In yesterday’s post I mentioned the TD-First Horizon situation as something that might be discussed at the various Congressional hearings this week, suggesting it could be good to ask representatives of the Federal Reserve Board and the OCC what specifically led them to conclude (based on publicly available reports at least) that TD Bank’s anti-money laundering practices may have been inconsistent with approval.
A few readers reached out to respectfully submit that I was being too credulous by taking the AML explanation at face value, saying I should have recognized an obvious pretext from the agencies for what it was. You can form your own opinion about that, but in any case this reader feedback got me thinking of at least one thing about the situation as publicly described that does not really add up.
The story that has been related to us in public materials is not that TD and First Horizon were definitively told by the agencies the transaction would not be approved, but rather that, per the subhead of the termination announcement, TD was “Unable to Obtain Timetable for Regulatory Approvals.” See also these comments from First Horizon on its special investor call after the termination was announced:
[Analyst]: … [O]bviously, a lot of people listening that have been involved and around your stock. And I know you said you can't say much, but is it as simple as big picture to frame this? TD couldn't get a reasonable approval time line. You both decided to walk away. There's 2 sides to every story, but essentially, you don't have any restrictions or regulatory concerns about your business as you move forward? You're free to operate as an independent company, and there's nothing burdening you at all, if that's a fair way to ask it.
[FHN CEO D. Bryan Jordan]: Yes. Yes, I'll state it back in what I think is as concisely as you articulated, we were unable to achieve a time line for approval. The issues are unrelated to First Horizon and there are no restrictions on our ability to operate the bank as we have for the last 159 years.
So, unable to obtain this timeline and faced with the possibility that the agencies would leave the merger hanging for an even longer period of time than they already had, TD decided to call off the deal.1
A few articles covering these recent developments have drawn parallels to a prior merger that was allowed to pend for a very long time. For example, in Canadian media coverage:
“It’s baffling to us because TD is one of the highest rated banks that we have globally, so we think their risk management and the way they operate is very strong,” [Michael Driscoll, who leads the North American financial institutions group at Morningstar Inc.’s DBRS Morningstar,] said. “And they’ve done — granted smaller ones — but they’ve done U.S. acquisitions prior, so it’s really puzzling to us.”
Driscoll noted that other bank transactions have faced long delays in the U.S. but were ultimately consummated, even when they concerned anti-money-laundering issues, such as M&T Bank’s US$3.7 billion purchase of Hudson City Bancorp., which took three years to finally close in 2015.
The Philadelphia Business Journal’s write up of the TD-First Horizon termination also cited the M&T-Hudson City Bancorp transaction, as did the WSJ article linked above.
But there is a problem with this comparison.
The 2012-2015 M&T-Hudson City Saga
As the Board explains in its 2015 M&T order, after M&T originally agreed to buy Hudson City in 2012, examinations of M&T by the FRBNY “revealed significant weaknesses” in M&T’s BSA/AML compliance program. On top of this, the FRBNY and CFPB also subsequently identified weaknesses in M&T’s consumer compliance practices.
BSA/AML weaknesses and consumer compliance concerns are the issues most often fatal to a proposed bank merger because, as the order explains, the Board believes these issues “raise[] concerns about whether the company’s managerial resources and the managerial resources of the proposed combined organization [are] consistent with approval.”
Ordinarily that would have been it for the M&T-Hudson City deal, but then something unexpected happened. M&T asked the Board to stay its consideration of the proposal while M&T worked to fix the identified weaknesses. Even though this was “highly unusual,” the Board ultimately agreed.
Thus the merger continued to pend and action by the Board was delayed until a few years later. Once M&T had devoted significant time and resources to addressing these supervisory issues, the Board concluded that “considerations relating to the financial and managerial resources and future prospects of the organizations involved, as well as the records of effectiveness of the organizations in combatting money-laundering activities, are consistent with approval.” Because other factors were also consistent with approval, the deal was then approved, subject to conditions.2
A Footnote
Perhaps wary of establishing an uncomfortable precedent with the M&T approval order, the Board included a footnote saying that a situation like this would not be allowed to happen again.
The Board expects that a banking organization will resolve all material weaknesses identified by examiners before applying to engage in expansionary activity. See, e.g., SR Letters 14-2 and 13-7. As noted, M&T’s issues largely arose during processing of this application, and the Board took the highly unusual step of permitting the case to pend while M&T addressed its weaknesses. The Board does not expect to take such action in future cases. Rather, in the future, if issues arise during processing of an application, the Board expects that a banking organization will withdraw its application pending resolution of any supervisory concerns.
Some saw this footnote as saying something new; others including the law firm most active in bank M&A saw it another way:3
The Federal Reserve’s approval of the M&T/Hudson City transaction is undeniably positive for M&T and for bank mergers generally. Despite this, there has been broad speculation about the meaning of a “footnote” to the approval order. There, the Federal Reserve noted that that it took the unusual step of allowing M&T’s application to remain pending while M&T addressed the concerns identified by the regulators, but that it does not expect to do so again in future applications. The Federal Reserve commented that “if issues arise during processing of an application, the Board expects that a banking organization will withdraw its application pending resolution of any supervisory concerns.”
A number of commentators have conjectured that this seemingly harsher stance on withdrawals marks a fundamental change. In fact, it is not. It has long been the Federal Reserve’s practice to require that an application be withdrawn if materially adverse issues arise. The Federal Reserve highlighted this longstanding position in supervisory guidance issued in February 2014, “there are instances when substantive issues are not resolved during the application review process, and Federal Reserve staff recommends that the Board deny the proposal. In such cases, the Federal Reserve’s general practice has been to inform the filer before final Board action that staff would recommend denial of the proposal to the Board in order to provide the filer the option to withdraw the application or notice.”
