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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 000-23975
FIRST NIAGARA FINANCIAL GROUP, INC.
(exact name of registrant as specified in its charter)
Delaware 42-1556195
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6950 South Transit Road, P.O. Box 514, Lockport, NY 14095-0514
- --------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(716) 625-7500
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one): Large accelerated filer |X| Accelerated filer |_| Non-accelerated filer
|_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|.
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes |_| No |_|
The Registrant had 10,739,703 shares of Common Stock, $0.01 par value,
outstanding as of November 8, 2006.
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1
FIRST NIAGARA FINANCIAL GROUP, INC.
FORM 10-Q
For the Quarterly Period Ended September 30, 2006
TABLE OF CONTENTS
Item Number Page Number
- ----------- -----------
PART I - FINANCIAL INFORMATION
1. Financial Statements
Condensed Consolidated Statements of Condition as of
September 30, 2006 and December 31, 2005 (unaudited).................................. 3
Condensed Consolidated Statements of Income for the
three and nine months ended September 30, 2006 and 2005 (unaudited)................... 4
Condensed Consolidated Statements of Comprehensive Income for the
three and nine months ended September 30, 2006 and 2005 (unaudited)................... 5
Condensed Consolidated Statements of Changes in Stockholders' Equity
for the nine months ended September 30, 2006 and 2005 (unaudited)..................... 6
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2006 and 2005 (unaudited)............................. 7
Notes to Condensed Consolidated Financial Statements (unaudited)........................ 8
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................. 16
3. Quantitative and Qualitative Disclosures about Market Risk.............................. 28
4. Controls and Procedures................................................................. 29
PART II - OTHER INFORMATION
1. Legal Proceedings....................................................................... 29
1A. Risk Factors............................................................................ 29
2. Unregistered Sales of Equity Securities and Use of Proceeds............................. 30
3. Defaults Upon Senior Securities......................................................... 30
4. Submission of Matters to a Vote of Security Holders..................................... 30
5. Other Information....................................................................... 30
6. Exhibits................................................................................ 30
Signatures................................................................................... 31
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
- --------------------------------------------------------------------------------
First Niagara Financial Group, Inc. and Subsidiary
Condensed Consolidated Statements of Condition
(unaudited)
September 30, December 31,
2006 2005
------------- ------------
(In thousands, except share
Assets and per share amounts)
Cash and cash equivalents ......................................... $ 124,678 $ 140,128
Securities available for sale ..................................... 1,204,048 1,604,888
Loans held for sale ............................................... 4,479 3,811
Loans and leases, net ............................................. 5,585,807 5,212,488
Premises and equipment, net ....................................... 96,612 92,118
Bank-owned life insurance ......................................... 78,953 76,667
Goodwill .......................................................... 698,947 698,636
Core deposit and other intangibles ................................ 53,309 62,071
Other assets ...................................................... 164,667 174,025
----------- -----------
Total assets ....................................... $ 8,011,500 $ 8,064,832
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits ........................................................ $ 5,581,474 $ 5,479,412
Borrowings ...................................................... 919,398 1,096,427
Other liabilities ............................................... 126,750 114,570
----------- -----------
Total liabilities .................................. 6,627,622 6,690,409
----------- -----------
Stockholders' equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized;
none issued ................................................. -- --
Common stock, $0.01 par value, 250,000,000 shares authorized;
120,044,736 shares issued in 2006 and 120,046,007 shares
issued in 2005 .............................................. 1,200 1,200
Additional paid-in capital .................................... 1,234,705 1,237,592
Retained earnings ............................................. 317,729 285,202
Accumulated other comprehensive loss .......................... (15,918) (18,330)
Common stock held by ESOP, 3,624,873 shares in 2006 and
3,740,659 shares in 2005 .................................... (27,308) (28,150)
Unearned compensation - restricted stock awards,
368,599 shares in 2005 ...................................... -- (3,908)
Treasury stock, at cost, 9,249,914 shares in 2006
and 7,280,704 shares in 2005 ................................ (126,530) (99,183)
----------- -----------
Total stockholders' equity ......................... 1,383,878 1,374,423
----------- -----------
Total liabilities and stockholders' equity ......... $ 8,011,500 $ 8,064,832
=========== ===========
See accompanying notes to condensed consolidated financial statements.
3
First Niagara Financial Group, Inc. and Subsidiary
Condensed Consolidated Statements of Income
(unaudited)
Three months ended Nine months ended
September 30, September 30,
-------------------- --------------------
2006 2005 2006 2005
-------- -------- -------- --------
(In thousands, except per share amounts)
Interest income:
Loans and leases .............................................. $ 91,715 80,547 $266,403 230,963
Securities available for sale and other investments ........... 13,311 15,750 43,264 45,779
-------- -------- -------- --------
Total interest income ............................... 105,026 96,297 309,667 276,742
Interest expense:
Deposits ...................................................... 34,995 21,743 94,299 56,638
Borrowings .................................................... 9,405 11,058 28,353 32,816
-------- -------- -------- --------
Total interest expense .............................. 44,400 32,801 122,652 89,454
-------- -------- -------- --------
Net interest income ...................................... 60,626 63,496 187,015 187,288
Provision for credit losses ...................................... 1,300 1,647 5,156 4,848
-------- -------- -------- --------
Net interest income after provision for credit losses 59,326 61,849 181,859 182,440
-------- -------- -------- --------
Noninterest income:
Banking services .............................................. 9,861 10,115 28,895 27,552
Risk management services ...................................... 10,855 8,213 33,380 19,655
Wealth management services .................................... 1,990 1,700 6,396 5,181
Lending and leasing ........................................... 1,608 1,923 5,324 5,269
Employee benefits administration .............................. 1,012 362 2,830 362
Gain on sale of manufactured housing loans .................... 2,954 -- 2,954 --
Gain on sale of real estate partnership ....................... -- 1,377 -- 1,377
Bank-owned life insurance ..................................... 774 965 2,277 3,093
Other ......................................................... 548 985 1,259 1,963
-------- -------- -------- --------
Total noninterest income ............................ 29,602 25,640 83,315 64,452
-------- -------- -------- --------
Noninterest expense:
Salaries and employee benefits ................................ 31,436 26,006 91,449 71,892
Occupancy and equipment ....................................... 5,538 5,091 16,452 13,982
Technology and communications ................................. 5,117 4,765 15,220 13,919
Marketing and advertising ..................................... 1,775 1,718 5,354 6,064
Professional services ......................................... 929 1,685 2,861 5,539
Amortization of core deposit and other intangibles ........... 2,890 3,254 8,964 8,616
Other ......................................................... 5,410 5,289 16,776 17,810
-------- -------- -------- --------
Total noninterest expense ........................... 53,095 47,808 157,076 137,822
-------- -------- -------- --------
Income before income taxes .......................... 35,833 39,681 108,098 109,070
Income taxes ..................................................... 12,275 15,508 37,134 39,711
-------- -------- -------- --------
Net income ............................................... $ 23,558 24,173 $ 70,964 69,359
======== ======== ======== ========
Earnings per common share:
Basic .............................................. $ 0.22 0.22 $ 0.66 0.63
Diluted ............................................ $ 0.22 0.22 $ 0.66 0.63
Weighted average common shares outstanding:
Basic .............................................. 106,599 110,227 107,206 109,859
Diluted ............................................ 107,548 111,239 108,176 110,858
See accompanying notes to condensed consolidated financial statements.
