HSBC Branch Acquisition, we consolidated 15
existing First Niagara branches into acquired HSBC branches and in the third
quarter of 2012, we consolidated 19 of the HSBC branches into First Niagara
branches, resulting in 103 net new full-service branches from the Branch
Acquisition.
In connection with the regulatory process for the HSBC Branch Acquisition, we
agreed with the U.S. Department of Justice ("DOJ") to assign our purchase rights
related to 26 HSBC branches in the Buffalo area. In January 2012, we entered
into an agreement with Key assigning our right to purchase the 26 HSBC Buffalo
branches as well as 11 additional HSBC branches in the Rochester area. On
July 13, 2012, Key acquired these 37 branches with a total of $2.0 billion in
deposits and approximately $256.5 million in loans, and paid us a deposit
premium of $91.5 million.
In January 2012, we also entered into separate agreements with Financial
Institutions, Inc. subsidiary Five Star Bank ("Five Star") and Community Bank
System, Inc. ("Community Bank") for them to purchase seven First Niagara
branches and 20 HSBC branches, for which we had assigned our purchase rights.
On June 22, 2012, Five Star acquired four First Niagara branches with $58.6
million in loans, assumed approximately $129.3 million in deposits, and paid us
a deposit premium of $5.3 million. On August 17, 2012, Five Star acquired four
of the HSBC branches, assumed approximately $18 million in loans, $157.2 million
in deposits, and paid us a deposit premium of $6.5 million.
On July 20, 2012, Community Bank acquired the remaining 16 HSBC branches, with a
total of $107.0 million in loans, $696.6 million in deposits, and paid us a
deposit premium of $23.8 million. On September 7, 2012, Community Bank acquired
three First Niagara branches, assumed approximately $55.4 million in loans,
$100.8 million in deposits, and paid us a deposit premium of $3.1 million.
We have incurred $179 million in pre-tax merger and acquisition expenses related
to the HSBC Branch Acquisition since we entered into the Purchase and Assumption
Agreement on July 30, 2011. These expenses include $65 million in prepayment
penalties on borrowings and swap termination fees; redundant facilities and
employee severance costs; technology costs related to system conversions; and
professional fees.
On April 15, 2011, we acquired all of the outstanding common shares of
NewAlliance Bancshares, Inc. ("NewAlliance"), the parent company of NewAlliance
Bank, and thereby acquired NewAlliance Bank's 88 branch locations in Connecticut
and Western Massachusetts. As a result of the merger, we acquired assets with a
fair value of $9.2 billion, including investment securities with a fair value of
$2.8 billion, loans with a fair value of $5.1 billion, and we assumed deposits
of $5.3 billion and borrowings of $2.3 billion. Under the terms of the merger
agreement, NewAlliance stockholders received 94 million shares of Company common
stock and cash consideration of $199 million.
BUSINESS AND INDUSTRY
We operate a multi-faceted regional bank with a community banking model that
provides our customers with a full range of products and services. These
products include commercial and residential real estate loans, commercial
business loans and leases, home equity and other consumer loans, wealth
management products, as well as various retail consumer and commercial deposit
products. Additionally, we offer insurance services through a wholly-owned
subsidiary of the Bank.
Our profitability is primarily dependent on the difference between the interest
we receive on loans and investment securities, and the interest we pay on
deposits and borrowings. The rates we earn on our assets and the rates we pay on
our liabilities are a function of the general level of interest rates and
competition within our markets. These rates are also highly sensitive to
conditions that are beyond our control, such as inflation, economic growth, and
unemployment, as well as policies of the federal government and its regulatory
agencies, including the Federal Reserve. We manage our interest rate risk as
described in Item 3, "Quantitative and Qualitative Disclosures about Market
Risk."
The Federal Reserve implements national monetary policies (with objectives such
as curbing inflation and combating recession) through its open-market operations
in U.S. Government securities, by adjusting depository institutions reserve
requirements, by varying the target federal funds and discount rates and by
varying the supply of money. The actions of the Federal Reserve in these areas
influence the growth of our loans, investments, and deposits, and also affect
interest rates that we earn on interest-earning assets and that we pay on
interest-bearing liabilities.
In September 2012, the Federal Open Market Committee ("FOMC") stated they intend
to maintain the exceptionally low levels for federal funds rate at least through
mid-2015. Such an accommodative stance of monetary policy was designed to
continue support to the labor markets and overall economy. The FOMC also
announced additional purchases of long-dated agency mortgage-backed securities
at the pace of $40 billion each month for an indefinite period which was
designed to move longer-term interest rates lower. Additionally, the FOMC
decided to continue its program known as "Operation Twist" through the end of
the year. These actions will further exacerbate longer-term pressures on the
industry net interest margin by; (i) continuing to reduce the yields on earning
assets relative to the cost of funding; (ii), causing borrowers to repay their
higher-yielding fixed rate loans at a faster rate; and (iii), reducing the rates
at which cash flows from these repayments could be reinvested.