But regardless of whether one viewed the footnote as announcing a new policy or as merely restating a longstanding practice of the Board, the bottom line was clear. The footnote describes a binary choice: either the Board has supervisory concerns with an organization that make the application inconsistent with approval, such that application must be withdrawn, or it does not.4
There is not supposed to be a third path in which the Board after 14 months tells the applicant “maybe there are supervisory concerns blocking approval, maybe there aren’t; we’ll let you know in a while, can’t say when.”
Back to TD-First Horizon
So if that is the policy, where does that leave us in terms of what happened in the TD-First Horizon case?
One explanation is just that everyone is talking past each other, intentionally or otherwise, and so something has been lost or garbled in the reporting. Under this interpretation when TD and First Horizon say TD could not get the agencies to give them a timetable, they really mean that the agencies told TD the application was unlikely to be approved and so should be withdrawn. This possibility cannot be ruled out, but it is at least in tension with, or even directly contradicted by, the parties’ public statements, so let’s set it aside for now.
Instead, let’s assume in the alternative that everything so far stated or reported publicly is accurate. That is, even 14 months after the TD’s applications to the Board and OCC were submitted, the agencies were uncertain whether TD’s AML practices were consistent with approval. And, more to the point, the agencies were so uncertain that they could not even provide a timeline to TD for when they might become certain and be able to decide on the application one way or the other. As a result, TD “could not provide assurance of regulatory approval in 2023 or 2024.”5
If this is true, doesn’t this contradict the approach described by the Board in its 2015 M&T order? If AML or other supervisory issues are identified, the Board said it would “expect” (read: require) a banking organization to withdraw its application pending resolution of such issues. Again assuming the veracity of all the public statements and reporting, this was not what the Board did here, instead taking a more sphinx-like approach.
I guess it is possible that the Board has, without public announcement, changed the longstanding position it articulated in the 2015 M&T order, and now applications from banking organizations with supervisory concerns may in fact be allowed to pend while the organization works to address those concerns.6 But that would be a weird change to make, and it would be even weirder to make it silently without public explanation, and it would be even weirder still to do it in the context of a deal for a regional bank during a period of stress for many regional banks.
***
Not for the first time, I do not really have a neat conclusion to this post. All this is just a roundabout waying of me saying that, with the benefit of hindsight, I wonder whether was I too dismissive yesterday of the Keith Noreika/Bryan Hubbard argument that the current situation amounts to a de facto ban on large bank M&A (unless of course the target bank has failed).7 In any case, even if these former OCC officials are wrong on that point, it is tough disagree with this one:
When applications for mergers and acquisitions pose an actual threat to the safety and soundness of the system, to competition or to the convenience and needs of consumers, regulators should act in a timely manner to disapprove such proposals. When proposals meet criteria for approval, regulators should act on their independent authority to approve them.
Thanks as always for reading. After allegedly being too credulous to the agencies yesterday, have I overcorrected and been too suspicious here? What else have I missed? Thoughts, challenges, criticisms are welcome at bankregblog@gmail.com.
The ticking fee structure under the merger agreement may also have been a consideration. As described by TD in its initial application:
In the Parent Merger, each share of FHN common stock issued and outstanding as of the effective time of the Parent Merger (other than shares owned by FHN as treasury stock or owned by FHN, TDB or TDGUS in a non-fiduciary or non-agency capacity and not as a result of debts previously contracted) will be automatically converted into the right to receive an amount in cash equal to $25.00. In the event that the effective time of the Parent Merger occurs more than nine months after the date of the Parent Merger Agreement, the per-share merger consideration will be increased by an additional amount of cash equal to $0.0017808 per day (equivalent to an annualized rate of 2.6% of the per share cash merger consideration) from the end of such nine-month period to the day immediately prior to the closing date of the Parent Merger
For instance:
The Board also expects that M&T will not engage in any expansionary activities, except for establishing branches in historically underserved communities, until supervisors are satisfied that the integration with Hudson City has been satisfactorily completed and examiners have confirmed that all risk-management and compliance systems at M&T are fully implemented, functioning effectively, adequate for proactively identifying and promptly addressing all risks within the combined organization, and reflective of its greater size and complexity.
Not directly relevant to this post but illustrative of the cyclical nature of these things: that October 2015 Wachtell memo hails the fact that a merger logjam at the Board was beginning to clear and that the Board was sending an “unmistakable signal that the bar for bank M&A transactions—even those involving large banks—has stopped rising.” This was good news for “properly structured transactions by experienced and skilled acquirers that understand the evolving new regulatory expectations” and so can expect to “receive approval on a reasonable and predictable timeline.”
Of course this does not guarantee approval on its own - other factors must also be consistent with approval.
This quote is from the First Horizon update call linked to earlier in the post.
This assumes of course that both parties, their employees, and other stakeholders will be willing to wait out the agencies, which was not the case here and is probably unlikely to be the case most of the time.
The reason I am hesitant to completely adopt this theory is that it still needs to answer the question of why the agencies have imposed a de facto ban now only after the Board and OCC have under the same leadership earlier approved other large regional bank deals like U.S. Bank-MUFG Union Bank and BMO-Bank of the West, or even slightly smaller deals like NYCB-Flagstar, which was for unexplained reasons too hairy for the FDIC to approve, but good enough for the Board and the OCC.