4
First Niagara Financial Group, Inc. and Subsidiary
Condensed Consolidated Statements of Comprehensive Income
(unaudited)
Three months ended Nine months ended
September 30, September 30,
--------------------- ---------------------
2006 2005 2006 2005
-------- -------- -------- --------
(In thousands)
Net income .................................................... $ 23,558 24,173 $ 70,964 69,359
Other comprehensive income (loss), net of income taxes:
Securities available for sale:
Net unrealized gains (losses) arising during the period 9,518 (6,927) 2,412 (9,898)
Reclassification adjustment for realized gains (losses)
included in net income ............................. -- 2 -- (1)
-------- -------- -------- --------
9,518 (6,925) 2,412 (9,899)
Minimum pension liability adjustment ........................ -- -- -- 121
-------- -------- -------- --------
Total other comprehensive income (loss) ............... 9,518 (6,925) 2,412 (9,778)
-------- -------- -------- --------
Total comprehensive income ......................... $ 33,076 17,248 $ 73,376 59,581
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
5
First Niagara Financial Group, Inc. and Subsidiary
Condensed Consolidated Statements of Changes in Stockholders' Equity
(unaudited)
Accumulated
Additional other
Common paid-in Retained comprehensive
stock capital earnings loss
---------- ---------- ---------- -------------
(In thousands, except per share amounts)
Balances at January 1, 2006 .... $ 1,200 1,237,592 285,202 (18,330)
Net income ..................... -- -- 70,964 --
Total other comprehensive
income, net ................. -- -- -- 2,412
Adoption of SFAS No. 123(R) .... -- (3,908) -- --
Purchase of treasury stock ..... -- -- -- --
Exercise of stock options, net . -- 519 (1,858) --
ESOP shares committed to be
released .................... -- 812 -- --
Restricted stock awards, net ... -- (1,548) -- --
Stock option expense ........... -- 1,238 -- --
Common stock dividend of
$0.34 per share ............. -- -- (36,579) --
---------- ---------- ---------- ----------
Balances at September 30, 2006 . $ 1,200 1,234,705 317,729 (15,918)
========== ========== ========== ==========
Common Unearned
stock compensation-
held by Restricted Treasury
ESOP stock awards stock Total
---------- ------------- ---------- ----------
(In thousands, except per share amounts)
Balances at January 1, 2006 .... (28,150) (3,908) (99,183) 1,374,423
Net income ..................... -- -- -- 70,964
Total other comprehensive
income, net ................. -- -- -- 2,412
Adoption of SFAS No. 123(R) .... -- 3,908 -- --
Purchase of treasury stock ..... -- -- (34,509) (34,509)
Exercise of stock options, net . -- -- 4,161 2,822
ESOP shares committed to be
released .................... 842 -- -- 1,654
Restricted stock awards, net ... -- -- 3,001 1,453
Stock option expense ........... -- -- -- 1,238
Common stock dividend of
$0.34 per share ............. -- -- -- (36,579)
---------- ---------- ---------- ----------
Balances at September 30, 2006 . (27,308) -- (126,530) 1,383,878
========== ========== ========== ==========
Accumulated
Additional other
Common paid-in Retained comprehensive
stock capital earnings loss
---------- ---------- ---------- -------------
(In thousands, except per share amounts)
Balances at January 1, 2005 .... $ 843 751,175 238,048 (5,437)
Net income ..................... -- -- 69,359 --
Total other comprehensive
loss, net ................... -- -- -- (9,778)
Common stock issued
for the acquisition of
Hudson River Bancorp ........ 357 484,093 -- --
Treasury shares issued for the
acquisition of Hatch Leonard
Naples, Inc. ................ -- 215 -- --
Purchase of treasury shares .... -- -- -- --
Exercise of stock options, net . -- 647 (3,214) --
ESOP shares committed
to be released .............. -- 743 -- --
Restricted stock awards, net ... -- 326 -- --
Common stock dividend
of $0.28 per share .......... -- -- (31,416) --
---------- ---------- ---------- ----------
Balances at September 30, 2005 . $ 1,200 1,237,199 272,777 (15,215)
========== ========== ========== ==========
Common Unearned
stock compensation-
held by Restricted Treasury
ESOP stock awards stock Total
---------- ------------- ---------- ----------
Balances at January 1, 2005 .... (29,275) (3,173) (24,019) 928,162
Net income ..................... -- -- -- 69,359
Total other comprehensive
loss, net ................... -- -- -- (9,778)
Common stock issued
for the acquisition of
Hudson River Bancorp ........ -- -- -- 484,450
Treasury shares issued for the
acquisition of Hatch Leonard
Naples, Inc. ................ -- -- 5,785 6,000
Purchase of treasury shares .... -- -- (71,040) (71,040)
Exercise of stock options, net . -- -- 5,068 2,501
ESOP shares committed
to be released .............. 843 -- -- 1,586
Restricted stock awards, net ... -- (1,663) 2,483 1,146
Common stock dividend
of $0.28 per share .......... -- -- -- (31,416)
---------- ---------- ---------- ----------
Balances at September 30, 2005 . (28,432) (4,836) (81,723) 1,380,970
========== ========== ========== ==========
See accompanying notes to condensed consolidated financial statements.
6
First Niagara Financial Group, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows
(unaudited)
Nine months ended September 30,
2006 2005
----------- -----------
Cash flows from operating activities: (In thousands)
Net Income ...................................................... $ 70,964 $ 69,359
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of fees and discounts, net ..................... 360 2,906
Provision for credit losses ................................. 5,156 4,848
Depreciation of premises and equipment ...................... 9,062 8,320
Amortization of core deposit and other intangibles .......... 8,965 8,616
Origination of loans held for sale .......................... (45,470) (42,318)
Proceeds from sales of loans held for sale .................. 72,253 44,786
(Gain) loss on sales of loans ............................... (2,738) 71
Gain on sale of real estate partnership ..................... -- (1,377)
ESOP and stock based compensation expense, net .............. 4,560 2,767
Deferred income tax expense ................................. 7,816 9,211
Net increase in other assets ................................ (6,188) (10,952)
Net increase in other liabilities ........................... 10,611 47,528
----------- -----------
Net cash provided by operating activities ................. 135,351 143,765
----------- -----------
Cash flows from investing activities:
Proceeds from sales of securities available for sale ............ -- 3,002
Proceeds from maturities of securities available for sale ....... 293,046 250,852
Principal payments received on securities available for sale .... 162,498 178,262
Purchases of securities available for sale ...................... (50,953) (352,373)
Net increase in loans ........................................... (399,668) (233,072)
Proceeds from surrender of bank-owned life insurance ............ -- 42,119
Acquisitions, net of cash and cash equivalents .................. -- (118,404)
Other, net ...................................................... (17,840) (11,296)
----------- -----------
Net cash used in investing activities ..................... (12,917) (240,910)
----------- -----------
Cash flows from financing activities:
Net increase in deposits ........................................ 102,062 231,581
Repayments of short-term borrowings, net ........................ (185,121) (88,029)
Proceeds from long-term borrowings .............................. 84,125 185,000
Repayments of long-term borrowings .............................. (70,665) (38,553)
Proceeds from exercise of stock options ......................... 2,028 1,613
Excess tax benefit from stock based compensation ................ 775 1,187
Purchase of treasury stock ...................................... (34,509) (71,040)
Dividends paid on common stock .................................. (36,579) (31,416)
----------- -----------
Net cash (used in) provided by financing activities ........ (137,884) 190,343
----------- -----------
Net (decrease) increase in cash and cash equivalents .............. (15,450) 93,198
Cash and cash equivalents at beginning of period .................. 140,128 67,642
----------- -----------
Cash and cash equivalents at end of period ........................ $ 124,678 $ 160,840
=========== ===========
Cash paid during the period for:
Income taxes .................................................. $ 34,770 $ 25,711
Interest expense .............................................. 123,525 86,274
Non-cash activity:
Loans transferred to held for sale ............................ $ 26,395 $ --
Acquisitions and dispositions of non-cash assets and liabilities:
Assets acquired, net of dispositions .......................... $ -- $ 2,786,672
Liabilities assumed, net of dispositions ...................... -- 2,166,765
See accompanying notes to condensed consolidated financial statements.
7
First Niagara Financial Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(unaudited)
The accompanying condensed consolidated financial statements of First Niagara
Financial Group, Inc. ("FNFG") and its wholly owned subsidiary First Niagara
Bank ("First Niagara") have been prepared using U.S. generally accepted
accounting principles ("GAAP") for interim financial information and the
instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, these
financial statements do not include all of the information and footnotes
required by GAAP for a full year presentation. In our opinion, all adjustments
necessary for a fair presentation have been included. Results for the three and
nine month periods ended September 30, 2006 do not necessarily reflect the
results that may be expected for the year ending December 31, 2006. Certain
reclassification adjustments were made to the 2005 financial statements to
conform them to the 2006 presentation. FNFG and First Niagara are referred to
collectively as "the Company," "we" or "our."
(1) Stock-Based Compensation
We offer several stock-based incentive plans which are described below.
Stock Option Plans. We have two stock-based compensation plans under which
options may be granted to directors and key employees. The 1999 Stock Option
Plan authorizes the issuance of up to 3,597,373 shares of common stock. The
Amended and Restated 2002 Long-Term Incentive Stock Benefit Plan authorizes the
issuance of up to 8,020,454 shares of common stock for grants of stock options,
stock appreciation rights, accelerated ownership option rights or stock awards.
As of September 30, 2006, both stock options and stock awards have been granted
under the 2002 plan. Under both plans, stock options have been granted with an
exercise price equal to the market price of our stock on the date of grant. All
options have a 10-year term and become fully vested and exercisable over a
period of 3 to 5 years from the grant date. When option recipients exercise
their options, we issue shares from treasury stock and record the proceeds as
additions to capital. At September 30, 2006, there were 4,841,171 shares
available for grant under these plans.
Restricted Stock Plan. Our 1999 Reward and Recognition Plan (the "RRP Plan")
authorizes the issuance of up to 1,438,949 shares of restricted stock to
directors and key employees. The restricted stock generally vests over 3 to 5
years from the grant date. As discussed above, restricted stock may also be
granted under the Amended and Restated 2002 Long-Term Incentive Stock Benefit
Plan. When restricted stock grants are forfeited before they vest, we reacquire
the shares, hold them in treasury, and use them to grant new awards.
Long-Term Performance Plan. We also have a Long-Term Performance Plan (the "LTIP
Plan") which provides our key executives with long term incentives based
primarily on performance, as a motivation for future performance and as a
retention tool for continued employment. This plan is a multi-year performance
plan, with cash and share-based incentive award opportunities if specific
performance targets are met. For the three year performance period beginning in
2005 these performance metrics include the achievement of total revenue,
earnings per share growth, return on assets and total shareholder return
targets, as well as certain Strategic Plan initiatives specified by the Board of
Directors. The LTIP Plan will be funded by shares previously approved and
authorized under our existing stock-based compensation plans. We allocated
87,401 shares in September 2006 and 42,400 shares during 2005 for potential
future rewards.
At September 30, 2006, we held more than 9.2 million shares of our stock as
treasury shares. This is more than adequate to meet the share requirements of
our current stock-based compensation plans. As part of our capital management
initiatives, we may repurchase additional shares under our current share
repurchase program. For the first nine months of 2006 we repurchased 2.5 million
shares of our stock. As of September 30, 2006, we are authorized to repurchase
an additional 6,076,761 shares under the current program. During the first nine
months of 2006 we issued 541,871 shares from treasury stock in connection with
the exercise of stock options and grants of restricted stock.
Effective January 1, 2006, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), Share-Based Payment, which replaces SFAS No. 123,
Accounting for Stock-Based Compensation, and supercedes Accounting Principles
Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and
related interpretations. SFAS No. 123(R) requires us to record compensation
costs related to stock-based awards. Prior to this year, we accounted for stock
options following the requirements of APB No. 25 which did not require us to
record compensation expense for fixed stock options if the exercise price of the
option equaled or exceeded the fair market value of our stock at the grant date.
