Tuesday, November 21, 2006

TD Bank to Take TD Banknorth Private

Scotia Capital, 21 November 2006

TD Bank to Acquire Remaining 41% of TD Banknorth - Shift in Strategy

• TD Bank announced that it will buy the remaining 41% stake in TD Banknorth for US$32.33 per BNK share or US$3.2 Billion (C$3.6 billion) in an all cash offer. The purchase price represents 15.8x 2007 EPS of US$2.05 per share and 6.5% premium to the closing price on November 17, 2006.

• Closing of the transaction is expected for March or April 2007. This transaction is expected to be accretive to TD by C$0.05 per share in 2007 and C$0.16 per share in 2008.

• TD's Tier 1 capital will decline to 9.8% from 12.1% and tangible common equity ratio will decline to 7.0% from 9.1%. The transaction will be financed by C$3.0 billion primarily of subordinated debt.

Shift in Strategy

• The 100% ownership of TD Banknorth we believe increases TD's strategic flexibility in terms of restructuring, sale, or vending it into a larger entity in the U.S. This buy-in represents a major shift in strategy as TD Banknorth was not the currency for U.S. expansion that the bank had initially anticipated. This step we view as necessary in an attempt to maximize returns from this investment over the next two to three years.

Shareholder Approval

• TD indicated that two large shareholders with discretion over 26 million of the total 99 million shares to be bought in have indicated that they view the transaction favourably.

• Private Capital Management (PCM), which owns 18.2 million BNK shares, and Aerial Capital Management (ACM) which owns approximately 8 million BNK shares, have indicated that they will vote in favour of the transaction.

Total Investment in TD Banknorth US$8.5 Billion

• Upon privatization of BNK, TD will have spent a total of US$8.5 billion or an average of US$35.21 per BNK share for 100% ownership in TD Banknorth. TD paid US$40 per share for its original 51% ownership in BNK.

• Pro-forma, BNK earnings will represent 13% of TD's earnings, versus the current 7% (YTD as at Q3/06).


• We view the transaction from a financial perspective as positive given the weak share price performance of TD Banknorth, small premium and accretive nature of the transaction (increased leverage). However, operational challenges at TD Banknorth remain, including competition, earnings pressure and low shareholder returns.

• Maintain 2-Sector Perform rating on shares of TD Bank.
Financial Post, Theresa Tedesco, 21 November 2006

'The key is admitting what you don't know."

That's how Ed Clark, president and chief executive of Toronto-Dominion Bank, explained his decision not to tamper with the existing management team at Banknorth Group Inc. just after his bank bought a majority stake in Maine's largest retail bank in 2004.

Two years -- and dismal returns on investment capital -- later, Clark has clearly decided he knows better.

The chief pinstripe most likely to win the award for best executive micro-manager on Bay Street announced that TD, Canada's second-largest by assets, plans to spend US$3.2-billion to buy out the 43% of TD Banknorth it doesn't already own.

The plan is to privatize the U.S. consumer bank, one of the largest in the northeastern United States. And to smooth that along, Clark shoved over William Ryan, TD Banknorth's current CEO and president, and installed his trusted lieutenant, Bharat Masrani, to be his eyes and ears in Portland, Me.

In fact, all of TD Banknorth's existing senior team but Ryan will likely be gone by March, 2008, while Ryan is committed to stay at least until 2010.

"Two years ago we didn't know them and they didn't know us, so certainly I thought it would take a few years [before TD bought 100%]," Ryan said yesterday in an interview. "Working with them in the last couple of years, both parties have gained a lot of respect for each other. We like each other."

With TD's U.S. partnership experiment now officially dead -- and Ryan relegated to wistfully eyeing potential acquisitions he admits he can't buy -- what else could a demoted executive say?

"You have to really be blowing smoke to believe that," said a Bay Street denizen.

Intellectually driven to know how everything works -- just ask his senior executive team about the number of calls they get from the corner office -- Clark's DNA is about control.

"There was no chance that he was ever going to let TD Banknorth do what it wanted. That was never going to happen because it's not in it for Ed to do anything without his approval," said a senior banker familiar with TD's chief executive.

Even so, Clark's Type-A personality aside, TD has discovered that the balance of maintaining local expertise and transplanting the culture and ideas from head office is tricky to achieve.

