Fnfg: a Story of Goodwill By: Michael Elias (Seas ’15)

Michael Elias 2920 Broadway 2207 Lerner Hall Tel: 347-967-7550 Email: [email protected]

FNFG: A STORY OF GOODWILL BY: MICHAEL ELIAS (SEAS ’15)

Stock: FNFG – Buy at $8.72, 3-Year Target Price: $12.17

Margin of Safety: 40%

Thesis: First Niagara Financial Group is a regional bank that over- expanded in the landscape of the post-financial crisis to the effect of diluting shareholder value. Despite this over-expansion, there has been a greater overreaction on the part of shareholders, dumping the stock well below its intrinsic value. However, this value was not diluted, it was merely transferred to the “intangible” Goodwill account. When included in the tangible book value, the Bank trades at a 30% discount to its asset value. When conservative estimates of earnings are used over three years, the Bank trades at a 40% discount to its Intrinsic Value

TABLE OF CONTENTS

Table of Contents

Business Overview ______1 Commercial & Retail Banking ______1 Growth By Acquisition ______1 Strong Core Deposits and Customer Relationships ______1 High Quality Loan Portfolios ______1 Industry Overview ______2 The Pain of 2008 ______2 Regulatory Reform ______2 Nature Of Competition ______2 Investment Thesis ______3 Aggressive Expansion Did Not Dilute Value; It Concealed Value ______3 Goodwill: Is It Good At All? ______3 Value of Goodwill ______3 Adjusted Tangible Book Value is Greater Than The Current Share Price by 30% ______4 Three Year Price Target Price: $12.17 ______4 Asset Reproduction Value ______5 Analyzing The Reproduction Cost Of FNFG’s Assets ______5 Cash ______5 Commercial Loan Portfolio ______5 Consumer Loan Portfolio ______5 Inventory ______5 Plant, Property, and Equipment (PPE) ______5 Investment Securities ______6 Advances ______6 Goodwill ______6 Deposits & Other Assets ______7 Intangibles ______7 Liabilities ______7 TABLE OF CONTENTS

Summary ______8 Earning Power Value ______9 Establishishing The Value of Expected Future Cash Flows ______9 Net Income ______9 Future Dividends ______9 Present Value of Future Cash Flows ______10 Catalysts for Growth ______11 Improving Net Interest Margin ______11 Improving Macro Outlook ______11 Insider Buying ______11 Higher Core Deposits Responsible for Greater Revenue ______11 Summary ______12 Misunderstood ______12 Undervalued ______12 Out of Favor ______12 Appendix ______14 Goodwill Analysis: Acquisition ______14 Goodwill Analysis: Sales and Divestitures ______15

FIRST NIAGARA FINANCIAL GROUP Business Overview

COMMERCIAL & RETAIL BANKING First Niagara Financial Group, Inc. is a regional bank holding company operating in the Mid-Atlantic, with a geographic footprint reaching across New York, Pennsylvania, Connecticut, and Western Massachusetts. Through FNFG’s wholly-owned bank subsidiary, First Niagara Bank, N.A. (‘the Bank’ from henceforth), the Bank provides a range of retail and commercial banking, as well as other financial services. The Bank provides its retail consumer and business customers with banking services, including residential and commercial real estate loans, commercial business loans, consumer loans, wealth management products, as well as retail and commercial deposit products. As of December 31, 2013, the Bank had $26.7 billion of deposits, $37.6 billion dollars in assets held throughout 421 full service branches.

GROWTH BY ACQUISITION The bank, over the past 13 years, has aggressively sought to expand the scope of its Mid- Atlantic operations. Total Assets Between 1999 and 2012 the Bank acquired 524 branch $40.000 locations from key competitors, increasing its core $30.000 deposits and net investments roughly twenty-two fold in the 13 year period. This was achieved through a series of $20.000 mergers, acquisition and branch purchases which were $10.000 financed largely through relatively small amounts of $0.000 cash, and large amounts of Bank stock. This had the effect of diluting shareholder value, while piling on deposit premiums to their goodwill account. This billions) in ($ Assets Total Fiscal Year goodwill is an integral component in determining the banks intrinsic value.