In the adoption of SFAS No. 123(R), we utilized the modified prospective
approach which applies to new awards and to awards modified, repurchased, or
cancelled after January 1, 2006. Additionally, any unvested stock awards granted
prior to that date are expensed as service is performed based on the grant-date
fair value calculated in accordance with SFAS No. 123. For restricted stock
awards we recognize compensation expense on a straight-line basis over the
vesting period for the fair market value of the award, measured at the grant
date.
8
First Niagara Financial Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(unaudited)
Our results for the nine month period ended September 30, 2006 include
share-based compensation expense totaling $2.9 million. This amount has been
recorded in salaries and employee benefits expense in the Condensed Consolidated
Statement of Income.
The following table shows the effect on net income and earnings per share as if
we had adopted the fair value provisions of SFAS No. 123 for all outstanding and
unvested awards in the comparable prior year period (in thousands, except per
share amounts):
Three months ended Nine months ended
September 30, 2005 September 30, 2005
------------------ ------------------
Net income as reported $ 24,173 $ 69,359
Add: Stock-based compensation expense
included in net income, net of
related income tax effects 234 708
Deduct: Stock-based compensation expense
determined under the fair-value based
method, net of related income tax effects (639) (1,779)
-------------- --------------
Pro forma net income $ 23,768 $ 68,288
============== ==============
Basic earnings per common share:
As reported $ 0.22 $ 0.63
Pro forma 0.22 0.62
Diluted earnings per common share:
As reported $ 0.22 $ 0.63
Pro forma 0.21 0.61
On December 28, 2005, our Board of Directors approved the accelerated vesting
for all stock options scheduled to vest by December 31, 2006. Due to this
acceleration, options to purchase 779,897 shares of our common stock, or 35% of
all unvested options outstanding, became exercisable immediately. All of the
accelerated options, except for 60,016 shares, had an exercise price above our
stock price on that date. All other contractual provisions related to these
options, including the portion of the options that will vest after 2006, remain
unchanged.
Stock Option Awards
The following is a summary of stock option activity during the nine months ended
September 30, 2006:
Weighted
Number of average
shares Exercise price
------------ --------------
Outstanding at January 1, 2006 4,408,823 $ 9.89
Granted 318,738 14.79
Exercised (311,921) 6.82
Forfeited (156,700) 13.11
------------
Outstanding at September 30, 2006 4,258,940 $ 10.36
============
9
First Niagara Financial Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(unaudited)
The following is a summary of stock options outstanding at September 30, 2006:
Weighted Weighted Weighted
average average average
Options exercise remaining Options exercise
Exercise price outstanding price life (years) exercisable price
- -------------------------- ------------ -------- ------------ ----------- --------
$3.49 - $4.16 1,099,628 $ 3.87 3.10 1,099,628 $ 3.87
$4.87 - $12.87 1,078,874 10.69 6.46 816,549 10.01
$12.91 - $13.28 1,385,090 13.02 8.13 546,874 13.10
$13.52 - $16.21 695,348 14.79 8.63 216,582 14.84
----------- -----------
Total 4,258,940 $ 10.36 6.49 2,679,633 $ 8.51
=========== ===========
Weighted
average
Aggregate remaining
intrinsic contractual
Total shares value (1) term
------------ --------- -----------
Options outstanding 4,258,940 $ 18,307,000 6.49 years
Options currently exercisable 2,679,633 16,422,000 5.29 years
(1) Intrinsic value is defined as the difference between the fair market value
of our stock at September 30, 2006 and the weighted average exercise price
of the stock award.
The total intrinsic value of stock options exercised during the nine months
ended September 30, 2006 was $2.3 million. As of September 30, 2006, we have
$5.0 million of unrecognized compensation cost related to unvested options
granted. We expect this cost to be recognized over a weighted average period of
1.4 years.
To estimate the fair value of our stock option awards, we use the Black-Scholes
valuation method. This method is dependent upon certain assumptions. The
following is a summary of stock options granted for the periods indicated as
well as the weighted-average assumptions utilized to compute the fair value of
the options:
Nine months ended
September 30,
--------------------------
2006 2005
---------- ----------
Options granted 318,738 1,343,970
Grant date weighted average fair value
per share $ 3.64 $ 3.50
Grant date weighted average share price $ 14.79 $ 13.05
Expected forfeiture of unvested options 10% 10%
Dividend yield 3.23% 2.75%
Risk-free interest rate 4.76% 4.04%
Expected volatility factor 27.80% 29.30%
Expected life (in years) 6.50 6.50
In the table above the risk-free interest rate is the U.S. Treasury rate
commensurate with the expected life of options on the date of their grant. We
based the volatility of our stock on historical volatility over a span of time
equal to the expected life of the options.
10
First Niagara Financial Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(unaudited)
Restricted Stock Awards
We expense the value of restricted stock grants over the applicable vesting
periods. At September 30, 2006 we have $6.0 million of unrecognized compensation
cost related to unvested awards granted under the RRP Plan. We expect this cost
to be recognized over a weighted average period of 2.1 years.
The following is a summary of restricted stock activity during the nine month
period ended September 30, 2006:
Weighted
Number of average grant
shares date fair value
--------- ---------------
Unvested at January 1, 2006 368,599 $ 12.89
Awarded 237,022 14.84
Vested (133,841) 11.98
Forfeited (2,961) 15.23
--------
Unvested at September 30, 2006 468,819 $ 14.12
========
(2) Earnings Per Share
The computation of basic and diluted earnings per share for the three and nine
month periods ended September 30, 2006 and 2005 is as follows (in thousands,
except per share amounts):
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2006 2005 2006 2005
--------- --------- --------- ---------
Net income available to common shareholders $ 23,558 24,173 $ 70,964 69,359
========= ========= ========= =========
Weighted average common shares outstanding:
Total shares issued 120,045 120,046 120,045 118,344
Unallocated ESOP shares (3,663) (3,817) (3,701) (3,856)
Unvested restricted stock awards (323) (388) (328) (397)
Treasury shares (9,460) (5,614) (8,810) (4,232)
--------- --------- --------- ---------
Total basic weighted average
common shares outstanding 106,599 110,227 107,206 109,859
Incremental shares from assumed exercise
of stock options 881 936 865 897
Incremental shares from assumed vesting
of restricted stock awards 68 76 105 102
--------- --------- --------- ---------
Total diluted weighted average
common shares outstanding 107,548 111,239 108,176 110,858
========= ========= ========= =========
Basic and diluted earnings per share $ 0.22 0.22 $ 0.66 0.63
========= ========= ========= =========
Anti-dilutive stock options and restricted stock
awards excluded from the diluted weighted average
common share calculations 484 332 1,322 314
========= ========= ========= =========
11
First Niagara Financial Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(unaudited)
(3) Loans Held for Sale
Our accounting policy for loans originated and intended for sale in the
secondary market is to record such loans at the lower of the aggregate cost or
market value based upon observable market prices or prices obtained from a third
party. Any subsequent decreases in market value are recognized as a charge to
earnings at the time the decline in value occurs. Gains and losses on sales of
loans held for sale are generally included in Lending and Leasing Income.
(4) Pension and Other Postretirement Plans
Net pension and postretirement cost (benefit), which is recorded within salaries
and employee benefits expense in the Condensed Consolidated Statements of
Income, is comprised of the following (in thousands):
Pension plans
-------------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Interest cost $ 910 964 $ 2,729 2,891
Expected return on plan assets (1,411) (1,396) (4,233) (4,188)
Amortization of unrecognized loss 135 95 422 286
Amortization of unrecognized prior service liability -- 4 -- 12
------- ------- ------- -------
Net pension benefit $ (366) (333) $(1,082) (999)
======= ======= ======= =======
Other postretirement plans
-------------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Interest cost $ 122 125 $ 366 375
Expected return on plan assets -- -- -- --
Amortization of unrecognized loss 40 25 119 76
Amortization of unrecognized prior service liability (16) (16) (48) (48)
------- ------- ------- -------
Net postretirement cost $ 146 134 $ 437 403
======= ======= ======= =======
Effective February 1, 2002, we froze all new participation and benefit accruals
in our pension plan. Accordingly, after that date, no employees are permitted to
enter the plan and future salary increases and years of credited service will
not be considered when computing benefits under the plan. Additionally, we
modified our post-retirement plan to include only those employees who met the
retirement eligibility requirements as of December 31, 2001.
12
First Niagara Financial Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(unaudited)
(5) Segment Information
We have two business segments, banking and financial services. The financial
services segment includes our risk (insurance), employee benefits administration
and wealth management operations. The banking segment includes all of our other
operations. Predominantly all of our assets relate to our banking segment.
