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Shares of First Niagara Financial Group Inc. (FNFG - Snapshot Report) fell 1.3% following the long-term rating downgrade of the company and its affiliates by Moody's Investors Service – the credit rating arm of Moody's Corporation (MCO - Analyst Report) – last Thursday. The company’s issuer rating was downgraded from Baa2 to Ba1 primarily due to anticipated deterioration in credit quality.

The financial rating of First Niagara Financial’s main operating bank, First Niagara Bank, was downgraded from C- to D+. While the bank’s long-term deposit was revised downward from Baa1 to Baa3, its short-term deposit rating slid from Prime-2 to Prime-3. Moreover, the baseline credit assessment came in at baa3.

However, the overall rating outlook was maintained at stable. This implies a lower possibility of the ratings witnessing any changes in the near term.

The overall economy in the U.S. is reviving, with most of the financial organizations reporting an improvement in credit quality in the last quarter. However, organic growth in the banking industry remained somewhat subdued, given soft demand for loans and sluggish growth in deposits.

The scenario at First Niagara Financial was somewhat different. Although the company reported steady growth in loans with nearly 9% year-over-year increase in 2013, its credit quality continued to deteriorate.

The decline in credit quality can be traced back to May 2012 when First Niagara Financial had acquired the New York branches of HSBC Holdings plc (HSBC - Analyst Report). Following the completion of the deal, total deposits with the company immediately increased to amount more than the total loans.

Now, though First Niagara Financial had capital in hand, it had limited avenues to invest which in turn marred profitability. Therefore the company initiated several measures to aggressively improve its organic loan growth.

As per the rating agency, First Niagara Financial priced its loans at a comparatively lower level than its peers and the terms and conditions related to lending were relaxed to a great extent. Therefore, the quality of the loans was compromised, which increase chances of future defaults.

Additionally, First Niagara Financial’s capital position is not strong enough to withstand the probable credit losses associated with the decline in credit quality. While the company’s risk-weighted tangible common equity ratio of 8.95% is below the baa3 BCA peer median of 11.82%, the Tier 1 leverage ratio of 7.26% lags the benchmark of 10.48%.

The rating downgrade has dampened market sentiment, as evident from the company’s stock price movement. Nevertheless, we remain optimistic about the company’s performance, given its strong fourth-quarter results. Apart from improvement in the top line, First Niagara Financial reported lower expenses as well.

First Niagara Financial currently holds a Zacks Rank #4 (Sell). A better-ranked financial organization is West Bancorp. Inc. (WTBA - Snapshot Report). It has a Zacks Rank #1 (Strong Buy).

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