STRONG CORE DEPOSITS AND CUSTOMER RELATIONSHIPS Throughout the expansion of the Bank, management has targeted suburban population centers. Through this approach, the Bank has been able to target the suburban homestay of the Mid-Atlantic, providing the suburban communities all of their banking related needs, including helping families achieve the American dream of homeownership, or providing a line of credit for a local start-up. As a result, the Bank is heavily integrated into the fabric of the communities it services, affording the bank a well defendable circle of competence in their domain of operation.

HIGH QUALITY LOAN PORTFOLIOS While expanding aggressively and rapidly, the Bank did a great job in managing the credit quality of their underlying commercial and consumer loan portfolios. More impressive still, the Bank has a Non-Performing Assets ratio 66% less than the national average for comparable banks. The banks had NPA’s constituting .52% of total assets vs 1.5% of competitors.

Page 1 FIRST NIAGARA FINANCIAL GROUP Industry Overview

THE PAIN OF 2008 In the aftermath of the undoubted malfeasance on the part of bankers and underwriters that caused the Financial Crisis of 2008, many investors have been turned off from banks, having taken excruciating losses on their positions. Others, including with mainstream America, have persecuted the banks for their greed and lack of remorse. When juxtaposed, these truths have the effect of leaving many financial institutions undervalued in the absence of investors. If there is anything we learn in the aftermath of 2008, it is that a healthy banking system, which properly facilitates the flow of credit, is the cornerstone of the market economy. The absence of which leads to the breakdown of life as we know it. As a result, the undervaluation of a sector that is essential to life as we know it represents an opportunity to finding value.

REGULATORY REFORM One reason why the banking sector has remained undervalued since the financial crisis, has been uncertainty regarding the future earning power of financial institutions as consequence of the regulatory reform imposed since the financial crisis. The Dodd–Frank Wall Street Reform and Consumer Protection Act, has enacted innumerous regulations on the way that banks conduct business, most directly relating to what depository banks can and cannot do. For this reason, there is a great potential for income streams once treasured by banks to disappear. The bulk of these rules relate to “Systemically Important Financial Institutions”, constituting banks with over $50 billion in assets. First Niagara, with $37 billion dollars in assets, has been spared from any material changes to their business as a result of the new regulations. For this reason, we can assume with a relative degree of certainty that that the earnings of the bank will remain materially unchanged until the $50 billion mark is reached.

NATURE OF COMPETITION As a result of the aggressive expansion pursued by management, the Bank has taken significant market share of available deposits away from its smaller competitors. This has made the bank sufficiently large enough that it can compete with the biggest banks, yet small enough to generate consistent returns on invested capital.

Deposit Market Share in Deposit Market Share in New Connecticut York

RBS Citizens First Niagara Bank Liberty Bank Wells Fargo Bank KeyBank Citibank TD Bank First Niagara Bank Deutsche Bank JPMorgan Chase Bank M&T Trust Company TD Bank Capital One Wells Fargo Bank HSBC Bank USA Bank of America People's United Bank Citibank Webster Bank The Bank of New York… Bank of America JPMorgan Chase Bank 0.00% 10.00% 20.00% 30.00% 0.00% 10.00% 20.00% 30.00% 40.00%

