TD, First Horizon terminate US$13.4-billion takeover, halting TD’s expansion in the U.S. southeast

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Toronto-Dominion Bank’s TD-T US$13.4-billion deal to buy Tennessee-based First Horizon Corp. FHN-N has been called off, allowing it to walk away from an ambitious takeover that some investors had soured on.

The termination of the deal, which the two banks said was done by mutual agreement, means TD is abandoning its most significant strategic move in years, giving up on an acquisition that would have made it the sixth-largest bank in the United States by assets, and would have offered it a path to expand its reach in the southeastern U.S., a long-sought goal for its leadership.

In the near term, analysts say there is upside for TD in scrapping the deal. The bank struck its purchase agreement with First Horizon last year at a premium price of US$25 a share, or 2.1 times the U.S. bank’s book value. After a subsequent period of turmoil in U.S. banking sent shares in regional lenders tumbling, dragging First Horizon’s stock price down to US$15.05 as of Wednesday’s close of trading, that price had started to look far too high.

Breaking off the deal also leaves TD flush with capital at a moment of acute economic uncertainty, when Canada’s banking regulator has been pushing minimum capital levels for Canada’s largest banks higher.

But it raises longer-term questions about TD’s ability to get potential future U.S. deals approved by American regulators, and leaves the Canadian bank with a diminished set of options for expanding its operations at home or abroad at a moment when rivals Royal Bank of Canada RY-T and Bank of Montreal BMO-T have both bulked up with landmark acquisitions.

The original Feb. 27 deadline for TD and First Horizon to close their deal was extended to May 27, but then TD warned in early March that it was struggling to secure approvals from U.S. regulators in a timely manner.

On Thursday, the banks announced their decision to scrap the transaction – a course of action they had only recently begun contemplating, according to First Horizon chief executive officer Bryan Jordan. TD said it had told First Horizon it did not have a timetable for winning regulatory approval. The agreement to terminate was signed late Wednesday night.

“We pursued every possible path to complete this transaction, without success,” Mr. Jordan said on a Thursday conference call. “I’d like to be very clear: The fact that regulatory approvals weren’t able to be obtained by May 27 did not relate in any way to First Horizon.”

First Horizon’s share price plunged in early trading, then rallied slightly to close down 33 per cent on Thursday, at US$10.06. TD’s share price hardly budged, closing up 0.25 per cent, at $81.67.

First Horizon’s falling share price over the past few weeks prompted some analysts to speculate that TD would seek to negotiate a lower purchase price. Two weeks ago, TD CEO Bharat Masrani told shareholders at his bank’s annual meeting that “we see the benefits of the merger.”

“That’s why we are into an extension and a discussion with First Horizon,” he added.

On Thursday, First Horizon’s CEO said no negotiations to alter the deal ever took place. “At no time did we discuss any changes in price or any other changes to the structure of the deal,” Mr. Jordan said on the conference call.

In a prepared statement, Mr. Masrani said TD is “disappointed with the outcome,” but that the decision “provides our colleagues and shareholders with clarity.” In a memo to staff, he said terminating the deal was the right move, “given the continued uncertainty on the timing of regulatory approvals.”

TD will pay First Horizon a US$200-million break fee in cash, as well as a US$25-million fee reimbursement, according to the original terms of the agreement.

Uncertainty about the fate of the First Horizon deal has weighed on TD’s stock, which has declined about 12 per cent over the past three months. Investors had expressed concerns about the price and timing of the deal because the banking sector is struggling. Share prices have dropped dramatically since the collapse of Silicon Valley Bank set off a panic in U.S. banking and put U.S. regional lenders under intense scrutiny.

In that context, some TD investors are signalling their relief.

“TD is walking away from a deal that was agreed to and priced in what seems like a different world for US regional banks,” Meny Grauman, an analyst at Scotia Capital Inc., said in a note to clients. “For TD to move to the sidelines now in this environment with a group-high CET1 ratio is not a bad thing,” he added, referring to the bank’s common equity Tier 1 capital ratio, a key measure of a bank’s capital levels and financial strength.

Yet TD is also losing out on an anticipated boost to profits that would have resulted from integrating First Horizon with its own operations and stripping out costs. And there are pressing questions about how TD will use the capital it isn’t spending on First Horizon to expand its business. In a much smaller deal, TD recently bulked up its U.S. capital markets business by acquiring New York-based investment bank Cowen Inc. for US$1.3-billion.

“The market needs to realize that there is a very complicated reappraisal of TD’s overall growth strategy that needs to come on the other side of this,” Mr. Grauman said.

Other Canadian banks are successfully expanding through acquisitions. Bank of Montreal BMO-T completed its $17.1-billion acquisition of California-based Bank of the West last month after facing less severe regulatory delays, narrowing TD’s advantage in the U.S. banking market. And TD’s chief rival, RBC, is buying HSBC Canada for $13.5-billion, pending regulatory and government approvals, securing what was widely seen as the crown jewel of the remaining acquisition targets in Canada.

TD is believed to have been one of the final bidders for HSBC Canada. But, with the First Horizon and Cowen deals pending, it may have faced constraints on its capital that RBC didn’t have.

Neither TD nor First Horizon have explained what held up regulatory approvals for the deal.

Approvals for U.S. bank mergers come from the Federal Reserve, the Office of the Comptroller of the Currency and other authorities. Such deals are attracting heightened scrutiny under U.S. President Joe Biden’s administration.

The regulatory issues at play “must be more serious than we had assumed,” RBC Dominion Securities Inc. analyst Darko Mihelic said in a note. “We therefore believe TD’s future ability to close U.S. deals may be in doubt and TD’s credibility as an acquirer has been dealt a blow.”

For now, TD may choose to use some of its robust capital reserves to buy back stock while it re-evaluates its options. It has more than $20-billion in extra capital above regulatory minimums, with the highest CET1 ratio of any major Canadian lender, at 15.5 per cent.

“I don’t think they will necessarily be quick to pivot to another target,” Jim Shanahan, an analyst at Edward Jones, said in an interview. “TD has long coveted a dense branch network in Florida and there aren’t really any other sizable acquisitions that would help them accomplish that.”