Perhaps TD's head honcho has figured it's better for the bank's balance sheet for it to be the sole shareholder of TD Banknorth and accrue all the appreciation and earnings flow that go with it, than merely collecting dividends as majority shareholder.

More importantly, TD's decision to maintain a wholly owned subsidiary in the U.S. represents an important strategic statement about the Canadian bank's long-term strategy south of the border.

Its partnership experiment with TD Banknorth is officially dead. In its place, TD has decided to maintain a beachhead in the United States -- TD Banknorth is the largest consumer bank in Maine, New Hampshire and Vermont, and has 600 branches in Massachusetts, Connecticut and New Jersey -- to develop a growth strategy similar to Royal Bank and Bank of Montreal.

So far, TD has found the massive U.S. market a difficult beast to tame. Return on investment capital from TD Banknorth is 4.8% for the first three quarters of 2006, compared with 24.3% for TD Canada Trust and Domestic Wealth Management.

That drag is expected to continue. "It's fair to say we are facing a challenging environment in the U.S.," Clark said yesterday. "We are well aware it may get worse before it gets better."

By privatizing TD Banknorth, Clark can shield the worsening results and alleviate the incessant pressure of delivering quarterly results demanded by the marketplace. That breathing space should provide TD the freedom to pursue a long-term vision even though the short-term prospects are not good.

For now, it looks as if Clark is throwing good money after bad when some say it would be easier to cut and run. That's not Clark's style. He's betting TD's future prosperity is in the United States - and the returns be damned.
The Globe and Mail, Derek DeCloet, 21 November 2006

Ed Clark's brilliant. Really, he is.

It's not that Ed Clark's deal to double his bet in the United States is a great move; it is far too early to know that. But the way he gets the Street to buy his rationale without a lot of skepticism -- that's the brilliant part. Maybe he is the smartest banker in Canada, maybe not, but he is unquestionably a damn fine salesman.

That's why he can do a part-reversal of his most important strategy, weaken the balance sheet, yet investors implicitly trust him, and Toronto-Dominion's stock price barely moves.

Trivia question: Who said the following? "The reality is, in America today, I would still say TD Bank stock is not their stock of choice. They tend to want to use local currency." If you said, "Ed Clark," give yourself 10 bonus points. He said it in July, 2005 -- all of 16 months ago.

The "local currency" angle was supposedly the bit of genius in TD's U.S. banking play. By controlling TD Banknorth, but leaving it a New York-traded public company, Mr. Clark could enjoy the best of both worlds. He could get a sizable piece of profits from a U.S. retail bank, something that's been extremely tough for a Canadian bank to do. Yet he could also use Banknorth shares in acquisitions. Local management, local stock, local bank, all steered via remote control by a benevolent owner in Toronto: Like we said, it looked brilliant.

And now? Last month, TD effectively gave Banknorth chief Bill Ryan, who'd just turned 63, the early boot upstairs and installed Bharat Masrani, a Toronto-educated TD veteran, as the new boss in Maine. And yesterday, it offered to buy out Banknorth's minority owners for about $3.2-billion (U.S.) and get rid of the NYSE listing.

Perhaps all that local stuff wasn't so important after all. Or at least, it became less important than some other factors, like price. Yesterday's offer for the 43 per cent of Banknorth that TD doesn't already own values the U.S. bank at roughly $7.4-billion. In effect, TD is paying less now than it did to acquire its majority stake in the summer of 2004, a creeping takeover without a big premium attached. Not bad.

But the real insight of this deal is that when it comes to U.S. banking, you are either in or you are out, and there is not much point in going halfway. And Mr. Clark has decided he is absolutely, positively in, with both feet. Banknorth's financial performance under TD's ownership has been uninspired. Return on equity (ROE), a key measure in banking, is south of 5 per cent for Banknorth, and the prospects for profit growth next year are minimal. Large U.S. regionals like M&T Bank, Fifth Third and SunTrust tend to have ROEs in the low to mid-teens.