Page 2 FIRST NIAGARA FINANCIAL GROUP Investment Thesis

AGGRESSIVE EXPANSION DID NOT DILUTE VALUE; IT CONCEALED VALUE The straw that broke the shareholders back in 2011-12 was the acquisition of 195 Branches and $9.1 billion of deposits from HSBC for a net deposit premium of $772 million (1% over the Book Value Vs Share Price average historical deposit premium.) With $13.33 $14.00 $12.17 $11.28 this acquisition, the bank had given over to $12.00 HSBC roughly 1/4th of the firms’ tangible $10.00 $8.72 books value. This premium was recorded on $8.00 $6.95 the banks’ balance sheet as goodwill, an $6.00 intangible account from the purview of $4.00 accounting. In most valuation measures, $2.00 little value is given to the goodwill account, $0.00 Book Tangible Share Adjusted Intrinsic particularly measures used to value financial Value Per Book Price Tangible Value Per stocks. As a result, over 60% of the Bank’s Share Value Per (8/22/14) Book Share book value is tied up in this intangible Share Value Per Share account, and intrinsically excluded from the valuations of street analysts. However, by understanding the “hidden assets” the goodwill represents and its value, we can excise a more accurate estimate of the Banks intrinsic value.

GOODWILL: IS IT GOOD AT ALL? In the process of expansion, the Bank added increasing Goodwill & Intangibles amount of goodwill to its balance sheet’s relating to the $3,000 purchase of assets at a premium to their fair market $2,500 value. While many analysts often give little weight to $2,000 this entry, it is critical for an intelligent investor to $1,500 determine the “hidden assets” represented by the $1,000 Goodwill. In the case of the Bank, the “hidden assets” in $ Millions represent the customer deposits that supports the bank. $500 Intrinsically, the value of the goodwill should accurately $0 represent the fair market value of the control premium FY FY FY FY FY FY FY FY 2006 2007 2008 2009 2010 2011 20122013 for the entirety of the Banks deposits. Fiscal Year

VALUE OF GOODWILL In order to determine a conservative value for goodwill, we must look at the history of transactions that the bank has engaged in to determine an acceptable premium for the deposits held by the bank. Historically, the acquisition premium paid by the Bank is 7.25%, while the historical premium received in sales is 5.66%. The largest sale the Bank made was the sale of $2B in deposits to KeyCorp for a deposit premium of $115M. This is the most comprable transaction relative to its current level of assets and will serve as the basis for our goodwill analysis. The implied premium of the KeyCorp sale was 5.75%. Applying this premium to the $26.7 billion of consumer deposits, we determine that a premium of $1.5 billion would need to be paid to acquire the $26.7 billion dollars in deposits held by the Bank. This represents a reproduction cost (what a new entrant

Page 3 FIRST NIAGARA FINANCIAL GROUP would have to pay to replicate the Bank’s current business) of roughly 61.7% of the goodwill account. This value must be added back to the tangible book value of assets in order to more accurately determine the value of shareholder equity.

ADJUSTED TANGIBLE BOOK VALUE IS GREATER THAN THE CURRENT SHARE PRICE BY 30% After determining the reproduction costs of both the assets and liabilities of the Bank, we see the Bank trades at a 30% discount to its asset value. In the graph below, you can see that the Bank has been trading below its adjusted tangible book value. This provides an investor the opportunity to get cheap access to a bank operating 1% below its long-term profitability as a result of historical low interest rates.

THREE YEAR PRICE TARGET PRICE: $12.17 Once we have determined the asset value, the next step is determining the value of the earnings. In order to remain conservative in our valuation, we assume the revenue stream remains constant and operating margins remain about the same. This is to prevent wild ambition on the part of future, uncertain earnings. Understanding that the money the Bank returns to its shareholders come primarily in the form of dividends, we can conservatively project the present value of expected future dividends. Over a three year holding period, we would hold the Banks shares until the full adjusted tangible book value is realized, while accumulating dividends along the way for our patience. In addition to the catalyst for growth on the part of an improving net interest margin, the Bank represents a value opportunity hidden in plain sight, ready to return to its historic price of $12-15 per share.