Selected information for our segments follows (in thousands):
Financial Consolidated
Banking Services Eliminations total
----------- ----------- ------------ ------------
For the three months ended:
September 30, 2006
Net interest income $ 60,517 $ 109 $ -- $ 60,626
Provision for credit losses 1,300 -- -- 1,300
----------- ----------- ----------- -----------
Net interest income after provision
for credit losses 59,217 109 -- 59,326
Noninterest income 15,742 13,889 (29) 29,602
Amortization of core deposit and
other intangibles 1,880 1,010 -- 2,890
Other noninterest expense 39,371 10,863 (29) 50,205
----------- ----------- ----------- -----------
Income before income taxes 33,708 2,125 -- 35,833
Income tax expense 11,425 850 -- 12,275
----------- ----------- ----------- -----------
Net income $ 22,283 $ 1,275 $ -- $ 23,558
=========== =========== =========== ===========
For the three months ended:
September 30, 2005
Net interest income $ 63,487 $ 9 $ -- $ 63,496
Provision for credit losses 1,647 -- -- 1,647
----------- ----------- ----------- -----------
Net interest income after provision
for credit losses 61,840 9 -- 61,849
Noninterest income 15,350 10,314 (24) 25,640
Amortization of core deposit and
other intangibles 2,330 924 -- 3,254
Other noninterest expense 36,405 8,173 (24) 44,554
----------- ----------- ----------- -----------
Income before income taxes 38,455 1,226 -- 39,681
Income tax expense 15,017 491 -- 15,508
----------- ----------- ----------- -----------
Net income $ 23,438 $ 735 $ -- $ 24,173
=========== =========== =========== ===========
For the nine months ended:
September 30, 2006
Net interest income $ 186,821 $ 194 $ -- $ 187,015
Provision for credit losses 5,156 -- -- 5,156
----------- ----------- ----------- -----------
Net interest income after provision
for credit losses 181,665 194 -- 181,859
Noninterest income 40,701 42,697 (83) 83,315
Amortization of core deposit and
other intangibles 5,685 3,279 -- 8,964
Other noninterest expense 114,581 33,614 (83) 148,112
----------- ----------- ----------- -----------
Income before income taxes 102,100 5,998 -- 108,098
Income tax expense 34,735 2,399 -- 37,134
----------- ----------- ----------- -----------
Net income $ 67,365 $ 3,599 $ -- $ 70,964
=========== =========== =========== ===========
13
First Niagara Financial Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(unaudited)
Financial Consolidated
Banking Services Eliminations total
----------- ----------- ------------ ------------
For the nine months ended:
September 30, 2005
Net interest income $ 187,274 $ 14 $ -- $ 187,288
Provision for credit losses 4,848 -- -- 4,848
----------- ----------- ----------- -----------
Net interest income after provision
for credit losses 182,426 14 -- 182,440
Noninterest income 39,174 25,348 (70) 64,452
Amortization of core deposit and
other intangibles 6,730 1,886 -- 8,616
Other noninterest expense 109,599 19,677 (70) 129,206
----------- ----------- ----------- -----------
Income before income taxes 105,271 3,799 -- 109,070
Income tax expense 38,191 1,520 -- 39,711
----------- ----------- ----------- -----------
Net income $ 67,080 $ 2,279 $ -- $ 69,359
=========== =========== =========== ===========
(6) Manufactured Housing Loan Sale
On July 21, 2006, we completed the sale of $24.7 million of manufactured housing
loans that were included in the assets acquired with the Hudson River Bancorp,
Inc. in January 2005. We had not originated any new loans for that portfolio and
the carrying amount of the loans had accordingly been reduced from the
originally acquired amount of $35.2 million. During the second quarter of 2006,
we decided to sell the remaining loans and, as a result, reclassified the net
carrying amount of the loans to our loans held for sale portfolio. The gain on
sale recognized in the third quarter of 2006 was $3.0 million.
(7) Recently Issued Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board released Interpretation
No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement 109." Effective for fiscal years beginning after December 15, 2006,
this interpretation provides guidance on the financial statement recognition and
measurement for income tax positions taken or expected to be taken in an income
tax return. It also provides related guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. While we are currently evaluating the effect of the guidance
contained in Interpretation 48, we do not expect the implementation to have a
material impact on our consolidated financial statements.
In September 2006, the Financial Accounting Standards Board released Statement
No. 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans" which requires us to a) recognize in our financial
statements an asset for a plan's overfunded status or a liability for a plan's
underfunded status; b) measure a plan's assets and its obligations that
determine its funded status as of the end of the employer's fiscal year (with
limited exceptions); and c) recognize changes in the funded status of a defined
benefit postretirement plan through comprehensive income in the year in which
the changes occur. While Statement No. 158 is generally effective for public
companies with fiscal years ending after December 15, 2006, the requirement to
measure plan assets and benefit obligations as of the date of the employer's
fiscal year-end financial statements is effective for fiscal years ending after
December 15, 2008. While we are currently evaluating the effect of the guidance
contained in this Statement, we do not expect the implementation to have a
material impact on our consolidated financial statements.
14
First Niagara Financial Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(unaudited)
The SEC staff recently released SEC Staff Accounting Bulletin ("SAB") No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" which addresses how
uncorrected errors in previous years should be considered when quantifying
errors in current-year financial statements. The SAB requires registrants to
consider the effect of all carry over and reversing effects of prior-year
misstatements when quantifying errors in current-year financial statements. The
SAB allows registrants to record the effects of adopting the guidance as a
cumulative-effect adjustment to retained earnings. The adjustment must be
reported as of the beginning of the first fiscal year ending after November 15,
2006. We are currently evaluating the impact of SAB No. 108.
In September 2006, the Financial Accounting Standards Board released Statement
No. 157, "Fair Value Measurements" which defines fair value, establishes a
framework for measuring fair value in GAAP, and enhances disclosures about fair
value measurements. This Statement applies when other accounting pronouncements
require fair value measurements; it does not require new fair value
measurements. This Statement is effective for financial statements issued for
fiscal years beginning after November 15, 2007, and interim periods within those
years. While we are currently evaluating the effect of the guidance contained in
this Statement, we do not expect the implementation to have a material impact on
our consolidated financial statements.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
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 condensed 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 and its subsidiary
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, credit
quality and government regulation and other factors discussed in the annual
report on Form 10-K for the year ended December 31, 2005 under Item 1A. "Risk
Factors." First Niagara Financial Group 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.
OVERVIEW
Who We Are
FNFG is a Delaware corporation and financial holding company serving both retail
and commercial customers through our one bank subsidiary, First Niagara, which
is a federally chartered savings bank subject to the Office of Thrift
Supervision regulation. We are positioned as one of the leading community banks
in Upstate New York, providing our customers with banking and financial
services. First Niagara has, among its subsidiaries, a wholly owned insurance
agency, First Niagara Risk Management, and a wholly owned full service benefits
administration and consulting firm, First Niagara Benefits Consulting.
Principal Products and Services and Locations of Operations
First Niagara is a multi market community banking and financial services company
that provides our customers with a full range of products and services. These
products include residential and commercial real estate loans, commercial
business loans and leases, home equity and other consumer loans, as well as
various consumer and commercial deposit products. Additionally, we offer risk
management (insurance) and wealth management products and services.
We actively seek to deepen relationships with our customers, many of whom use
more than one of these products and services. We operate 119 full-service
banking offices, 160 ATMs and two loan production offices across Upstate New
York.
Information About Our Business and the Industry
Our profitability is primarily dependent on the difference between interest we
receive on loans and investment securities, and the interest we pay on deposits
and borrowings. The rate we earn on our assets and the rate we pay on our
liabilities is a function of the general level of interest rates and competition
within our markets. Interest rates are highly sensitive to many economic
conditions that are beyond our control, such as inflation, recession and
unemployment.
Our business is also influenced by the monetary and fiscal policies of the
federal government and the policies of regulatory agencies, particularly the
Federal Reserve. 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, and by varying the target federal funds and
discount rates. The actions of the Federal Reserve in these areas influence the
growth of our loans, investments, and deposits and also affect interest rates
that we earn on interest-earning assets and that we pay on interest-bearing
liabilities.
We also derive a significant amount of noninterest income from our banking and
financial services activities. In order to minimize the volatility caused by
changes in the interest rate environment we continue to diversify our revenue
sources through our customer focused strategy and by acquiring other financial
services companies that provide sources of noninterest income.
How Economic Factors Impact Us
Our business is concentrated in Upstate New York, therefore, our financial
results are affected by economic conditions in this geographic area. The Upstate
New York economy continues to be challenged by a downsizing manufacturing sector
and an environment of high operating costs. These factors, coupled with the
general migration to the Southern and Western areas of the United States for
both cost and quality of life reasons, have caused job growth in the Upstate
markets to noticeably lag other parts of the country. Because of this
environment, opportunities to grow and expand our business are primarily a
function of product and customer experience differentiation as opposed to
economic growth. If we are unable to sustain this competitive posture or if the
economic and business conditions in our markets further deteriorate, both our
ability to grow our business, as well as the quality of our loan portfolio,
could materially impact our financial results.
16
Our Opportunities, Challenges and Risks
We believe that our growth will result from the execution of our customer
centric strategy which positions us as our customers "Trusted Financial
Advisor." Our Strategic Plan, which we refer to internally as our "Strategic
Blueprint" continues to be executed with that focus.
We also believe that the consolidation of community banks will continue and, in
that regard, we will continue to evaluate acquisition opportunities. We will
also consider acquisition opportunities in other business lines, including, but
not limited to, specialty finance, risk and wealth management. In the past, we
have successfully integrated acquired companies and de novo (new) branches into
our operations. If bank acquisition opportunities are limited in markets we wish
to enter or expand our business, we will evaluate opening de novo branches.
Competition in the banking and financial services industry across Upstate New
York is intense. We compete with commercial banks, savings institutions, credit
unions, finance companies, mutual funds, insurance companies, mortgage brokerage
firms and brokerage and investment banking firms. Many of these competitors
(whether regional or national) have substantially greater resources and lending
capacity than we do and may offer certain services that we do not or cannot
provide.
CRITICAL ACCOUNTING POLICIES
Our accounting policies are important to understanding the financial results
that we report. Our accounting policies are described in Note 1 in the "Notes to
Consolidated Financial Statements" presented in our 2005 Form 10-K. Our most
complex accounting policies require judgment to determine the reported amount of
assets, liabilities, commitments and contingencies. We have established policies
and control procedures that are intended to ensure valuation methods are applied
consistently and that the process for changing those methodologies occurs in a
controlled manner. A brief description of our current accounting policies
involving significant management valuation judgments follows:
Allowance for Credit Losses
The allowance for credit losses represents our best estimate of expected losses
in our loan and lease portfolio. In establishing our provision for credit
losses, we consider the estimated net realizable value, the fair value of the
underlying collateral, as well as several other factors including: (i) current
economic conditions and the related impact on specific borrowers and industry
groups, (ii) historical default experiences, and (iii) expected loss in the
event of default.
