KEY KeyCorp

By Rachel Louise Ensign, Emily Glazer and Dana Cimilluca 

KeyCorp said Friday that it has agreed to acquire First Niagara Financial Group Inc. in a deal valued at about $4.1 billion, producing a tie-up of two regional banks at a time when such firms are grappling with low interest rates and burgeoning regulatory costs.

It is one of the biggest bank tie-ups of the year and further solidifies 2015 as the biggest year for bank deals since the financial crisis.

The deal values the Buffalo, N.Y.-based First Niagara at a modest premium to its market capitalization of just under $4 billion. The 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.

First Niagara shareholders will receive 0.68 KeyCorp shares and $2.30 in cash for each First Niagara common share, representing a per share value of $11.40 based on the closing price of KeyCorp common stock Thursday.

The deal is expected to close by the third quarter of 2016.

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

U.S. bank deal activity in 2015 hit the highest level since the financial crisis 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.

New York Community 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 according to Dealogic $65 billion worth of deals were announced as the financial crisis led to a number of big mergers.

Shares of the banks involved in the deals reacted negatively to the news of the deals Thursday. Key shares closed down 3.7%, while First Niagara shares fell 4.2%. New York Community's share price dropped 12%, and Astoria stock fell more than 7%.

Regional lenders such as Cleveland-based Key and First Niagara have been under pressure from low interest rates that make lending less profitable and that now are anticipated to drag on longer than many had expected. But the two banks have had divergent fortunes of late. Key's per-share profit has been on the rise as fee revenue has climbed, while First Niagara's per-share earnings have fallen after a series of troubled acquisitions.

The two banks operate in some similar areas but deploy different business models. First Niagara is a community-focused bank known for its strong deposit base, while Key has bolstered its investment-banking business.

A merger would boost Key's branch count in New York state, according to SNL Financial. In the Buffalo area, where both banks have just over 50 branches each, the combined bank would have a 35% market share of deposits.

First Niagara, which has about 390 branches in New York, Pennsylvania, Connecticut and Massachusetts, last year 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, although 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 midweek, some of these people said.

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.

Similar considerations were in play in New York Community's announced deal for Astoria. New York Community was right below the $50 billion threshold but will now go over with the purchase.

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

(END) Dow Jones Newswires

October 30, 2015 07:42 ET (11:42 GMT)

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