FY2013 FY2014* FY2015* FY2016* Net Income Growth 75.18% 1.02% 1.02% 1.02% Net Income $295.00 $299.77 $304.41 $309.12 Dividend Payout Ratio (Common Shares) 38.37% 38.37% 38.37% 38.37% Dividend Payments (Common Shares) $113.20 $115.03 $116.81 $118.62 Present Value of Future Dividends N/A $108.52 $103.96 $99.59

Discount Rate 6% Present Value of Future Dividends $312.08 Adjusted Tangible Book Value $3,975.61 ATBV + Expected Future Dividends $4,287.69 Shares Outstanding 352.4 Intrinsic Value Per Share $12.17

Page 4 FIRST NIAGARA FINANCIAL GROUP Asset Reproduction Value

ANALYZING THE REPRODUCTION COST OF FNFG’S ASSETS To determine an appropriate value for the net assets of First Niagara Financial Group, we must analyze the reproduction cost of their balance sheet. Working our way down the balance sheet, we find the cost pursuant to a newcomer to the market, if they were to replicate FNFG’s positions identically.

Cash A new entrant would be forced to pay 100% for the cash account of the business

Commercial Loan Portfolio In the past, the Bank has sold a small subsections of their commercial loan portfolio, comparable to their entire commercial loan portfolio. The portfolio was sold at 99.64% of book value. Historically, commercial portfolios can fetch anywhere between 98-102% of book value when sold. This is determined by many factors including percentage on non-performing assets (NPA) in the portfolio, as well as the underwriting standards utilized in constructing the portfolio. Concordant with Graham’s approach, we will assume the newcomer will can acquire the loan portfolio at the low end of the spectrum, at 98% of book value.

Consumer Loan Portfolio In its history, the Bank has not divested or liquidated any part of consumer loan portfolio, leaving us without a reference standard with respect to their consumer loan portfolio. Consumer Loan Portfolio Book Value Low Mid High However, we can extrapolate one Residential Real Estate $ 3,448 104% 105% 106% by observing the historical high Home Equity $ 2,752 103% 104% 104% and low sale prices of the Indirect Auto $ 1,544 104% 106% 107% individual classes of loan portfolios Credit Cards $ 325 116% 119% 122% constituting the whole consumer Other Consumer $ 302 98% 100% 102% loan portfolio. Again, taking the Total Consumer Portfolio $ 8,371 $ 8,699 $ 8,786 $ 8,874 low end of the historical cost of acquisition, we determine the acquisition will be 103.92% for the present composition of its underwriting standards. This will be the cost of reproduction for the Bank’s Consumer Loan Portfolio,

Inventory It is unclear what the inventory represented on the balance sheet is. To be on the conservative side, we will assume the reproduction cost is half of its books value, a reproduction cost of 50%.

Plant, Property, and Equipment (PPE) As established earlier, the Bank went on an expansion spree, acquiring as many as 520 branch locations in the past 10 years. In the process, the bank has substantially increased the size of PPE account. As it has expanded, it has also depreciated a large portion of its original branch locations to nearly zero. Adding back the value of depreciation to the Bank’s location, we observe that depreciation has eaten away roughly 33% of the firm’s property. Once added back, we determine the reproduction cost to a new entrant would be 149% of the book value. We will exclude the present value of the PPE adjusted to inflation in order to provide a conservative estimate of the value of the Bank’s PPE.

Page 5 FIRST NIAGARA FINANCIAL GROUP Investment Securities The Bank has made investments in various securities with the depository surplus it holds. Investment Securites These investments total $11.3B in a wide range of instruments. As depicted in the figure to the right, Collateralized the Bank has made substantial investment in Mortgage Collateralized Mortgage Obligations, par for the Obligations Residential course for an entity engaging in real estate 8% 5% Mortgage-Backed financing. Other investments include, 8% Securities Debt Securities Collateralized Loan Obligations, Residential 12% 44% Mortgage Backed Securities and a few others. In Commercial order to determine the reproduction cost, we 15% Mortgage-Backed must determine the cost of acquiring these 3% Securities Collateralized securities on the secondary market. The fair price 5% Loan Obligations of these securities is provided in the FY2013 10-K, Asset-Backed and we have much reason to believe that the price Securities of these securities has changed significantly in Corporate Debt either direction since its publishing. On the &Trust Preferred balance sheet, these investments are recorded net of amoritization. Adding back the value of amoritization the the book value, we derive the reproduction costs of these investments. We assume that the value of these securties have not changed significantly in the course of the past few months, as would have been noted in the Q2 Earnings Call.

