HBAN Huntington Bancshares Inc

KeyCorp is in advanced talks to buy First Niagara Financial Group Inc., people familiar with the matter said, a tie-up that would combine two regional banks at a time when such firms are grappling with low interest rates and burgeoning regulatory costs.

The deal could value Buffalo, N.Y.-based First Niagara at a modest premium to its market capitalization of just under $4 billion at Wednesday's close, the people said. It would be one of the biggest bank tie-ups of the year and would solidify 2015 as the biggest year for bank deals since the financial crisis.

Assuming the talks don't fall apart, the deal could be announced as soon as Friday, the people said.

Bank deals are slowly coming back as larger lenders try to become more efficient by getting bigger and smaller banks put themselves up for sale as their businesses struggle. But bank mergers still face some hurdles like tough regulatory scrutiny—and the biggest U.S. banks are effectively prohibited from doing deals.

The likely deal price represents more of a premium over where First Niagara shares traded in September, before reports first surfaced that the bank might be for sale.

U.S. bank deal activity in 2015 hit the highest level since the financial crisis on Thursday, when the announcement of New York Community Bancorp Inc.'s purchase of Astoria Financial Corp. brought the volume of deals in the sector to $28.4 billion for the year, according to Dealogic. Any deal announcement for First Niagara would push that total even higher.

New York Community on Thursday morning said it agreed to buy Astoria in a stock-and-cash transaction valued at $2 billion. This year's total is now the highest since 2009, when $65 billion worth of deals were announced as financial crisis led to a number of big mergers, according to Dealogic.

A tie-up between Cleveland-based Key and First Niagara would bring together two mid-sized banks that operate in some similar areas but deploy somewhat different business models. First Niagara is a community-focused bank known for its strong deposit base, while Key has successfully bolstered its investment-banking revenue in recent quarters.

First Niagara, which has about 390 branches in New York, Pennsylvania, Connecticut and Massachusetts, has grappled with lingering issues from acquisitions of its own. Last year the lender recorded an $800 million goodwill write-down as it reduced the value of four acquisitions it made from 2009 to 2011. Shares plummeted on the news at the time.

Several banks were interested in buying First Niagara, though the number has winnowed in recent days, people familiar with the deal discussions said. Huntington Bancshares Inc. was in advanced deal talks as recently as Monday, but Key emerged as the most likely suitor by mid-week, some of these people said.

Bank profits have been under pressure from low interest rates that have lingered longer than many banks were expecting. Those conditions also make deals attractive.

Mergers often allow banks to boost revenue faster than expenses climb. For instance, they can help a bank spread the increasingly expensive costs of complying with government regulations across a broader revenue base. That has led to deals cropping up around regulatory thresholds that kick in when banks hit a certain size.

First Niagara has $39 billion in assets, putting it not far from the $50 billion threshold that would make the bank a systemically important financial institution and subject it to the Federal Reserve's stress tests. Key, meanwhile, has nearly $95 billion in assets, making it one of the smaller banks subject to the stress tests.

Regulators including the Federal Reserve and the Office of the Comptroller of the Currency have been informed about the talks, a person familiar with the matter said. That isn't unusual, although the scrutiny has been greater than in the past, the person said.

Key has been trying to become more efficient and a deal for First Niagara could help the bank do that in the long run. In the third quarter Key's efficiency ratio, a measure of costs as a percentage of revenue where lower is better, declined to 66.9% from 69.7% a year earlier. Chief Financial Officer Don Kimble said on the third-quarter earnings call that Key still thinks it can get its efficiency ratio to the low-60s range.

But Key has remained under pressure from low interest rates that have made lending less profitable. KeyCorp's net interest margin, an important gauge that measures how much a bank earns from the difference between what it pays on deposits and what it takes in on loans and investments, declined slightly in the third quarter. The metric edged down to 2.87% from 2.88% in the second quarter and fell from 2.96% a year earlier.

Another recent development has paved the way for more bank deals: a prominent long-stalled bank acquisition was finally approved by the Fed last month, and the Fed in its approval reassured banks such a delay won't happen again.

The Fed took more than three years to approve M&T Bank Corp.'s acquisition of Hudson City Bancorp Inc., making it the longest delay ever for a U.S. deal valued at more than $1 billion. The delay was caused by the Fed's concerns about M&T's internal controls.

In its approval order, the Fed said banks with compliance issues will be expected to withdraw their merger applications until they are resolved. Guggenheim analyst Jaret Seiberg said in a note at the time that the new guidance provides more clarity, "a road map on how to ensure a deal can secure Federal Reserve approval."

Write to Rachel Louise Ensign at rachel.ensign@wsj.com, Emily Glazer at emily.glazer@wsj.com and Dana Cimilluca at dana.cimilluca@wsj.com

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(END) Dow Jones Newswires

October 29, 2015 13:25 ET (17:25 GMT)

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