MARKET AREAS AND COMPETITION
Our business operations are concentrated in our primary market areas of New
York, Pennsylvania, Connecticut, and Western Massachusetts. Therefore, our
financial results are affected by economic conditions in these geographic areas.
If economic conditions in our markets deteriorate or if we are unable to sustain
our competitive posture, our ability to expand our business and the quality of
our loan portfolio could materially impact our financial results.
Our primary lending and deposit gathering areas are generally concentrated in
the same counties as our branches. We face significant competition in both
making loans and attracting deposits in our markets as they have a high density
of financial institutions, some of which are significantly larger than we are
and have greater financial resources. Our competition for loans comes
principally from commercial banks, savings banks, savings and loan associations,
mortgage banking companies, credit unions, insurance companies, and other
financial services companies. Our most direct competition for deposits has
historically come from commercial banks, savings banks, and credit unions. We
face additional competition for deposits from the mutual fund industry, internet
banks, securities and brokerage firms, and insurance companies. In these
marketplaces, opportunities to grow and expand are primarily a function of how
we are able to differentiate our product offerings and customer experience from
our competitors.
REGULATORY REFORM
We continue to monitor the potential effects on our businesses of regulatory
reform, including the Dodd-Frank Wall Street Reform and Consumer Protection Act
("Dodd-Frank"), and the revised capital and liquidity frameworks published by
the Basel
Committee on Banking Supervision in December 2010, known as "Basel III."
On June 7, 2012, the Federal Reserve published three notices of proposed
rulemaking that will impact most financial institutions, two of which are most
relevant to us: "Regulatory Capital, Implementation of Basel III, Minimum
Regulatory Capital Ratios, Capital Adequacy, and Transition Provisions"
("Regulatory Capital") and "Regulatory Capital Rules: Standardized Approach for
Risk-Weighted Assets; Market Discipline and Disclosure Requirements"
("Risk-Weighted Assets"). These proposed rules are extensive and are subject to
further regulatory action and interpretation as well as a comment period that
ended October 22, 2012.
While uncertainty exists in the final form of the U.S. rules implementing the
Basel III framework, based on preliminary assessments of the proposed framework
we believe we will continue to exceed all estimated well-capitalized regulatory
requirements over the course of the proposed phase-in period, and on a fully
phased-in basis.
On October 9, 2012, the Federal Reserve and OCC announced publication of their
final rules regarding company-run stress testing as required by Dodd-Frank. The
rules will require covered institutions with average total consolidated assets
greater than $10 billion to conduct an annual company-run stress test of
capital, consolidated earnings and losses under one base and at least two stress
scenarios provided by the agencies. The rules delay implementation for covered
institutions with total consolidated assets between $10 billion and $50 billion.
Institutions with total consolidated assets between $10 billion and $50 billion,
such as us, will use data as of September 30, 2013 to conduct the stress test,
using scenarios that are released by the agencies in November 2013. Stress test
results must be reported to the agencies in March 2014.
Regulatory Reform is discussed in our Annual Report on Form 10-K for the year
ended December 31, 2011 under Item 1, "Business-Supervision and Regulation," and
Item 1A, "Risk Factors."
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We evaluate those accounting policies and estimates that we judge to be
critical: those most important to the presentation of our financial condition
and results of operations, and that require our most subjective and complex
judgments. Accordingly, our accounting estimates relating to investment
securities accounting, the accounting treatment and valuation of our acquired
loans, the adequacy of our allowance for loan losses, and the analysis of the
carrying value of goodwill for impairment are deemed to be critical, as our
judgments could have a material effect on our results of operations. Additional
accounting policies are more fully described in Note 1 in the "Notes to
Consolidated Financial Statements" presented in our 2011 Annual Report on Form
10-K. A description of our current accounting policies involving significant
management judgment follows:
Investment Securities
As of September 30, 2012, our available for sale and held to maturity investment
securities totaled $12.0 billion, or 34% of our total assets. We use third party
pricing services to value our investment securities portfolio, which is
comprised predominantly of Level 2 fair value measured securities. Fair value of
our investment securities is based upon quoted market prices of identical
securities, where available. If such quoted prices are not available, fair value
is determined using valuation models that consider cash flow, security
structure, and other observable information. For the vast majority of the
portfolio, we validate the prices received from these third parties, on a
quarterly basis, by comparing them to prices provided by a different independent
pricing service. For the remaining securities that are priced by these third
parties where we are unable to obtain a secondary independent price, we review
material price changes for reasonableness based upon changes in interest rates,
credit outlook based upon spreads for similar securities, and the weighted
average life of the debt securities. We have also reviewed detailed valuation
methodologies provided to us by our pricing services. Where sufficient
information is not available from the pricing services to produce a reliable
valuation, we estimate fair value based on broker quotes, which are reviewed
using the same process that is applied to our securities priced by pricing
services where we are unable to obtain a secondary independent price.