Advances A bank advance is loan made by a bank to a customer, usually against the security of a property or asset. These advances are generally given to customers in a sudden, unexpected financial position. Given the nature of the situation, it is significantly more likely that these advances will have difficulty, if not default in their lifetime. As such, an appropriate discount should be sufficiently large enough to reflect the increased risk. As such, we shall use a conservative estimate of 60% to represent the cost of reproducing these advances given the higher probability of non-performance.

Goodwill Alas, the part of the balance sheet which often muddles of fact and fiction, as well as past mistakes. In the case of the Bank, its voracious appetite for expansion led to a surge in the value of its Goodwill. While often overlooked or ommited from most analysis, we must determine appropriate value of the “hidden assets” represented by the goodwil. In the Appendix, we can see the amount of goodwill added to the balance sheet and what they got in return for the goodwill. It should be heavily noted that in the case of the Bank, the hidden asset represented by the goodwill is the control premium associated with customer deposits. The corner stone of the banking system are the cash flows from the banks depositors; the more money deposited in the bank, the more money can be earned on it via interest. Keeping in mind that depositors and depositors accounts are the lifeblood of the system, we see why other banks would charge a noteworthy premium to those seeking to acquire them.

In order to determine the fairest reproduction cost associated, we must analyze the historical premium paid, and received for deposits. In aggregate, the Bank paid an average deposit premium of 7.25% on the $33.4B of deposits they have acquired over the years. In constrast, they have received an average deposit premium of

Page 6 FIRST NIAGARA FINANCIAL GROUP 5.66% on the $3.3B of deposits they have sold to competitors. We will assume a 5.66% control premium for the deposits on the current $26.7B in customer deposits. The cost pursuant to a newcomer into the market to acquire the Banks depositis, as well as the value of the Bank’s goodwill is $1.51B, roughly 61% of the Bank’s recorded goodwill. Adding this amount back to the tangible book value translates into the Bank trading at a 30% discount to its book value, making it an exceptional opportunity both in the case of liquidation, but even more so as a going concern.

Deposits & Other Assets We assume that a new entrant must replicate the entirety of the Bank’s core deposits, translating into a reproduction cost of 100%.

Intangibles We are giving zero value to the intangibles of the bank including consumer lists, brand value and other human capital. As consequence, we assume a reproduction cost of 0%.

Liabilities We are assuming the new entrant must pay the full reproduction cost of the banks liabilities which constitute the deposits of its customers, a small percentage of debt, relative to the entire capital structure (D/E ≈ .2), as well as it’s notes payable to suppliers. This represents a reproduction cost of 100% for the firms’ liabilities.

Page 7 FIRST NIAGARA FINANCIAL GROUP SUMMARY $ in MM Reproduction Cost Reproduction Value FY 2013 Cash 100% $463 $463 Marketable Securities Commercial Loan Portfolio 98% $12,601.82 $12,859.00 Consumer Loan Portfolio Real Estate 104% $3,586 $3,448 Home Equity 103% $2,835 $2,752 Indirect Auto 104% $1,606 $1,544 Credit Cards 116% $377 $325 Other Consumer Loans 98% $296 $302 Inventory 50% $25 $50 Notes Receivable $0 Other Current Assets $0 Total Current Assets 100.21% $21,789 $21,743

Net PPE 149% $623 $418 Investment Securities Collateralized Mortgage Obligations 98% $4,882 $4,985 Residential Mortgage-Backed Securities 101% $578 $574 Debt Securities 102% $338 $332 Commercial Mortgage-Backed Securities 104% $1,831 $1,759 Collateralized Loan Obligations 103% $1,431 $1,392 Asset-Backed Securities 101% $905 $896 Corporate Debt &Trust Preferred 101% $872 $863 States & Political Subdivisions 103% $529 $516 Other Non-Current Assets 100% $45 $45 Advances 50% $286.50 $573 Deferred Charges $0 Goodwill 61.7% $1,512 $2,449 Other Intangibles 0% $0 $94 Deposits & Other Assets 100% $989 $989 TOTAL ASSETS 97.30% $36,611 $37,628

