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FNFG > SEC Filings for FNFG > Form 10-Q on 31-Jul-2014All Recent SEC Filings




Quarterly Report

Management's Discussion and Analysis of Financial Condition and Results ITEM 2. of Operations

The following discussion and analysis is intended to provide greater details of our results of operations and financial condition and should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this document. Certain statements under this caption constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which First Niagara Financial Group, Inc. and its subsidiaries operate, projections of future performance and perceived opportunities in the market. Our actual results may differ significantly from the results, performance, and achievements expressed or implied in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, economic conditions, competition in the geographic and business areas in which we conduct our operations, fluctuation in interest rates, changes in the credit quality of our borrowers and obligors on investment securities we own, increased regulation of financial institutions or other effects of recently enacted legislation, and other factors discussed under Item 1A. "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013. First Niagara Financial Group, Inc. does not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements.
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 June 30, 2014, we had $39 billion in assets, $27 billion in deposits, and 411 full-service branch locations across New York, Western and Eastern Pennsylvania, Connecticut, and Western Massachusetts. The Company and the Bank are referred to collectively as "we" or "us" or "our."
In January 2014, we announced a Strategic Investment Plan that represents a pivot in our strategic imperatives by choosing to collectively accelerate certain investments in people, process, and technology. At the end of our planned three to four year investment period, our objective is to be better positioned to i) deliver greater fee generation and revenue capabilities by improving our value proposition to our retail and commercial clients; ii) improve operating leverage by lowering integration costs of new systems and our overall cost to serve; iii) address growing industry wide regulatory imperatives such as cybersecurity; and iv) improve our overall financial returns. The total cash spend for these investments is currently estimated at between $200 million and $250 million. Our Board of Directors has formed a Technology Committee to assist the Board of Directors in overseeing the planning and execution of our strategic investment in major technology projects; reviewing and approving major financial commitments related to the Strategic Investment Plan; from a technology perspective, monitoring how the Strategic Investment Plan competitively positions us in relation to our peers; and advising the Risk Committee of the Board of Directors on risk management associated with the Strategic Investment Plan and major technology vendor relationships. There are three components that make up this strategic technology investment: 1) Revenue Generation, 2) Next Gen Infrastructure, and 3) Integration Layer. First, approximately one half of our planned overall investment will be focused on revenue generation by building specific new products and service enhancements. The second component, which is approximately 25% of our planned overall investment, is building our Next Gen Infrastructure, with a primary focus of reducing our overall operating costs and operational risk. The third area of focus, which is also approximately 25% of our planned overall investment, is on our technology integration capabilities that will significantly reduce our cost of delivering the first two components. The improved integration capabilities piece will allow us to lower both our development and operating costs while increasing our speed to market and maximizing our product capabilities.

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For the revenue generation side, this is the continuation of the strategic plan we laid out in the fall of 2012. The key priorities that the revenue investments are intended to achieve include i) greater customer acquisition - whether it is the upper middle market commercial customer, indirect and direct customers including those who want home equity loans or credit cards, or a core deposit consumer customer attracted to a more robust online digital portal; ii) greater fee income generation both in the commercial segment, with more sophisticated cash management needs, and retail segments of our franchise; iii) greater commercial and consumer loan and deposit balances; and iv) effective cross-selling using customer relationship management and customer data to customize financial solutions.
The second piece of our Strategic Investment Plan, building our Next Gen Infrastructure, will drive improved operating leverage by lowering the cost to serve our customers. With the investments we are making, we expect to be able to consolidate our existing distributed model that will drive a reduction in vendors involved. This is intended to reduce the per-transaction costs, improve the customer experience, and address one of the top concerns that regulators are focused on today, cybersecurity.
The last piece of our overall investment is the redesign of our technology integration architecture. That is, we expect to create a simpler and less costly environment in which to build, integrate, and evolve our products and services so we achieve an environment in which new technologies can be more easily integrated and increase our speed to market while reducing product integration risk and our information technology budget. We will also invest in integrated data analytics which will enable us to better understand our customers' preferences using a complete 360 view of our customers.
We are actively enhancing our business cases and building detailed program execution plans for the Strategic Investment Plan. These detailed plans will provide the scope and timelines for each of the discrete programs that make up this Strategic Investment Plan. Additionally, we are actively working with a few key consultants to assist in the detailed planning effort, while at the same time ramping up our own resources necessary to execute and then operate our new capabilities. We remain within our time and budget estimates as we continue to move forward on initial projects and complete planning for others.
We operate a multi-faceted regional bank that provides our customers with a full range of products and services. These include commercial real estate loans, commercial business loans and leases, residential real estate, home equity, indirect auto, credit cards, and other consumer loans, as well as retail and commercial deposit products and insurance services, which we offer through a wholly owned subsidiary of the Bank. We also provide wealth management products and services. Our business model has and will continue to evolve from our thrift roots to a relationship based community banking model that is supported by enhanced products and services that better serve our customer needs. Our profitability is primarily dependent on 1) the difference between the interest we receive on loans and investment securities, and the interest we pay on deposits and borrowings, and 2) our cost to deliver these products. 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, the structure of the instrument, 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 actions and policies of the federal government and its regulatory agencies, including the Federal Reserve. While the prolonged low interest rate and weak economic environment has pressured our net interest income and margin in recent years, more recently, the competition from banks and non-banks has intensified both from a pricing and structural perspective. Absent an improvement in the competitive environment, net interest income will be challenged until we see an increase in short term interest rates. 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