We conduct a quarterly review and evaluation of our investment securities
portfolio to determine if any declines in fair value below amortized cost are
other than temporary. In making this determination, we consider some or all of
the following factors: the period of time the securities have been in an
unrealized loss position, the percentage decline in fair value in comparison to
the securities' amortized cost, credit rating, the financial condition of the
issuer and guarantor, where applicable, the delinquency or default rates of
underlying collateral, credit enhancement, projected losses, level of credit
loss, and projected cash flows. If we intend to sell a security with a fair
value below amortized cost or if it is more likely than not that we will be
required to sell such a security, we would record an other than temporary
impairment charge through current period earnings for the full decline in fair
value below amortized cost. For debt securities that we do not intend to sell or
it is more likely than not that we will not be required to sell before recovery,
we would record an other than temporary impairment charge through current period
earnings for the amount of the valuation decline below amortized cost that is
attributable to credit losses. The
remaining difference between the debt security's fair value and amortized cost
(i.e. decline in fair value not attributable to credit losses) is recognized in
other comprehensive income.
Our investment securities portfolio includes residential mortgage-backed
securities and collateralized mortgage obligations. As the underlying collateral
of each of these securities is comprised of a large number of similar
residential mortgage loans for which prepayments are probable and the timing and
amount of such prepayments can be reasonably estimated, we estimate future
principal prepayments of the underlying residential mortgage loans to determine
a constant effective yield used to apply the interest method, with retroactive
adjustments made as warranted.
Acquired Loans
Loans that we acquire in acquisitions subsequent to January 1, 2009 are recorded
at fair value with no carryover of the related allowance for loan losses.
Determining the fair value of the loans involves estimating the amount and
timing of principal and interest cash flows expected to be collected on the
loans and discounting those cash flows at a market rate of interest.
We have acquired loans in four separate acquisitions after January 1, 2009. For
each acquisition, we reviewed all loans greater than $1 million and considered
the following factors as indicators that such an acquired loan had evidence of
deterioration in credit quality and was therefore in the scope of Accounting
Standards Codification ("ASC") 310-30 (Loans and Debt Securities Acquired with
Deteriorated Credit Quality):
• Loans that were 90 days or more past due;
• Loans that had an internal risk rating of substandard or worse. Substandard is consistent with regulatory definitions and is defined as having a well defined weakness that jeopardizes liquidation of the loan;
• Loans that were classified as nonaccrual by the acquired bank at the time of acquisition; or
• Loans that had been previously modified in a troubled debt restructuring.
Any acquired loans that were not individually in the scope of ASC 310-30 because
they did not meet the criteria above were either (i) pooled into groups of
similar loans based on the borrower type, loan purpose, and collateral type and
accounted for under ASC 310-30 by analogy or (ii) accounted for under ASC 310-20
(Nonrefundable fees and other costs.)
Acquired loans accounted for under ASC 310-30 by analogy
We performed a fair valuation of each of the pools and each pool was recorded at
a discount. We determined that at least part of the discount on the acquired
pools of loans was attributable to credit quality by reference to the valuation
model used to estimate the fair value of these pools of loans. The valuation
model incorporated lifetime expected credit losses into the loans' fair
valuation in consideration of factors such as evidence of credit deterioration
since origination and the amounts of contractually required principal and
interest that we did not expect to collect as of the acquisition date. Based on
the guidance included in the December 18, 2009 letter from the AICPA Depository
Institutions Panel to the Office of the Chief Accountant of the SEC, we have
made an accounting policy election to apply ASC 310-30 by analogy to qualifying
acquired pools of loans that (i) were acquired in a business combination or
asset purchase, (ii) resulted in recognition of a discount attributable, at
least in part, to credit quality; and (iii) were not subsequently accounted for
at fair value.