The safe thing for Mr. Clark to do would be to stop putting money in, stop funding Mr. Ryan's endless acquisition schemes -- just hold everything, as Royal Bank did when it encountered some trouble at its own U.S. regional bank in North Carolina. Perhaps that's the route he would have chosen, too, if not for the restless Banknorth minority asking to be bought out. That he stepped up and wrote a cheque is a signal that he's willing to be more contrarian than a lot of other bankers (and that's probably wise -- why, after all, wait for a turnaround that makes Banknorth more expensive to privatize?).

And yet, it is probably more of a gamble than you'd think if you looked only at the market's blasé reaction (TD fell 0.44 per cent to $67.45). Even for a bank of its size, a $3.2-billion, all-cash deal is a lot to swallow. The bank entered this deal with well more than $1-billion in excess common equity; now it will lose all of that cushion and then some.

That means no more big deals for at least a year, and dividend increases will likely be modest, too, as the bank rebuilds its capital. Mr. Clark knows this, knows that Banknorth's numbers won't look so great in 2007, and knows that if he's wrong in the long run, it's going to harm his legacy at TD. Somehow, he manages to not let any of that bother him. When you've got the aura, why worry?
The Globe and Mail, Andrew Willis, 21 November 2006

Toronto-Dominion Bank put further U.S. expansion on ice yesterday by offering to take its TD Banknorth Inc. subsidiary private for $3.6-billion, a takeover that would eliminate the Canadian bank's best currency for American acquisitions.

TD is offering to buy the 43-per-cent of TD Banknorth it doesn't own at the request of directors and major shareholders in the Portland, Me.-based bank, which is struggling in the face of intense competition and a slowing economy in the northeastern United States.

The Canadian bank is offering $32.33 (U.S.) for each TD Banknorth share, after buying its initial stake back in 2004 for $40 a share. The offer is a thin 6.5-per-cent premium to TD Banknorth's closing price on Friday. Two U.S. money managers that together hold 11 per cent of TD Banknorth have already agreed to sell.

"It has been and will continue to be a very difficult banking environment," said Bill Ryan, chief executive officer at TD Banknorth. He said: "Our investors were asking when TD would buy the rest of Banknorth, and saying they would like to see it sooner rather than later."

TD Bank CEO Ed Clark said the decision to buy 100 per cent of the U.S. unit now, rather than wait in hopes of a cheaper deal, reflects motivated sellers with short-term outlooks and a deep-pocketed buyer that takes a long-term view of its U.S. operations.

"These privatizations are difficult to do, and we found ourselves with the support of directors and two of the biggest shareholders," said Mr. Clark, pointing to the troubles that companies such as Sears Holdings Corp. have encountered when trying to buy out minority shareholders.

He added: "We were setting aside capital to buy TD Banknorth anyway, so from our point of view, there's no extra cost to buying now."

But Mr. Clark agreed that there is no quick turnaround in sight at TD Banknorth, which has seen profit decline in five of the past six quarters. The outlook for U.S. retail banking is bleak, with the housing market in freefall and a recession possible in 2007.

TD Banknorth used its shares to buy two New Jersey banks in the two years since TD bought in. But Mr. Clark said further U.S. branch acquisitions are on hold until TD Banknorth's profitability improves.

TD rivals such Royal Bank of Canada and Bank of Montreal have also struggled to bring profit levels at U.S. retail operations to anything close to those of their Canadian parents, and both these banks own 100 per cent of the American subsidiaries.

TD's turnaround plans are focused on grassroots marketing and in-branch initiatives aimed at attracting more clients to basic services such as chequing accounts. Owning all of the U.S. bank will make it easier to blend operations between the U.S. bank and its Canadian parent. "It makes sense. Accounting-wise, you can then consolidate it into the overall operation, as opposed to having it hanging out there," said David Rea, chairman of Toronto-based Davis-Rea Ltd., which owns TD shares.

While Mr. Clark expects the offer to be accepted -- it needs the approval of TD Banknorth shareholders and state regulators -- Mr. Clark said: "It's not the end of the world if [TD Banknorth] shareholders say no to this transaction."

If accepted, the deal is expected to close by April, 2007. Not all TD Banknorth shareholders were thrilled with the terms. Bloomberg News reported shareholder Helene Hutt sued the bank yesterday, claiming the $32.33 a share offer is "grossly unfair."