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deposits, and also affect interest rates that we earn on interest-earning assets and that we pay on interest-bearing liabilities in order to better position our overall interest rate risk profile.
Since 2011, the Federal Reserve has taken certain actions, such as "Operation Twist" and Quantitative Easing, aimed at keeping short- and long-term interest rates low, thus spurring economic growth in the labor and housing markets. The current round of Quantitative Easing began in September 2012, and was an open-ended program calling for the purchase of $85 billion per month in agency mortgage-backed securities and longer term Treasury securities. These actions had the cumulative impact of flattening the yield curve, keeping interest rates low and therefore reducing the yields on our earning assets. We have been replacing higher yielding, fixed rate, longer duration loans that prepaid or refinanced away with lower yielding, shorter duration loans. In June 2013, the Federal Reserve began discussing the tapering of the Quantitative Easing program. This discussion caused the yield curve to steepen appreciably, and slowed the refinancing market in our mortgage banking business. Subsequent to its December 2013 meeting, the Federal Reserve began tapering its monthly purchases of Treasury and agency mortgage-backed securities by $10 billion and subsequent to its June 2014 meeting, the Federal Reserve announced that it would discontinue the program by October 2014. While the Federal Open Market Committee ("FOMC") voting members are unanimous in their decision to discontinue monthly bond purchases by October 2014, they are increasingly divided on the timing of any increase to short-term interest rates. Certain Federal Reserve policy officials have expressed growing concern that maintaining an accommodative monetary policy for longer will lead to inflation exceeding the Federal Reserve's 2% inflation target and accordingly, the timing of the first increase to short-term interest rates should be early 2015 or potentially sooner. This view is currently offset by other FOMC members, including Federal Reserve Chair, Janet Yellen, who believe the accommodative policy needs to be maintained and that the Federal Reserve would continue to hold interest rates low until the outlook for the labor market and the general economy improve, including higher overall wages and fewer part time employees. Additionally, some market participants are expressing views that the Federal Funds terminal rate will be 2% lower than historic levels of 4% to 5%, which would impact the steepness of the yield curve in a normalized interest rate environment if correct. Further, depositor behavior is also subject to much debate regarding the pace and timing of deposits flowing out of the banking system. Currently, the Federal Reserve is also reviewing its mechanisms for how they will raise interest rates when the decision is made to do so and include, in addition to conventional measures such as increases to the Federal Funds Rate, new tools such as paying interest on excess reserves and the use of reverse repurchase agreements. The timing and use of these tools may affect the direction and impact of short-term rate increases. We do not expect to see significant improvement in net interest income until short-term interest rates increase, and the impact on net interest income will be influenced by the nature, timing, market reaction and customer behavior, all of which are very unpredictable.
Our business operations are concentrated in our primary market areas of New York, Western and Eastern 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 areas 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, as well as additional competition for deposits from the mutual fund industry, internet banks, securities and brokerage firms, and insurance companies, as well as nontraditional competitors such as large retailers offering bank-like products. In addition to the traditional sources of competition for loans and deposits, payment processors and other companies exploring direct peer-to-peer banking provide additional competition