The excess of expected cash flows from acquired loans over the estimated fair
value of acquired loans at acquisition is referred to as the accretable discount
and is recognized into interest income over the remaining life of the acquired
loans using the interest method. The difference between contractually required
payments at acquisition and the cash flows expected to be collected at
acquisition is referred to as the nonaccretable discount. The nonaccretable
discount represents estimated future credit losses expected to be incurred over
the life of the acquired loans. Subsequent decreases to the expected cash flows
require us to evaluate the need for an addition to the allowance for loan
losses. Subsequent improvements in expected cash flows result in the reversal of
a corresponding amount of the nonaccretable discount which we then reclassify as
accretable discount that is recognized into interest income over the remaining
life of the loan using the interest method. Our evaluation of the amount of
future cash flows that we expect to collect takes into account actual credit
performance of the acquired loans to date and our best estimates for the
expected lifetime credit performance of the loans using currently available
information. Charge-offs of the principal amount on acquired loans would be
first applied to the nonaccretable discount portion of the fair value
adjustment. To the extent that we experience a deterioration in credit quality
in our expected cash flows subsequent to the acquisition of the loans, an
allowance for loan losses would be established based on our estimate of future
credit losses over the remaining life of the loans.
Acquired loans that met the criteria for nonaccrual of interest prior to the
acquisition may be considered performing upon acquisition, regardless of whether
the customer is contractually delinquent, if we can reasonably estimate the
timing and amount of the expected cash flows on such loans and if we expect to
fully collect the new carrying value of the loans. As such,
we may no longer consider the loan to be nonaccrual or nonperforming and may
accrue interest on these loans, including the impact of any accretable discount.
We have determined that we can reasonably estimate future cash flows on our
current portfolio of acquired loans that are past due 90 days or more and on
which we are accruing interest and expect to fully collect the carrying value of
the loans net of the allowance for acquired loan losses.
Allowance for Loan Losses
We determined our allowance for loan losses by portfolio segment, which consist
of commercial loans and consumer loans. Our commercial loan portfolio segment
includes both business and commercial real estate loans. Our consumer portfolio
segment includes residential real estate, home equity, and other consumer loans.
We further segregate these segments between loans which are accounted for under
the amortized cost method (referred to as "originated" loans) and loans acquired
(referred to as "acquired" loans), as acquired loans were originally recorded at
fair value, which includes an estimate of lifetime credit losses, resulting in
no carryover of the related allowance for loan losses.
Originated loans
We establish our allowance for loan losses through a provision for credit losses
based on our evaluation of the credit quality of our loan portfolio. This
evaluation, which includes a review of loans on which full collectability may
not be reasonably assured, considers, among other matters, the estimated fair
value of the underlying collateral, economic conditions, historical net loan
loss experience, and other factors that warrant recognition in determining our
allowance for loan losses. We continue to monitor and modify the level of our
allowance for loan losses to ensure it is adequate to cover losses inherent in
our loan portfolio. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review our allowance for loan
losses.
For our originated loans, our allowance for loan losses consists of the
following elements: (i) specific valuation allowances based on probable losses
on specifically identified impaired loans; and (ii) valuation allowances based
on net historical loan loss experience for similar loans with similar inherent
risk characteristics and performance trends, adjusted, as appropriate, for
qualitative risk factors specific to respective loan types.
For our originated loans, when current information and events indicate that it
is probable that we will be unable to collect all amounts of principal and
interest due under the original terms of a business or commercial real estate
loan greater than $200 thousand, such loan will be classified as impaired.
Additionally, all loans modified in a troubled debt restructuring ("TDR") are
considered impaired. The need for specific valuation allowances are determined
for impaired loans and recorded as necessary. For impaired loans, we consider
the fair value of the underlying collateral, less estimated costs to sell, if
the loan is collateral dependent, or we use the present value of estimated
future cash flows in determining the estimates of impairment and any related
allowance for loan losses for these loans. Confirmed losses are charged off
immediately. Prior to a loan becoming impaired, we typically would obtain an
appraisal through our internal loan grading process to use as the basis for the
fair value of the underlying collateral.
Commercial loan portfolio segment
We estimate the allowance for our commercial loan portfolio segment by
considering their type and loan grade. We first apply a historic loss rate to
loans based on their type and loan grade. This amount is then adjusted, as
necessary, for qualitative considerations to reflect changes in underwriting,
market or industry conditions, or based on changes in trends in the composition
of the portfolio, including risk composition, seasoning, and underlying
collateral. Our loan grading system is described in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" under the heading
"Credit Risk."
Consumer loan portfolio segment
We estimate the allowance for loan losses for our consumer loan portfolio
segment by first estimating the amount of loans that will eventually default
based on delinquency severity. We then apply a loss rate to the amount of loans
that we predict will default based on our historical net loss experience. This
amount is then adjusted, as necessary, for qualitative considerations to reflect
changes in underwriting, market or industry conditions or based on changes in
trends in the composition of the portfolio, including risk composition,
seasoning, and underlying collateral. We obtain and review refreshed FICO scores
on a quarterly basis, and trends are evaluated for consideration as a
qualitative adjustment to the allowance. Other qualitative considerations
include, but are not limited to, the evaluation of trends in property values,
building permits and unemployment.
Acquired Loans . . .
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