Analysts agreed that TD appears to be offering a discount price. Mario Mendonca of Genuity Capital Markets said he was "positively predisposed" to a buyout that will play out at 16 times TD Banknorth's forecast earnings, compared with multiples of up to 21 times earnings paid for similar-sized U.S. regional banks. "While we thought this move would be several years off, the deal appears to be struck at a reasonable valuation and reduces some potential near-term uncertainty," said analyst Jason Bilodeau at UBS Securities Canada.
Bloomberg, Sophia Pearson, 20 November 2006

TD Banknorth Inc., Maine's biggest bank, was sued by shareholders over a $3.2 billion buyout agreement with parent company Toronto-Dominion Bank.

Toronto-Dominion, Canada's second-biggest lender, today disclosed plans to buy the 43 percent of TD Banknorth it doesn't already own to boost earnings from U.S. consumer banking. The price of $32.33 a share is ``grossly unfair,'' shareholder Helene Hutt said in a lawsuit filed in Delaware Chancery Court.

``The intrinsic value of TD Banknorth's common stock is materially in excess of the amount offered,'' Hutt said in the suit, one of at least three filed in the court today that seek to block the transaction. The bid is 6.5 percent higher than TD Banknorth's Nov. 17 closing price.

Independent directors of TD Banknorth invited Toronto- Dominion to bid for the shares. Toronto-Dominion intends to turn around TD Banknorth's declining profits in three or four years by making fewer acquisitions and focusing on internal growth, Toronto-Dominion Chief Executive Officer Edmund Clark said on a conference call with investors.

More than a dozen TD Banknorth board members are named in Hutt's lawsuit, including Chairman and CEO William Ryan. Board members breached their duties to stockholders by forcing the sale at an ``unfair'' price and are obligated to ``explore all alternatives to maximize shareholder value,'' the suit said.

Ryan said in a telephone interview that he hadn't seen Hutt's suit and couldn't comment. Hutt's attorney is former Milberg Weiss partner Seth Rigrodsky, who left the firm this year to start his own practice.

Albert Goldstein, who owns 8,000 shares of TD Banknorth, claimed in a separate suit that board members ``misleadingly'' portrayed the offer price as a premium.

The market price of Banknorth's stock has been ``artificially depressed'' in recent months by restructuring charges and other impairments, Goldstein said in his suit.

TD Banknorth shares rose $1.83 to $32.18 in New York Stock Exchange composite trading at 4:16 p.m., giving the Portland, Maine-based company a market value of $7.35 billion.

Hutt's suit is Helene Hutt v. TD Banknorth Inc. et al, 2556-N, Delaware Chancery Court (Wilmington).
Bloomberg, Sean B. Pasternak, 20 November 2006

Toronto-Dominion Bank, Canada's second-biggest lender, agreed to buy the 43 percent of TD Banknorth Inc. it doesn't already own for $3.2 billion as it tries to revive earnings at its slumping U.S. consumer bank.

Toronto-Dominion offered $32.33 per share in cash for TD Banknorth stock, the Toronto-based company said in a statement today. That's 6.5 percent higher than TD Banknorth's closing price on Nov. 17.

Toronto-Dominion Chief Executive Officer Edmund Clark is trying to turn around TD Banknorth, whose profit has declined in five of the last six quarters. He said that Maine's biggest bank will make fewer acquisitions and focus on internal growth.

``There's simply no question that owning 100 percent will facilitate us driving even harder to do the things you have to do in Banknorth for it to be competitive three or four years from now,'' Clark said on a conference call with investors.

The transaction will add 2 cents to Toronto-Dominion's earnings per share in the year that began Nov. 1, and 12 cents a share in fiscal 2008, Chief Financial Officer Colleen Johnston said. Although TD Banknorth's earnings have declined, Clark said Toronto-Dominion earnings growth this year may top 10 percent. He said TD Banknorth's rate of return of about 6.5 percent is ``not acceptable.''

Toronto-Dominion is taking advantage of a slumping TD Banknorth stock price to buy out remaining shareholders. TD Banknorth shares had risen just 1 percent since March 2005, when Toronto-Dominion completed the purchase of a 51 percent stake. The offer today is 19 percent below Toronto-Dominion's original purchase price of $40 a share in stock and cash.