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for our products and services. 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. We offer a variety of financial services to meet the needs of the communities that we serve, functioning under a philosophy that includes a commitment to customer service and the community.
More recently, competition for loans, particularly commercial loans, has intensified given the weak economic activity within our markets and nationally. This increased competition from banks and non-banks has resulted in accelerated loan prepayments, particularly in our investor owned commercial real estate portfolio as borrowers gravitate towards financial institutions that are more willing to compete on price, loan structures or tenor. This competition is most notable in Eastern Pennsylvania and New England.
Durbin Amendment
In July 2013, the U.S. District Court for the District of Columbia (the "District Court") issued an order granting summary judgment to the plaintiffs in a case challenging certain provisions of the Federal Reserve's rule concerning electronic debit card transaction fees and network exclusivity arrangements (i.e., routing for PIN and signature debit card transactions) (the "Current Rule") that were adopted to implement Section 1075 of the Dodd-Frank Act (the "Durbin Amendment"). The District Court held that, in adopting the Current Rule, the Federal Reserve violated the Durbin Amendment's provisions concerning which costs are allowed to be taken into account for purposes of setting fees that are reasonable and proportional to the costs incurred by the issuer and therefore the Current Rule's maximum permissible fees of 21 cents per transaction were too high. In addition, the District Court held that Current Rule's network non-exclusivity provisions concerning unaffiliated payment networks for debit cards also violated the Durbin Amendment. In September 2013, the District Court agreed to stay its ruling pending the Federal Reserve's expedited appeal to the District of Columbia Circuit Court of Appeals ("D.C. Circuit"). In January 2014, following receipt of appellate and amicus briefs in the case, a three-judge panel for the D.C. Circuit heard oral arguments in this case. In March 2014, the D.C. Circuit largely ruled in favor of the Federal Reserve's interpretation of the Durbin Amendment. We will continue to monitor future developments. We recorded $14 million and $13 million of debit card interchange revenues for the six months ended June 30, 2014 and 2013, respectively. Volcker Rule
The Volcker Rule provisions of the Dodd-Frank Act restrict the ability of affiliates of insured depository institutions to sponsor or invest in private funds or to engage in certain types of proprietary trading. Although the Volcker Rule became effective on July 21, 2012 and the final rules became effective April 1, 2014, in connection with the adoption of the final rules on December 10, 2013 by the responsible agencies, the Federal Reserve issued an order extending the period during which institutions have to conform their activities and investments to the requirements of the Volcker Rule to July 21, 2015. The issuance of the final Volcker Rule restricts our ability to hold debt securities issued by Collateralized Loan Obligations ("CLOs") where our investment in these debt securities is deemed to be an ownership interest in a CLO and the CLO itself does not qualify for an exclusion in the final rule for loan securitizations. On April 7, 2014, the Federal Reserve announced that it intends to grant banking entities two additional one year extensions, which together would extend until July 21, 2017 the time period for institutions to conform their ownership interests in CLOs to the stated provisions of the final Volcker Rule. Only CLOs in place as of December 31, 2013 that do not qualify for the exclusion in the final rule for loan securitizations would be eligible for the extension.
We have $1.3 billion of CLO investments at June 30, 2014 with a weighted average yield of 3.3% that could be impacted by this rule. These investments are further described under "Risk Management-Investment Securities Portfolio." While we believe that it is unlikely that regulatory agencies will initiate any further changes in the Volcker Rule, we continue to evaluate options with external parties including outside legal counsel and trade associations (The Clearing House Association LLC) that we believe would make the CLO securities compliant with the stated provisions of the final Volcker Rule. These include including developing structural solutions that we can apply to our CLO securities and other solutions initiated by the asset managers of the CLO structures.