While we use available information to recognize losses on loans, additional
credit loss provisions may be necessary based on numerous factors, including
changes in economic conditions. To the best of our knowledge, the allowance for
credit losses includes all losses that we believe are both probable and
reasonable to estimate at the balance sheet date. However, there can be no
assurance that the allowance for credit losses will be adequate to cover all
losses that may in fact be incurred from our present loan and lease portfolio.
Changes in the financial condition of individual borrowers, general economic
conditions, historical loss experience and the condition of the various markets
in which collateral may be sold may all affect the level of our allowance for
credit losses.
Goodwill
We assess goodwill each year for impairment in accordance with SFAS No. 142.
This assessment generally involves evaluating the estimated earnings from the
related assets and liabilities of our business segments based upon the present
value of future cash flows. If the estimated fair value of a business segment,
to which we have allocated goodwill, is less than the financial statement
carrying value of that segment, we would take a charge against earnings to
reduce the value of the goodwill. In our 2005 evaluation of the impairment of
goodwill, we did not identify any individual segment where the fair value was
less than the financial statement carrying value. A more detailed description of
our methodology for testing goodwill for impairment and the related assumptions
made can be found within the "Critical Accounting Estimates" section filed in
Part II, Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" of our 2005 Form 10-K.
17
RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
Overview
Net income for the third quarter of 2006 was $23.6 million, or $0.22 per diluted
share. The results compare to net income of $24.2 million or $0.22 per diluted
share for the same period of 2005. For the nine months ended September 30, 2006
net income was $71.0 million, or $0.66 per diluted share. For the nine month
period, this represents a 2 percent increase in net income and a 5 percent
increase in diluted earnings per share from 2005.
There were two significant and unusual items that impacted our earnings in the
third quarter of 2006. First was the sale of $24.7 million of manufactured
housing loans, acquired as part of the Hudson River acquisition, at a gain and
the related decrease in interest income from that portfolio. Second was the
reduction in the number of members of the Board of Directors from 15 to 10 which
resulted in the recognition of additional compensation expense of $1.9 million
for the retiring directors. Two unusual items impacting the 2005 third quarter
results include a $1.4 million pre-tax gain from the sale of a real-estate joint
venture, as well as a $1.4 million tax charge from the surrender of bank owned
life insurance policies.
Given the constraints of our current operating environment, which includes a
flatter (and at times inverted) yield curve and very competitive loan and
deposit pricing, key trends noted during the first nine months of the year
include:
o 9% annualized loan growth, including double digit annualized
increases in commercial and home equity balances;
o A 2% annualized increase in deposits compared to year-end balances,
including an 8% annualized increase in higher cost certificates of
deposits;
o A decline in the taxable equivalent net interest rate margin to
3.54% for the third quarter;
o Very favorable credit trends; and
o Noninterest income at 31% of total revenues, driven by strong growth
in our financial services businesses.
Analysis of Financial Condition as of September 30, 2006
Total assets were $8.0 billion at September 30, 2006 as compared to $8.1 billion
at December 31, 2005. Key trends include:
o Higher yielding commercial loans represent an increasing percentage
of our total loans;
o Variable rate, relationship-based home equity loans increased at a
20% annualized rate over the first nine months of 2006;
o Deleveraging of our balance sheet, resulting in reductions of $400.8
million in investment securities and $187.2 million in wholesale
borrowings since December 31, 2005;
o The interest rate driven shift in our deposit mix, with certificate
of deposit balances increasing to 40% of deposits from 38% at
December 31, 2005;
o Noninterest bearing deposits increased to $628.3 million, an 8%
annualized increase from December 31, 2005.
18
Loans
Our loan portfolio is concentrated in commercial real estate and business
lending, as well as residential mortgages. Our strategy calls for a continued
emphasis on increasing commercial loan originations because of the higher
yielding nature of these loans. We also actively market home equity loans given
their low credit risk and relationship building benefits. The following table
presents the composition of our loan portfolio at the dates indicated.
(Dollars in thousands) September 30, 2006 December 31, 2005
----------------------------- -----------------------------
Amount Percent Amount Percent
------------ ------- ------------ -------
Commercial:
Real estate $ 1,802,423 32.0 % $ 1,647,576 31.3 %
Construction 234,888 4.2 222,907 4.2
Business 546,976 9.7 473,571 9.0
------------ ------- ------------ -------
Total commercial loans 2,584,287 45.9 2,344,054 44.5
Residential real estate(1) 2,254,295 40.0 2,182,907 41.4
Home equity 463,773 8.2 403,340 7.7
Other consumer 178,131 3.1 178,732 3.4
Specialized lending (2) 156,281 2.8 159,759 3.0
------------ ------- ------------ -------
Total loans and leases 5,636,767 100.0 % 5,268,792 100.0 %
------------ ------- ------------ -------
Net deferred costs and premiums 26,217 19,847
Allowance for credit losses (72,698) (72,340)
------------ ------------
Total loans and leases, $ 5,590,286 $ 5,216,299
============ ============
net
(1) Included in residential real estate loans are $4.5 million and $3.8
million of loans held for sale at September 30, 2006 and December 31,
2005, respectively.
(2) Includes commercial leases, financed insurance premiums and certain
manufactured housing loans.
Total loan balances increased by $368.0 million from December 31, 2005 to
September 30, 2006. This increase was driven by a 14% annualized overall
commercial loan growth, including a 21% annualized increase in commercial
business lending. We also had significant growth in both our residential
mortgage and home equity portfolios which remain key components of our customer
relationship-based strategy.
CREDIT QUALITY, ALLOWANCE FOR CREDIT LOSSES, AND CREDIT LOSS PROVISION
Credit quality is one of the risks we encounter in the ordinary course of
business and is described as how our loans perform relative to their repayment
terms. In general, when loan payments are timely and defaults are low, credit
quality is high. Making loans is inherently risky. No matter how financially
sound a client or lending decision may seem, a borrower's ability to repay can
be affected adversely by economic changes and other factors. In the process of
making loans, we make subjective judgments about a borrower's ability to repay
and the value of any underlying collateral.
Credit risk is the risk associated with the potential inability of some of our
borrowers to repay their loans according to their contractual terms. This
inability to repay could result in higher levels of nonperforming assets, credit
losses, and provisions for credit losses all of which could potentially reduce
our earnings.
We take a number of steps to lessen the risks associated with making loans:
o We base our lending decisions on rigorous underwriting criteria,
which we apply consistently. For commercial loans, we often require
personal guarantees from our clients, and we test our clients'
ability to withstand rising interest rates and economic slowdowns.
We have a credit administration function that implements and
monitors compliance with our underwriting standards.
o We make the majority of our loans within the Upstate New York area.
We target our commercial lending services to small and medium sized
businesses. This geographic and client focus requires us to stay
cognizant of economic and other external factors that may affect our
borrowers' ability to repay.
o We endeavor to keep the composition of our loan portfolio
diversified among various loan types and industry sectors.
o We continually monitor our loan portfolio to identify potential
problems early and to avoid disproportionately high concentrations
of loans to any one borrower, industry or geography.
o We regularly review all past-due loans and those not performing
according to their contractual terms.
o We conduct an internal risk-rating analysis that classifies all
loans outstanding.
o We evaluate the value of collateral when the loan is originated and
periodically monitor changes to its value.
19
We set aside an amount for credit losses that represents our best estimate of
known and inherent losses based on judgments we make regarding loan
collectibility. In calculating the allowance for credit losses, we evaluate
economic factors, historical net loss experience, delinquency trends, and
movements within internal risk rating classifications, among other things. We
continually reassess the allowance and charge loans deemed uncollectible against
the reserve when circumstances do not warrant its continuance as a viable asset.
We credit recoveries, if any, to the allowance.
The portion of the reserve that we do not allocate to specific loans reflects
the inherent losses within the loan portfolio that have not yet been
specifically identified.
Loan growth does not automatically result in increases in the provision and
reserve for credit losses because the allowance reflects the credit quality of
the loan portfolio overall. New loans do not automatically carry higher levels
of risk than loans already in the portfolio.
To us, the primary indicators of credit quality are the level of our
nonperforming and classified loans combined with the net charge-off ratio which
measures loan losses as a percentage of total loans outstanding.
The following table presents the analysis of the allowance for credit losses for
the periods indicated.
Nine months ended September 30,
-------------------------------
(Dollars in thousands) 2006 2005
-------- --------
Balance at beginning of period ........................... $ 72,340 $ 41,422
Net charge-offs:
Charge-offs ........................................... (6,549) (7,452)
Recoveries ............................................ 1,751 2,788
-------- --------
Net charge-offs .................................... (4,798) (4,664)
Allowance obtained through acquisitions .................. -- 30,684
Provision for credit losses .............................. 5,156 4,848
-------- --------
Balance at end of period ................................. $ 72,698 $ 72,290
======== ========
Ratio of annualized net charge-offs to average loans
outstanding during the period ......................... 0.12% 0.13%
======== ========
Ratio of annualized provision for credit losses to average
loans outstanding during the period ................... 0.13% 0.13%
======== ========
Allowance for credit losses to total loans ............... 1.28% 1.37%
======== ========
Credit Quality for the Three and Nine Months Ended September 30, 2006
At September 30, 2006, total loans were $5.6 billion, an increase of 7%,
including a 10% increase in higher risk commercial loans. Since December 31,
2005, while loan balances have increased, our primary credit quality indicators
have improved:
o The ratio of net charge-offs to average loans was .09% for the third
quarter of 2006 as compared to .17% for the third quarter of 2005.
