First Niagara's HSBC Pain and Gain

NEW YORK (TheStreet) -- For long-term shareholders of First Niagara Financial Group (FNFG), the company's deal to purchase 195 branches from HSBC (HBC) has been a very rough ride, but the shares are attractively priced for investors looking for a solid growth and income play.

First, the bad news: The Buffalo lender late Wednesday priced a $450 million common equity offering at $8.50 a share, and also priced a $350 million preferred offering with a very high coupon of 8.625%. While the dilution to common equity was lower than the original capital raise in the range of $750 million to $800 million the company announced back in August, First Niagara also cut the quarterly dividend on its common shares in half to 8 cents.

The shares were down 2% in early trading Thursday to $8.82.

Sterne Agee analyst Matthew Kelley -- who said in a report on Oct. 20 that the 64 cent annual dividend [remained] "safe" -- still rates the shares a buy, with an $11 price target, although the analyst said in an interview Thursday that "it's undeniable that the common shareholders have suffered a great deal of pain over the past six months over this transaction," with the company's "tangible book value being taken down 30%."

Factoring in the dividends, First Niagara's shares had a negative return of 24% through Wednesday's market close at $8.97, from July 29, the last trading session before the company announced the HSBC deal on Aug. 1

Kelley said he also was surprised at the high coupon for the preferred, saying he would have anticipated a "6.5% to 7% range," but that the 8.625% coupon "only impacts earnings by a penny a share per year."

Kelley also pointed out that even with the reduced quarterly payout, First Niagara's shares would "still provide a healthy 4% yield" at the common offering price of $8.50, and the 32-cent annual payout would represent a relatively low 38% payout ratio, based on the consensus 2012 earnings estimate of 84 cents, among analysts polled by FactSet.

Guggenheim Securities analyst David Darst has a neutral rating on First Niagara, with a $10 price target, and predicted in a Nov. 16 report -- after the company announced that it had reached an agreement with the Justice Department to alleviate anti-competitive concerns by divesting 40 of the acquired HSBC branches and roughly $4 billion in deposits after completing the HSBC deal -- that First Niagara would need to "reduce the dividend to rebuild capital."

So even with the dividend on the common cut in half, First Niagara's payout stacks up decently against most bank stocks. Here are some of the higher paying names among large bank components of the KBW Bank Index (I:BKX):

• The bank holding company with the highest dividend yield among the index components is New York Community Bancorp (NYB) of Westbury, N.Y., with a yield of 8.47%, based on a 25-cent quarterly payout and Wednesday's closing price of $11.80. The company's third-quarter payout ratio was over 90%, on earnings of 27 cents a share.
• Next is People's United Financial (PBCT), with a dividend yield of 4.98%, based on Wednesday's close of $12.66 and a quarterly payout of 16 cents. The Bridgeport, Conn., lender's third-quarter payout ratio was over 100%, with earnings of 15 cents a share, but People's United was very strongly capitalized as of Sept. 30, with a Tier 1 common equity ratio of 17.00%, according to SNL Financial.
• M&T Bank (MTB), which like First Niagara is headquartered in Buffalo, N.Y., has a dividend yield of 3.75%, based on Wednesday's close at $74.64 and a quarterly payout of 70 cents. The third-quarter payout ratio was 53%, based on EPS of $1.32.
• Among the "big four" U.S. banks, JPMorgan Chase (JPM) has the highest dividend yield of 2.94%, based on Wednesday's close at $34.00 and a 25-cent quarterly payout. The third-quarter payout ratio was less than 25%, with EPS of $1.02.

In addition to the 40 branch divestitures the company agreed to in its deal with the Justice Department, First Niagara also plans to sell roughly 60 more branches acquired from HSBC, which Kelley said would be in the "the upstate Adirondack region and the downstate region along the Pennsylvania border."

Kelley believes that with the capital raise behind it, First Niagara is a solid growth play, and that "going forward I see a company that is going to be quite profitable and will generate returns that will put in the top quartile among high performing banks."

While he is still neutral on First Niagara, since under Guggenheim's rating system "we need to have about 15% upside to our target for a stock to be buy-rated," Darst said "the shares are approaching a level where we would consider upgrading them, but they are not there yet."

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.