Notes Payable 100% $4,822 $4,822 Accounts Payable 100% $26,665 $26,665 Current Portion of Long Term Debt $0 Current Portion of Long Term Debt $0 Accrued Expenses $0 Income Taxes Payable $0 Other Current Liabilities $0 Total Current Liabilities 100% $31,487 $31,487 Deferred Charges (Taxes/Income) $0 Convertible Debt $0 Long Term Debt 100% $734.00 $734 Non-Current Current Capital Leases $0 Other Long Term Liabilities 100% $414.00 $414 Minority Interest (liabilities) $0 Total Liabilities 100% $32,635 $32,635 Tangible Book Value $2,450 Tangible Book Value Per Share $6.95 Average Share Price $8.18 Adjusted Tangible Book Value Per Share $11.28 Adjusted Tangible Book Value $3,975.61

Page 8 FIRST NIAGARA FINANCIAL GROUP Earning Power Value

ESTABLISHISHING THE VALUE OF EXPECTED FUTURE CASH FLOWS Having established an adjusted tangible book value for the Bank, we must shift our focus to determining the value of the cash flows expected from the Bank over the duration of our holding period of 3 years. The bank distributes part of its net income back to shareholders in the form of dividends. In order to project conservatively the value of these future cash flows, we must conservatively project the value of the Bank’s Net Income

Net Income As the bank expanded in the landscape of the post-financial crisis, it saw the size of its asset base increase sizably. Intrinsically, the net income of the firm has increased nearly 300% throughout its expansion. However, this increase in net income came at the expense of a lower net income margin Net Income throughout the expansion process. It was not until 2013 that the net income reached a new $350.00 equillibrium given the new level of assets (the $300.00 Bank had a large non-recurring expense relating $250.00 $200.00 to its HSBC branch acquisition in FY2012.) In $150.00

FY2013, the Bank had a net profit margin of in $ MM $100.00 18.72%, slightly higher than their historical $50.00 average of 15%. Given the scale of their $0.00 expansion, we will assume that they will be able to sustain this margin as a result of their larger asset base. We will assume that Net Income grows at roughly 1% a year, as depicted in Fiscal Year forward projections of net income supplied above. This assumes that the net income stream grows at the same rate as the Bank’s return on assets, roughly 1%. With this conservative assumption, we can calculate the value of future dividend we can expect to receive.

Future Dividends For a company that appears to be in financial distress, as observed by the share price, the bank Dividend Payout Ratio has paid exceptionally high percentages of its net 140% income out to shareholders. In 2013, at the end of 120% its expansion phase, the Bank offered a dividend 100% payout ratio of 38%, returning $113M to its 80% 60% common shareholders. This is well below the 40%

historical payout ratio and can serve as a means of Net ofIncome % 20% conservatively estimating future dividends. 0% Assuming the low end of the historical dividend payout ratio, we can conservatively calculate the future value of expected dividends. Fiscal Year

Page 9 FIRST NIAGARA FINANCIAL GROUP

Present Value of Future Cash Flows Up to this point, we have assumed a net income growth of 1%, as well as a dividend payout ratio of 38%. We can calculate now calculate the present value of the expected future dividends. By performing a discounted cash flow analysis, we determine that present value of future dividend cash flows is approximately $312 million dollars, with a discount rate of 6%. This is the amount that shareholders can expect to receive over the three year holding period. Adding the adjusted tangible book value to the expected future cash flows, we determine the Intrinsic Value of the Bank to its shareholders. Dividing this amount by the intrinsic value by the number of shares outstanding, we determine that the Bank has an intrinsic value to its common equity shareholders of $12.17, implying a margin of safety of 40% over its current share price