For the nine months of 2006, the ratio of .12% is consistent with
the .13% for the same nine month period in 2005.
o Non-performing loans to total loans was 30 basis points at September
30, 2006 compared to 43 basis points for the same period of 2005 and
41 basis points at December 31, 2005.
o The allowance for credit losses to non-performing loans at September
30, 2006 was 424% compared to the 323% at September 30, 2005 and
330% at December 31, 2005.
20
We place loans on nonaccrual status when they become 90 days past due or earlier
if there is uncertainty regarding the collectibility of interest or principal.
When a loan is placed on nonaccrual status, any interest previously accrued and
not collected is reversed from income.
The following table presents our non-accruing loans and non-performing assets at
the dates indicated.
(Dollars in thousands) September 30, December 31,
2006 2005
------------- ------------
Non-accruing loans:
Commercial real estate ................................. $ 7,196 $ 6,755
Commercial business .................................... 2,960 3,171
Residential real estate ................................ 3,450 5,911
Home equity ........................................... 667 567
Other consumer ........................................ 633 953
Specialized lending ................................... 2,225 4,573
------- -------
Total non-accruing loans ........................... 17,131 21,930
Property acquired through foreclosure ................. 659 843
------- -------
Total non-performing assets ........................ $17,790 $22,773
======= =======
Total non-accruing loans as a percentage of total loans ... 0.30% 0.41%
======= =======
Total non-performing assets as a percentage of total assets 0.22% 0.28%
======= =======
Allowance for credit losses to non-accruing loans ......... 424% 330%
======= =======
In light of the levels of past due, nonaccruing, and classified credits, we
believed that the September 30, 2006, provision for credit losses and allowance
for credit losses reflected a reasonable assessment of inherent credit losses
within our various loan portfolios.
Investment Securities Portfolio
Our securities portfolio is comprised primarily of U.S. government agency
securities, mortgage backed securities, collateralized mortgage obligations,
obligations of states and political subdivisions and corporate debt instruments.
All of our investment securities are classified as available for sale and are
recorded at fair value with unrealized gains or losses, net of the deferred tax
effect, reported as increases or decreases in our stockholders' equity. Portions
of our portfolio are utilized for pledging requirements for deposits of state
and local subdivisions, securities sold under repurchase agreements, and FHLB
advances. Federal Funds sold and certain other short-term instruments are
included in cash and cash equivalents.
Given the flat yield curve and narrow spreads between investment yields and
rates paid on wholesale borrowings, we have been partially funding loan growth
with cash flows from maturing investment securities and increased deposits. As a
result, our securities available for sale decreased $400.8 million from December
31, 2005. Our investment portfolio remains well positioned to provide us a
stable source of cash flow while limiting earnings volatility, as the weighted
average estimated remaining life of securities available for sale at September
30, 2006 was 2.4 years.
Deposits
The following table depicts the composition of our deposits as of the dates
indicated:
(Dollars in thousands) September 30, 2006 December 31, 2005
--------------------------- ---------------------------
Amount Percent Amount Percent
------------ ------- ------------ -------
Core Deposits:
Savings..................................... $ 1,531,048 27.4 % $ 1,619,187 29.6 %
Interest-bearing checking................... 1,219,743 21.9 1,182,995 21.6
Noninterest-bearing......................... 628,321 11.3 592,076 10.8
------------ ------ ------------ ------
Total core deposits...................... 3,379,112 60.6 3,394,258 62.0
Certificates................................... 2,202,362 39.4 2,085,154 38.0
------------ ------ ------------ ------
Total deposits........................... $ 5,581,474 100.0 % $ 5,479,412 100.0 %
============ ====== ============ ======
21
We continue to focus our efforts on deposit gathering and retention given the
importance of this lower cost funding source to support our loan growth. During
the first nine months of 2006, our deposit balances increased $102.1 million, or
3% annualized as we saw a deposit shift from lower-rate core deposits accounts,
which declined $15.1 million during the period, into higher-rate certificate of
deposits accounts which increased $117.2 million,. Our deposit levels continue
to be impacted by our efforts to maintain pricing discipline within our highly
competitive marketplace. As a result, marketing initiatives will continue to
focus on building relationships through core checking accounts, which increased
$73.0 million since December 31, 2005.
Borrowings
We continue to strategically reduce our wholesale borrowings, $187.2 million
since December 31, 2005, given the flat-to inverted yield curve and the very
narrow spreads earned on our investment securities. As an alternative funding
source we expanded our base of municipal deposits. While the margins on these
deposits are narrow, they currently carry a lower cost than new wholesale
borrowings. Since December 31, 2005, our municipal deposits increased 14% to
$351.4 million.
Results of Operations for the Three and Nine Months Ended September 30, 2006 and
September 30, 2005
The following table summarizes our net income, earnings per common share and
other key financial ratios for the periods indicated:
Three months ended Nine months ended
------------------------------- ---------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
(Dollars in thousands, except per share amounts)
Net interest income $ 60,626 $ 63,496 $ 187,015 $ 187,288
Noninterest income 29,602 25,640 83,315 64,452
----------- ----------- ----------- -----------
Total income 90,228 89,136 270,330 251,740
Noninterest expense 53,095 47,808 157,076 137,822
Net income 23,558 24,173 70,964 69,359
Earnings per common share:
Basic $ 0.22 $ 0.22 $ 0.66 $ 0.63
Diluted $ 0.22 $ 0.22 $ 0.66 $ 0.63
Return on average assets, annualized 1.16% 1.20% 1.18% 1.19%
Return on average equity, annualized 6.79% 6.89% 6.91% 6.75%
Return on average tangible equity, annualized (1) 15.02% 14.84% 15.39% 14.18%
(1) Tangible equity is defined as total stockholders' equity less goodwill and
other intangibles assets.
22
Net Interest Income
In the twenty-one months from January 1, 2005 to September 30, 2006, the Federal
Reserve raised its benchmark overnight federal funds rate twelve times,
including six increases since September 30, 2005. Each increase was a 25 basis
point increment over the previous rate. Those interest rate increases resulted
in a more rapid rise in the rates we pay on our interest-bearing liabilities
than in the yields that we earn on our interest earning assets. The result of
these conditions was a narrowing of the net interest spread from the first
quarter of 2005 through the third quarter of 2006. Future changes in market
interest rates or spreads, as well as changes in our asset and liability
portfolios could adversely impact our net interest income and net interest
margin.
The following table presents our condensed average balance sheet information as
well as tax equivalent interest income and yields. A tax equivalent basis is
used in order to provide the most comparative yields among all types of interest
earning assets. That is, interest on tax-exempt securities and loans are
restated as if the interest we earned was taxed at our statutory income tax
rates adjusted for the non-deductible portion of interest expense that we
incurred to acquire these assets. Yields earned on interest-earning assets,
rates paid on interest-bearing liabilities and average balances are based on
average daily balances:
Three months ended September 30,
---------------------------------------------------------------------------------
2006 2005
-------------------------------------- --------------------------------------
Average Interest Average Interest
(Dollars in thousands) outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate
----------- ---------- ------ ----------- ---------- ------
Interest-earning assets:
Loans and leases(1) .................... $ 5,625,084 $ 91,919 6.50% $ 5,101,853 $ 80,733 6.30%
Securities available for sale and
other investments(2) ............... 1,359,116 14,385 4.23 1,784,864 16,659 3.74
----------- ---------- ------ ----------- ---------- ------
Total interest-earning assets .... 6,984,200 106,304 6.06 6,886,717 97,392 5.64
----------- ---------- ------ ----------- ---------- ------
Allowance for credit losses ............... (72,909) (72,778)
Noninterest-earning assets(3)(4) .......... 1,122,018 1,188,643
----------- -----------
Total assets ..................... $ 8,033,309 $ 8,002,582
=========== ===========
Interest-bearing liabilities:
Savings deposits ....................... $ 1,560,235 $ 6,145 1.56% $ 1,669,466 $ 4,736 1.13%
Checking deposits ...................... 1,205,336 5,961 1.96 1,151,334 3,311 1.14
Certificates of deposit ................ 2,236,959 22,889 4.06 1,905,781 13,696 2.86
Borrowed funds ......................... 928,765 9,405 3.99 1,183,924 11,057 3.68
----------- ---------- ------ ----------- ---------- ------
Total interest-bearing
liabilities ................... 5,931,295 44,400 2.97 5,910,505 32,800 2.20
----------- ---------- ------ ----------- ---------- ------
Noninterest-bearing deposits .............. 614,880 584,870
Other noninterest-bearing liabilities ..... 111,460 114,390
----------- -----------
Total liabilities ................ 6,657,635 6,609,765
Stockholders' equity(3) ................... 1,375,674 1,392,817
----------- -----------
Total liabilities and
stockholders' equity ........... $ 8,033,309 $ 8,002,582
=========== ===========
Net interest income ....................... $ 61,904 $ 64,592
========== ==========
Net interest rate spread .................. 3.09% 3.44%
====== ======
Net earning assets ........................ $ 1,052,905 $ 976,212
=========== ===========
Net interest rate margin .................. 3.54% 3.75%
========== ==========
Ratio of average interest-earning assets
to average interest-bearing liabilities 117.75% 116.52%
=========== ===========
23
Nine months ended September 30,
---------------------------------------------------------------------------------
2006 2005
-------------------------------------- --------------------------------------
Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate
----------- ---------- ------ ----------- ---------- ------
Interest-earning assets:
Loans and leases(1) .................... $ 5,478,895 $ 267,004 6.50% $ 4,942,150 $ 231,546 6.25%
Securities available for sale and
investments
other investments(2) ............... 1,518,340 46,897 4.12 1,781,275 48,102 3.60
----------- ---------- ------ ----------- ---------- ------
Total interest-earning assets .... 6,997,235 313,901 5.99 6,723,425 279,648 5.55
----------- ---------- ------ ----------- ---------- ------
Allowance for credit losses ............... (72,659) (73,671)
Noninterest-earning assets(3)(4) .......... 1,126,065 1,148,986
----------- -----------
Total assets ..................... $ 8,050,641 $ 7,798,740
=========== ===========
Interest-bearing liabilities:
Savings deposits ....................... $ 1,582,470 $ 17,275 1.46% $ 1,649,213 $ 12,813 1.04%
Checking deposits ...................... 1,178,656 15,502 1.76 1,176,003 9,430 1.07
Certificates of deposit ................ 2,184,477 61,522 3.76 1,759,985 34,395 2.62
Borrowed funds ......................... 1,033,213 28,353 3.65 1,201,763 32,816 3.63
----------- ---------- ------ ----------- ---------- ------
Total interest-bearing
liabilities ................... 5,978,816 122,652 2.74 5,786,964 89,454 2.06
----------- ---------- ------ ----------- ---------- ------
Noninterest-bearing deposits .............. 587,704 538,579
Other noninterest-bearing liabilities ..... 111,335 100,075
----------- -----------
Total liabilities ................... 6,677,855 6,425,618
Stockholders' equity(3) ................... 1,372,786 1,373,122
----------- -----------
Total liabilities and
stockholders' equity ............. $ 8,050,641 $ 7,798,740
=========== ===========
Net interest income ....................... $ 191,249 $ 190,194
========== ==========
Net interest rate spread .................. 3.25% 3.49%
====== ======
Net earning assets ........................ $ 1,018,419 $ 936,461
=========== ===========
Net interest rate margin .................. 3.65% 3.77%
========== ==========
Ratio of average interest-earning assets
to average interest-bearing liabilities.. 117.03% 116.18%
=========== ===========
(1) Average outstanding balances are net of deferred costs and premiums and
include loans held for sale.
