Pain management.
That's the best description of First Niagara's new payment plan for HSBC's upstate New York franchise. Relying on cheap stock will put a financial hurting on the Buffalo bank and its investors next year.
The $1 billion deal for 195 branches from Syracuse to Albany was sold to investors in July as an immediate moneymaker. On Tuesday First Niagara backpedaled and described it as an eventual one, at best.
The transaction will lower operating earnings-per-share by 1% to 2% in 2012, not boost them by the 10% to 11% the company first assumed. If it was a capital burden before, it threatens to become a capital killer: It would lower First Niagara's tangible book value by about 30%, or substantially more than the 17% to 18% decline executives had first forecast.
The $31 billion-asset company began reworking the finances of the deal this week in a way that basically distributes the financial burden of that negative outlook as widely as possible.
Everybody with a stake in the bank and its ambitious post-crisis growth agenda would lose something.
For First Niagara Chief Executive John Koelmel, that means credibility on Wall Street.
The former banking consultant is the architect of First Niagara's purchase of the one-time operation of Marine Midland Bank, a prized asset M&T Bank Corp. and KeyCorp also coveted.
Koelmel won it by agreeing to terms that made the deal particularly vulnerable when the stock market tumbled in August.
Now his fourth big acquisition since 2009 will probably be his last until he shakes the perception that he over-reached after successfully pulling off deals in Connecticut and Pennsylvania, experts say.
"They had plans to roll out an M&A strategy and deploy the capital that they had raised a number of years ago," says David Darst, an analyst that covers the company for Guggenheim Securities LLC. "For those shareholders that have been buying into the growth story of the past year - they really got hurt."
Shares of First Niagara fell as much as 3% on Wednesday before finishing nearly unchanged at $8.97. The company declined to comment for this story.
First Niagara revised downward most of its key financial assumptions of the deal in a presentation to investors late Tuesday. The returns will be smaller. First Niagara's margin will be narrower after it closes. Its book value will be lower.
The problems with buying HSBC's branches are partly just bad luck tied to the poor economy and volatile equity markets. But Darst and other critics say Koelmel owns the blame for not having the money in hand to pay for the deal before he signed it.
It figured it could comfortably issue up to $800 million issuing stock by the time the deal is to close by mid-2012. But its shares have fallen nearly 28% since the summer.
"Many investors consider that a management mistake," Darst says. "They would have been better served had they come to market with a pre-arranged private equity market investor."
Shareholders now stand to lose half their dividend in the first cut to the company's quarterly payout ever. The company decided to mitigate that blow to shareholders by basically putting more strain on its balance sheet. It is raising substantially less common equity than planned, and more preferred shares and subordinated debt. It commenced a $440 million common offering Tuesday and a $250 million preferred offering on Wednesday.
Though those moves would reduce dilution to common shareholders, they would increase the dilution of the company's book value because of the way common shares are classified as capital. That is a chief reason First Niagara has to cut its dividend to 8 cents per quarter: It needs the expected $110 million in annual savings to replenish capital.
One more thing has skewed the deal returns. The market rate for branches and deposits has fallen because buyers are wary of absorbing deposits they cannot lend out profitably.
That is a problem for First Niagara because it intends to sell or close up to half of HSBC's branches. It will lose money on the $4 billion of deposits it aims to unload, by selling them for less than it bought them. It paid a deposit premium of 6.67% for all $15 billion of HSBC's upstate deposits and expects to fetch a premium of just 4% to 5% for the ones it sells.
Selling something for less than you bought it creates goodwill, which eats capital.
The company said it expects total goodwill and intangibles to increase by $800 million — or 44% — between the end of September and mid-2012.