Discount Rate 6% Present Value of Future Dividends $312.08 Adjusted Tangible Book Value $3,975.61 ATBV + Expected Future Dividends $4,287.69 Shares Outstanding 352.4 Intrinsic Value Per Share $12.17

Page 10 FIRST NIAGARA FINANCIAL GROUP Catalysts for Growth

In our analysis, we have given almost zero value to growth opportunities. This is because a bird in the hand is certainly worth more than two in the bush. In our valuation, it is imperative that we restrict our assumptions regarding the future, less certain cash flows. By giving zero value to growth, we are getting all of the catalysts for growth for free. This provides an investor the opportunity to get cheap access to a bank operating 1% below its long-term profitability as a result of historical low interest rates.

IMPROVING NET INTEREST MARGIN Frequency: Quarterly, End of In the wake of the financial crisis, we have seen a Period USNIM significant drop in interest rates with respect to 6.00% historical levels, as a result, banks have seen some 5.00% of their profitability squeezed. With the 4.00% expectation that the Federal Reserve will increase 3.00% the short term rate in either 2015 or 2016, we can 2.00% expect banks to see an increased profitability as a 1.00% result of the reversion to longer term historical net 0.00% interest margins. This increase of roughly 100 basis points to the historic levels will increase the banks

pretax profit by roughly $370 million dollars

1986-01-01 1988-02-01 1990-03-01 1992-04-01 1994-05-01 1996-06-01 1998-07-01 2000-08-01 2002-09-01 2004-10-01 2006-11-01 2008-12-01 2011-01-01 2013-02-01 Time (5 Quarters) IMPROVING MACRO OUTLOOK With the number of people unemployed steadily decreasing, payroll numbers increasing and consumer spending levels rising again, it is relatively safe to say that an acceleration of economic activity is abound. With increased spending, the Bank will return more money from its interest income operations. In addition, stronger economic activity implies higher levels of deposit available for reinvestment by the bank, resulting in higher net income.

INSIDER BUYING While not necessarily a catalyst for growth, the fact that the Bank’s management have steadily and consistently been buying shares for their personal accounts. This is a sign that the Bank is undervalued, since those who are most familiar with its operations are buying up the shares, and this putting their money where their mouth is. Even more noteworthy, the buying is occurring among all of the banks management, with not one employee selling their shares in the past year.

HIGHER CORE DEPOSITS RESPONSIBLE FOR GREATER REVENUE With higher deposit levels, the bank will see an increase in its ability to generate larger amounts of free cash flow for its investors. This juxtaposed with a higher net interest margin translates to heightened profitability for the bank.

Page 11 FIRST NIAGARA FINANCIAL GROUP Summary

The history of capital markets are littered with undervalued securities that became so by virtue of human misjudgments. The story of First Niagara Financial Group is one that shares much in common with these securities. The three following phrases adequately represent the manner in which this opportunity would be attractive to an investor seeking value.

MISUNDERSTOOD After sailing through the turbulent vicissitudes of the financial crisis, the Bank capitalized on their healthy position by expanding the breadth of their operation into an adjacent geographical region (Pennsylvania) as well as strengthening their hold on their primary market of operation, New York and Connecticut. After three profitable acquisitions, the Bank paid above 1% of the average premium in an effort to acquire $9B in deposits from HSBC USA Inc. in late 2011. Investors at the time, thought this was a foolish transaction and a sell off ensued. Under pressure from the remaining shareholders, CEO John Koelmel, who had led the expansion, resigned after holding out for over a year. During that year, the stock reached record lows. After an interim CEO, Gary Crosby, was announced as they underwent the search process for a new CEO. The stock surged on hopes of the Bank installing more “competent” management. Later the Bank announced that Crosby would remain CEO, giving explicit forward guidance, stating “We’re out of the (mergers and acquisitions) business and we’re going to focus on the business that we have built over the last handful of years and building long-term shareholder value out of that business.” With their expanded pool of assets, and new management, the Bank is poised to have a long career of providing financing to its communities.