(2) Average outstanding balances are at amortized cost.
(3) Average outstanding balances include unrealized gains/losses on securities
available for sale.
(4) Average outstanding balances include bank-owned life insurance, earnings
on which are reflected in noninterest income.
Our net interest income and net interest rate margin have been impacted by
various factors:
o Loan portfolio growth and the repricing of our variable rate assets
resulted in an increase in both interest income and tax equivalent
yield on our interest earning assets;
o Pressures from the flat (and at times inverted) yield curve, caused
the rates paid on our interest-bearing liabilities to increase
faster than the yield received on our interest-earning assets;
o The continuing shift in our deposit mix from lower paying core
deposits to higher rate certificate and money market accounts; and
o The competitive environment for loans and deposits.
Provision for Credit Losses
Favorable credit quality trends resulted in a third quarter 2006 provision for
credit losses of $1.3 million, or .09% of annualized average loans, as compared
to $1.6 million or .13% of annualized average loans in the third quarter of
2005. On a year-to date basis, the third quarter 2006 provision for credit
losses of $5.2 million compares to the $4.8 million through September 30, 2005.
24
Noninterest Income
The following table sets forth information by category of noninterest income for
the periods indicated:
Three months ended Nine months ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
(Dollars in thousands)
Banking services ......................... $ 9,861 $ 10,115 $ 28,895 $ 27,552
Risk management services ................. 10,855 8,213 33,380 19,655
Wealth management services ............... 1,990 1,700 6,396 5,181
Lending and leasing ...................... 1,608 1,923 5,324 5,269
Employee benefits administration ......... 1,012 362 2,830 362
Gain on sale of manufactured housing loans 2,954 -- 2,954 --
Gain on sale of real estate partnership .. -- 1,377 -- 1,377
Bank-owned life insurance ................ 774 965 2,277 3,093
Other .................................... 548 985 1,259 1,963
----------- ----------- ----------- -----------
Total noninterest income ............ $ 29,602 $ 25,640 $ 83,315 $ 64,452
=========== =========== =========== ===========
As a % of total revenues ............ 32.81% 28.77% 30.82% 25.60%
=========== =========== =========== ===========
We are strategically focused on increasing the ratio of noninterest income to
total revenues in order to help mitigate the volatility created by fluctuations
in the yield curve and the impact that has on our net income. While operating in
a competitively priced (soft) insurance market, the increase in revenues from
risk management services reflects the benefits of our expanded sales force from
the Hatch Leonard Naples, Inc. ("HLN") acquisition. Risk management (insurance)
revenues have also benefited from increased referrals generated by an integrated
relationship-based sales approach utilized by our commercial lenders and risk
management sales teams. The increase in wealth management revenue is a result of
our stepped up efforts within our branch network to have retail sales personnel
licensed to sell our investment products. Expanding these businesses is one of
our key strategic objectives, as they are an important component of our customer
relationship-based strategy.
Our favorable credit quality and highly competitive market resulted in a
reduction of fees collected on loans and leases when comparing the third quarter
of 2006 to the same quarter in 2005.
Other significant events impacting noninterest income variation are as follows:
o In July 2006, we sold the manufactured housing loan portfolio that
was acquired in the Hudson acquisition. The gain on the sale was
$3.0 million;
o In August 2005, we acquired HLN, an insurance agency with operations
across Upstate New York;
o In September 2005, we acquired the Burke Group, an employee benefits
administration and compensation consulting firm; and
o Beginning in the third quarter of 2005, income earned on bank-owned
life insurance decreased due to the surrender of $40.0 million of
policies obtained through acquisitions; and
o In August 2005, we realized a gain of $1.4 million from the sale of
a real estate joint venture.
Noninterest Expense
The efficiency ratio, which is a standard banking industry metric used to
measure the average cost of earning one dollar of revenue, is computed by
dividing noninterest expenses by the sum of net interest income and noninterest
income. Improving the efficiency ratio is achieved through an increase in
revenues and/or a corresponding decrease in operating expenses, which would
generally indicate a more efficient operating structure. Conversely, an increase
in the efficiency ratio would generally indicate a decrease in overall
efficiency. As with any standard ratio, there are limitations inherent in this
measure.
25
The following table shows the major components of operating expenses for the
periods indicated:
Three months ended Nine months ended
------------------------------- -------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
(Dollars in thousands)
Salaries and employee benefits .. $ 31,436 $ 26,006 $ 91,449 $ 71,892
Occupancy and equipment ......... 5,538 4,765 16,452 13,958
Technology and communications ... 5,117 5,091 15,220 13,982
Marketing and advertising ....... 1,775 1,685 5,354 5,539
Professional services ........... 929 1,718 2,861 6,064
Amortization of core deposits and
other intangibles ............... 2,890 3,254 8,964 8,616
Other ........................... 5,410 5,289 16,776 17,771
------------- ------------- ------------- -------------
Total noninterest expense .. $ 53,095 $ 47,808 $ 157,076 $ 137,822
============= ============= ============= =============
Efficiency Ratio ........... 58.8% 53.6% 58.1% 54.7%
============= ============= ============= =============
Increases in noninterest expenses for the three and nine month periods of 2006
include:
o $1.9 million of board fees and accelerated equity awards as a result
of the downsizing of the Board of Directors from 15 to 10 during the
current quarter;
o $1.1 million of severance costs in the second quarter of 2006
resulting from the implementation of certain process improvement
efficiencies;
o Increased commissions attributable to revenue growth in risk and
wealth management;
o Incentive payments related to an increased level of cross-sell
activity;
o Increased occupancy costs related to opening de novo branches and a
new regional market center in Western New York;
o Additional compensation costs related to the expensing of stock
options due to the implementation of SFAS 123(R); and
o Full integration of operating costs associated with the acquisition
of HLN and Burke Group.
The first quarter of 2005 includes $2.3 million of merger costs related to the
acquisition of Hudson River Bancorp, Inc. The decrease in our professional
services expense is primarily related to implementation costs associated with
our Strategic Blueprint initiatives incurred during 2005.
Given the pressures on revenue growth, we have accelerated the implementation of
certain strategic process improvement initiatives. During the second and third
quarters of 2006, we consolidated four branch locations and combined our two
call centers.
Income Taxes
Our effective tax rate for the nine months ended September 30, 2006 declined to
34.4% as compared to 36.4% for same period in the prior year due to the benefit
of our expanding municipal banking business and the related increased investment
in tax-advantaged securities and loans.
26
CAPITAL RESOURCES
For the nine months ended September 30, 2006, we declared three common stock
dividends totaling $0.34 per share, or $36.6 million. This represents a payout
ratio of 52% and a 21% increase over the prior year on a per share basis.
During the first nine months of 2006, we increased our capital $9.5 million
including:
o $34.4 million increase from earnings of $71.0 million net of $36.6
million in cash dividends;
o $1.7 million increase from the issuance of common stock under our
ESOP;
o $5.5 million increase from stock-based compensation activities;
o $2.4 million increase from unrealized gains on securities, net of
taxes; and
o $34.5 million decrease for repurchase of shares.
Given the consistent price of our stock we did not repurchase any of our common
stock during the third quarter of 2006. For the nine months ended September 30,
2006, common stock repurchases were 2.5 million shares. As of September 30,
2006, we remain authorized to repurchase 6.1 million shares, which includes a
5.6 million share authorization from our Board of Directors announced near the
end of the first quarter. While treasury stock purchases are an important
component of our capital management strategy, the extent to which we repurchase
shares in the future will depend on a number of factors including market trends
and prices and alternative uses for our capital.
Our capital ratios continued to exceed the regulatory guidelines for both
well-capitalized and adequately capitalized institutions. The following table
shows First Niagara's ratios as of September 30, 2006. The regulatory guidelines
are intended to reflect the varying degrees of risk associated with different
on- and off-balance sheet items.