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Should we no longer be able to hold such securities, we could i) sell these securities expeditiously, and not be able to realize the value we might be able to realize with a normal market sale; ii) recognize all unrealized losses on such securities should we determine it is not more likely than not that we can hold any securities that have a fair value less than book value to a time when the fair value would be at least equal to its book value, which could be the security's maturity; and iii) reinvest proceeds in other, likely lower yielding investments, which would reduce our revenues. Of the bonds that do not qualify for an exclusion for loan securitizations, at June 30, 2014, we had $253 million of CLO securities with fair values less than their book values, aggregating to a $1 million unrealized loss. We continue to believe it is more likely than not that we can hold any underwater bonds to recovery, which could be maturity as the Federal Reserve has extended the holding period to July 21, 2017 and we believe that other structural remedies would enable us to make the existing securities compliant with the stated ownership interest provisions of the final Volcker Rule and thus allow us to continue holding the bonds after the conformance period ends.
Regulatory Reform is discussed in our Annual Report on Form 10-K for the year ended December 31, 2013 under Item 1, "Business-Supervision and Regulation," and Item 1A, "Risk Factors."
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 those which require our most subjective and complex judgments. Accordingly, our accounting estimates relating to the valuation of our investment securities, prepayment assumptions on our collateralized mortgage obligations and mortgage-backed securities, the accounting treatment and valuation of our acquired loans, 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 and have been discussed under this same heading in Item 7 of our 2013 Annual Report on Form 10-K. Additional accounting policies are more fully described in Note 1 in the "Notes to Consolidated Financial Statements" presented in our 2013 Annual Report on Form 10-K. The following are critical accounting estimates that have changed since our 2013 Annual Report on Form 10-K:
Investment Securities
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 as warranted.
In order to compute the constant effective yield for these securities, we estimate pooled level cash flows for each security based on a variety of factors, including historical and projected prepayment speeds, current and future interest rates, yield curve assumptions, security issuer and the current political environment. These cash flows are then translated into security level cash flows based on the tranche we own and the unique structure and status of each security. At June 30, 2014, the par value of our portfolio of residential mortgage-backed securities totaled $6.1 billion, which included $5.6 billion of collateralized mortgage obligations. In the determination of our constant effective yield, we estimate that we will receive $0.9 billion of principal cash flows on our collateralized mortgage obligations over the next 12 months. Allowance for Loan Losses
Impaired loans
Beginning in the second quarter of 2014, we raised our threshold for evaluating commercial loans individually for impairment from $200 thousand to $1 million. Impaired loans to commercial borrowers with outstandings less than $1 million are pooled and measured for impairment collectively. Additionally, all loans modified in a troubled debt restructuring ("TDR"), regardless of dollar size, are considered impaired. The impact of this change to our

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allowance for loan losses was not significant. This change is being implemented on a prospective basis, accordingly, prior period financial disclosures have not been revised.

                                    2014                                  2013
At or for the quarter
ended                      June 30      March 31        December 31     September 30     June 30
Selected financial
condition data:                                  (in millions, except per share amounts)
Total assets             $   38,625   $    37,990     $      37,628   $       37,341   $   37,150
Loans and leases, net        22,122        21,536            21,230           20,891       20,359
Investment securities:
Available for sale            6,684         7,060             7,423            7,610        7,916
Held to maturity              4,834         4,467             4,042            3,842        3,857
Goodwill and other
intangibles                   2,528         2,535             2,543            2,550        2,558
Deposits                     27,445        27,598            26,665           26,969       27,150
Borrowings                    5,624         4,871             5,556            4,902        4,431
Stockholders' equity     $    5,079   $     5,026     $       4,993   $        4,938   $    4,903
Common shares
outstanding                     355           354               354              354          354
Selected operations
Interest income          $      302   $       300     $         310   $          307   $      298
Interest expense                 30            29                30               29           29
Net interest income             272           271               280              278          269
Provision for credit
losses                           23            25                32               28           25
Net interest income
after provision for
credit losses                   249           246               248              250          244
Noninterest income               81            77                89               91           96
Restructuring charges             -            10                 -                -            -
Noninterest expense             244           238               227              231          235
Income before income tax         86            74               110              110          105
Income taxes                     12            14                33               31           33
Net income                       74            59                78               79           71
Preferred stock dividend          8             8                 8                8            8
Net income available to
common stockholders      $       66   $        52     $          70   $           72   $       64
Common stock and related
per share data:
Earnings per common
Basic                    $     0.19   $      0.15     $        0.20   $         0.20   $     0.18
Diluted                        0.19          0.15              0.20             0.20         0.18
Cash dividends                 0.08          0.08              0.08             0.08         0.08
Book value(1)                 13.53         13.40             13.31            13.15        13.06
Tangible book value per
share(1)(2)                      6.31        6.15              6.04             5.86         5.74
Market Price (NASDAQ:
High                           9.61         10.65             11.34            11.02        10.17
Low                            8.27          8.19             10.14             9.78         8.79
Close                          8.74          9.45             10.62            10.37        10.07

(1) Excludes unallocated employee stock ownership plan shares and unvested restricted stock shares.

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