Two laggards

30 October 2015 By Rob Cox

As the financial crisis peaked in October 2008, a handful of troubled banks sidled up to the U.S. Treasury Department to beg for cheap bailout money. Two of those laggards, KeyCorp and First Niagara Financial, are now banding together in search of safety.

Cleveland-based Key, the bigger of the two, clinched a deal to acquire First Niagara for $4.1 billion in cash and create America’s 13th-largest financial institution. The two hope to cut $400 million of costs and become more efficient. If their shareholders are lucky, the resulting firm may eventually make tasty prey for a stronger rival.

Seven years have passed since Key took $2.5 billion from former Treasury Secretary Hank Paulson’s Troubled Asset Relief Program. It paid the government back in 2011. First Niagara redeemed its $184 million of preferred stock from the Treasury just a year after snapping it up.

But both banks are still relative slackers. In Key’s last quarter, its return on average common equity was 8.19 percent, below its cost of capital. Return on average assets was below the 1 percent that shareholders normally consider acceptable. By comparison, market leader U.S. Bancorp racked up a 14.1 percent return on equity and 57 percent more than Key’s return on assets.

Key still bested its Buffalo-based quarry’s performance. First Niagara’s returns were 0.61 percent on assets and 5.51 percent on equity. The hope is that by combining these two regional banking also-rans, they will somehow become more efficient.

The union targets $400 million of savings from crunching together technology infrastructure, paying less for stuff like pens chained to desks and closing branches. Key said it expects the deal to eke out an internal rate of return of 15 percent in a couple of years.

Key’s shareholders aren’t really buying it, which is unsurprising given its meh performance. Based on Thursday’s closing prices, Key offered a premium to First Niagara’s tangible book value of about $4.56 a share, or some $1.6 billion in total. The capitalized value of the synergies should come to over $2.5 billion. Rather than credit the difference to Key’s market cap, they swiped some $650 million from the bank’s value.

The lesson: Investors like only one thing less than investing in a loser – investing in two at the same time.


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