To be well capitalized
Minimum under prompt corrective
Actual capital adequacy action provisions
---------------------- ----------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ------- ---------- -------- ---------- ---------
(Dollars in thousands)
Tangible capital $ 574,522 7.90 % $ 109,088 1.50 % $ N/A N/A %
Tier 1 (core) capital 574,522 7.90 290,901 4.00 363,626 5.00
Tier 1 risk based capital 574,522 11.11 N/A N/A 310,376 6.00
Total risk based capital 639,184 12.36 413,835 8.00 517,293 10.00
We review our capital position and make adjustments as needed to assure that our
capital base is sufficient to satisfy existing and impending regulatory
requirements, meet appropriate standards of safety and soundness, and provide
for future growth.
LIQUIDITY
Liquidity refers to our ability to obtain cash, or to convert assets into cash
efficiently and economically. We manage our liquidity to ensure that we have
sufficient cash to:
o Support our operating and investing activities;
o Meet increases in demand for loans and other assets;
o Provide for decreases in deposits and borrowings; and
o Minimize excess balances in lower yielding asset accounts.
Cash, interest-bearing demand accounts at correspondent banks and brokerage
houses, federal funds sold, and other short-term money market investments are
our most liquid assets. The levels of those assets are monitored daily and are
dependent on operating, financing, lending and investing activities during any
given period. Excess short-term liquidity is usually invested in overnight
federal funds sold. In the event that funds beyond those generated internally
are required due to higher than expected loan commitment fundings, deposit
outflows or the amount of debt maturing, additional sources of funds are
available through the use of repurchase agreements, the sale of loans or
investments or the use of our various lines of credit.
Our standing in the national markets, and our ability to obtain funding from
them, factor into our liquidity management strategies. Our credit rating is
investment grade, and substantiates our financial stability and consistency,
over time, of our earnings. Fitch Rating has assigned us a long-term issuer
default rating of BBB and a short-term issuer rating of F2.
27
Factors or conditions that could affect our liquidity management objectives
include changes in the mix of items on our balance sheet; our investment, loan,
and deposit balances; our reputation; and our credit rating. A significant
change in our financial performance or credit rating could reduce the
availability, or increase the cost, of funding from the national markets.
We use a mix of liquidity sources, including deposit balances; cash that is
generated by the investment and loan portfolios; short- and long-term
borrowings, as well as term federal funds; internally generated capital; and
other credit facilities.
As of September 30, 2006, our total cash, interest-bearing demand accounts,
federal funds sold and other money market investments was $124.7 million. In
addition to cash flow from operations, deposits and borrowings, funding is
provided from the principal and interest payments received on loans and
investment securities. While maturities and scheduled amortization of loans and
securities are predictable sources of funds, deposit balances and the pace of
mortgage prepayments are greatly influenced by the level of interest rates, the
economic environment and local competitive conditions.
Our primary investing activities are the origination of loans, the purchase of
investment securities and the acquisition of banking and financial services
companies. The higher level of loan growth and the lower level of investment
security purchases and wholesale borrowings in 2006 reflects our strategy of
funding loan growth and maturing borrowings with the cash flow generated from
our investment securities and deposit growth.
We have a total of $1.04 billion available under existing lines of credit with
the Federal Home Loan Bank, Federal Reserve Bank and a commercial bank that may
be used to fund lending activities, liquidity needs and/or to adjust and manage
our asset and liability position.
In the ordinary course of business, we extend commitments to originate
residential, commercial and other loans to our customers. Commitments to extend
credit are agreements to lend to a customer as long as conditions established
under the contract are not violated. Commitments generally have fixed expiration
dates or other termination clauses and may require the customer to pay a fee.
Since we do not expect all of our commitments to be funded, the total commitment
amounts do not necessarily represent our future cash requirements. We evaluate
each customer's creditworthiness on a case-by-case basis. Collateral may be
obtained based upon our assessment of the customers' creditworthiness. In
addition, we may extend credit commitments on fixed rate loans which expose us
to interest rate risk given the possibility that market rates may change between
the commitment date and the actual extension of credit. As of September 30,
2006, we had outstanding commitments to originate residential real estate,
commercial real estate and business, and consumer loans of approximately $364.3
million, which generally have an expiration period of less than 120 days.
Commitments to sell residential mortgages amounted to $10.7 million at the end
of the third quarter.
We also extend credit to consumer and commercial customers, up to a specified
amount, through lines of credit. The borrower is able to draw on these lines as
needed, therefore the funding requirements for these products are generally more
difficult to predict. The credit risk involved in issuing these commitments is
essentially the same as that involved in extending loans to customers and is
limited to the total amount of these instruments. Unused commercial lines of
credit amounted to $494.8 million at September 30, 2006 and generally have an
expiration period of less than one year. Home equity and other consumer lines of
credit totaled $203.3 million and have an expiration period of up to ten years.
In addition to the above, we issue standby letters of credit to third parties
that guarantee payments on behalf of commercial customers in the event the
customer fails to perform under the terms of the contract between the customer
and the third-party. Standby letters of credit amounted to $63.9 million at
September 30, 2006 and generally have an expiration period of less than two
years. Since the majority of unused lines of credit and outstanding standby
letters of credit expire without being funded, our obligation under the above
commitment amounts is substantially less than the amounts reported. It is
anticipated that we will have sufficient funds available to meet our current
loan commitments and other obligations through our normal business operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- --------------------------------------------------------------------------------
Our primary market risk is interest rate risk, that is, the potential volatility
of our earnings that arises from fluctuations in market interest rates. Changes
in market interest rates, whether they are increases or decreases, and the pace
at which the changes occur can trigger repricings and changes in the pace of
payments, which individually or in combination may affect our net interest
income, positively or negatively.
Most of the yields on our interest earning assets, including floating-rate loans
and investments, are related to market interest rates. So is our cost of funds,
which includes the rates we pay on interest-bearing deposits and borrowings.
Interest rate sensitivity occurs when the interest income (yields) we earn on
our assets changes at a pace that differs from the interest expense (rates) we
pay on liabilities.
Our Asset and Liability Committee monitors our sensitivity to interest rates and
enacts strategies to manage our exposure to interest rate risk. Our goal is to
maximize the growth of net interest income on a consistent basis by minimizing
the effects of fluctuations associated with changing market interest rates. In
other words, we want changes in loan and deposit balances, rather than changes
in market interest rates, to be the primary drivers of growth in net interest
income.
28
The primary tool we use to assess our exposure to interest rate risk is a
computer modeling technique that simulates the effects of variations in interest
rates on net interest income. These simulations, which we conduct at least
quarterly, compare multiple hypothetical interest rate scenarios to a stable,
interest rate environment.
The following table shows the estimated impact on net interest income for the
next twelve months resulting from potential changes in the interest rates. The
calculated changes assume a parallel shift across the yield curve. The effects
of changing the yield curve slope are not considered in the analysis. These
estimates require us to make certain assumptions including the pace of payments
from loan and mortgage-related investments, reinvestment rates, and deposit
maturities. These assumptions are inherently uncertain and, as a result, we
cannot precisely predict the impact of changes in interest rates on net interest
income. Given this, actual results may differ significantly due to the timing,
magnitude and frequency of interest rate changes and changes in market
conditions:
Calculated increase (decrease) at
September 30, 2006
-------------------------------------
Changes in Net interest
interest rates income % Change
---------------------- ------------ ----------
(Dollars in thousands)
+200 basis points $ (5,223) (2.15) %
+100 basis points (2,460) (1.01)
-100 basis points 1,497 0.62
-200 basis points 1,063 0.44
Item 4. Controls and Procedures
- --------------------------------------------------------------------------------
In accordance with Rule 13a-15(b) of the Exchange Act, we carried out an
evaluation as of September 30, 2006 under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e)
under the Exchange Act. Based on that evaluation, our Chief Executive Officer
and Chief Financial Officer have concluded that our disclosure controls and
procedures are effective as of September 30, 2006.
During the quarter ended September 30, 2006, there have been no changes in our
internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, these controls.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
- --------------------------------------------------------------------------------
There are no material pending legal proceedings to which the Company or its
subsidiary are a party other than ordinary routine litigation incidental to our
businesses.
Item 1A. Risk Factors
- --------------------------------------------------------------------------------
There are no material changes to the risk factors as previously disclosed in
Item 1A. to Part I of our 2005 Form 10-K.
29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
- --------------------------------------------------------------------------------
a) Not applicable.
b) Not applicable.
c) The following table discloses information regarding the repurchases of our
common stock made during the third quarter of 2006:
Total number of
shares purchased as Maximum number
part of publicly of shares yet
Number of shares Average price per announced repurchase to be purchased
Month purchased share paid plans) under the plans
------------------ ---------------- ----------------- -------------------- ---------------
July -- $ -- -- 6,076,761
August -- -- -- 6,076,761
September -- -- -- 6,076,761
----------------
Third quarter 2006 -- $ --
================
Item 3. Defaults upon Senior Securities
- --------------------------------------------------------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
- --------------------------------------------------------------------------------
Not applicable.
Item 5. Other Information
- --------------------------------------------------------------------------------
(a) Not applicable.
(b) Not applicable.
Item 6. Exhibits
- --------------------------------------------------------------------------------
The following exhibits are filed herewith:
Exhibits
--------
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
99.1 Summary of Quarterly Financial Data
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST NIAGARA FINANCIAL GROUP, INC.
Date: November 9, 2006 By: /s/ Paul J. Kolkmeyer
-------------------------------------
Paul J. Kolkmeyer
President and Chief Executive Officer
Date: November 9, 2006 By: /s/ John R. Koelmel
-------------------------------------
John R. Koelmel
Executive Vice President, Chief
Financial Officer