UNDERVALUED While the HSBC transaction did come at the cost of reducing the Bank’s tangible book value, it did not destroy value you as shareholders wrongly assumed, it merely concealed it in a place that most equity analysts, bankers and traders would never bother to look, the Goodwill account. Once it is realized that the value of the goodwill represents the control premium on deposits in their vaults, the stock price will more accurately reflect its intrinsic value. The Banks asset value alone surpasses the current stock price by 30%, without including the value of earnings and growth. This provides a sufficient margin of safety in the net assets great enough to protect the investor from loses in the case of liquidation (low debt in capital structure)

OUT OF FAVOR In the fallout associated with the financial crisis, many investors with exposure to banks experienced unprecedented losses. As consequence, banks and other financial service providers have been undervalued on the whole since 2008. The reason lies in the uncertain future earning power of banks in the face of regulatory

Page 12 FIRST NIAGARA FINANCIAL GROUP reform pursuant to the Dodd–Frank Wall Street Reform and Consumer Protection Act. With some regulations still being developed and others still not enforced, it is unclear what the affect will be to banks. Luckily, the Bank is spared from many of the regulations enacted by Dodd-Frank, since the bank does not have the requisite $50B in assets to be considered a “Systemically Important Financial Institution.” The largest impact of the regulations comes in the ability of the bank to purchase certain types of asset-backed securities, which constitute less than 3% of the Bank’s investment portfolio.

Page 13 FIRST NIAGARA FINANCIAL GROUP Appendix

GOODWILL ANALYSIS: ACQUISITION Goodwill Transaction Generated ($ in Deposits Acquired Implied Deposit Company Type 000’s) ($ in 000’s) Premium Branch HSBC USA. Inc Acquisition $772,000.00 $9,100,000 8.48% PNC Financial Services Group, Branch Inc. Acquisition $130,079.00 $3,893,699 3.34% Company New Alliance Bancshares Acquisition $676,727.00 $8,712,097 7.77% Harleysville National Company Corporation Acquisition $130,889.00 $5,646,195 2.32% Company Great Lakes Bancorp Acquisition $41,769.00 $891,973 4.68% Company Hudson River Bancorp Acquisition $352,528.00 $2,579,259 13.67% Company Troy Financial Corporation Acquisition $218,091.00 $1,247,755 17.48% Company Finger Lakes Bancorp, Inc Acquisition $32,811.00 $387,818 8.46% Company Iroquois Bancorp, Inc. Acquisition $43,800.00 $595,126 7.36% Company CNY Financial Group Acquisition $17,000.00 $296,294 5.74% Company Albion Banc Corp. Acquisition $7,600.00 $78,711 9.66% Total Goodwill $2,423,294.00 Total Deposits Acquired $33,428,927.00 Average Deposit Premium Paid 7.25%

Page 14 FIRST NIAGARA FINANCIAL GROUP

GOODWILL ANALYSIS: SALES AND DIVESTITURES

Transaction Premium Deposits Sold Implied Deposit Company (Number of Branches) Type Received Premium Financial Institutions, Inc. (8 Branch $286,500.00 Branches) Divestiture $15,032.00 5.25% Community Bank System, Inc. (19 Branch $797,400.00 Branches) Divestiture $31,000.00 3.89% Branch $2,000,000.00 KeyCorp (37 Branches) Divestiture $115,000.00 5.75% Branch $19,700.00 C.C.Bancorp, Inc. (2 Branches) Divestiture $585.00 2.97% Elmira Savings Bank, FSB (4 Branch $78,000.00 Branches) Divestiture $12,230.00 15.68% Branch $76,629.00 Legacy Bancorp, Inc. (5 Branches) Divestiture $9,770.00 12.75% Pathfinder Bancorp Inc. (MHC) (1 Branch $26,400.00 Branch) Divestiture $2,400.00 9.09% Total Premium Collected $186,017.00 Total Deposits Sold $3,284,629.00 Average Deposit Premium Collected 5.66%

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