``TD Banknorth is an average bank that hasn't done anything at all clever,'' said Christopher Lowe, who helps manage the equivalent of $7.4 billion at Burlington, Ontario-based AIC Ltd., including 7.5 million Toronto-Dominion Bank shares. ``That's given TD an opportunity to buy it at a fair price.''

TD Banknorth profit has declined on rising costs for acquisitions and advertising, and as demand for loans slows. The Portland, Maine-based bank said last week that earnings in 2007 will be little changed from this year, or between $2.05 and $2.15 a share.

``This has been, and will continue to be, a very difficult banking environment,'' said TD Banknorth CEO William Ryan. ``We think it's a very fair price, knowing that this market is not going to get better in the near future.''

The bank said independent directors of TD Banknorth invited Toronto-Dominion to make a bid for the shares it doesn't own. The bid was backed by the TD Banknorth board, and the purchase is expected to close in March or April, the banks said in the statement. Private Capital Management and Ariel Capital Management, which own a combined 26.2 million shares, are expected to support the bid, the bank said.

TD Banknorth shareholders saw ``more downside risk than upside potential,'' Clark said on the call.

Shares of Toronto-Dominion fell 30 cents to C$67.45 at 4:10 p.m. trading on the Toronto Stock Exchange. TD Banknorth shares rose $1.83, or 6 percent, to $32.18 in New York Stock Exchange composite trading, for a market value of $7.35 billion.

TD Banknorth has about 600 branches in states including Connecticut, Massachusetts and New Jersey. Since Toronto- Dominion took control of TD Banknorth, the firm has purchased Hudson United Bancorp and agreed to buy Interchange Financial Services Corp., both based in New Jersey.

Toronto-Dominion bought a 51 percent stake of TD Banknorth in March 2005 for about $3.51 billion as its first entry into U.S. consumer banking. The total investment in the bank will be $8.5 billion if this bid is approved. TD Banknorth may be taken private after the purchase.

Standard & Poor's credit analyst Lidia Parfeniuk said TD Banknorth's earnings trends and the erosion of capital sparked by this purchase will delay a possible debt upgrade for Toronto- Dominion.

``The acquisition of TD Banknorth is proving to be somewhat of a disappointment,'' Parfeniuk said in a statement.

The bank may also delay its planned share buyback to later this fiscal year as a result of the investment, Johnston said.

Toronto-Dominion's investment trumps its Canadian rivals. Royal Bank of Canada, the biggest lender, has spent more than $6 billion since 2000 on U.S. banks and brokerages such as RBC Centura, while Bank of Montreal has spent about $2.8 billion since 1984, mostly to expand Harris Bank in the Chicago area.

In the fiscal third quarter, TD Banknorth's contribution to Toronto-Dominion's earnings was C$68 million, or 8.5 percent of overall profit. The bank expects the U.S. unit to contribute about 13 percent of earnings once the deal is completed. Toronto-Dominion reports fourth-quarter results on Dec. 8.

Separately, TD Banknorth shareholder Helene Hutt sued the bank today, saying the $32.33 a share offer is ``grossly unfair.''
Financial Post, Duncan Mavin, 20 November 2006

Dominion Bank agreed Monday to buy the 43% of Portland, Maine-based TD Banknorth it does not already own for US$32.33 a share, in a move that was widely praised by banking industry analysts.

But the US$3.2-billion acquisition was not popular with some TD Banknorth shareholders and one investor has launched a lawsuit claiming the Canadian bank’s offer is "grossly unfair."

"The intrinsic value of TD Banknorth’s common stock is materially in excess of the amount offered," said lawyers for a TD Banknorth shareholder who filed a suit in Delaware Chancery Court.

The lawyers said they are seeking to block the transaction.

A U.S.-based institutional investor who holds TD Banknorth stocks also said the price is "a little bit low.

"You could argue that its a fair price, but its at the low end of the range of fair," he said.

TD’s offer is 6.5% higher than the closing price of TD Banknorth stock on Friday.

TD chief executive Ed Clark said the offer represented a "fair" price for the remaining shares. Also, TD was invited to bid for the shares by independent directors of TD Banknorth.

The current valuation of Banknorth’s outstanding shares is a reflection of several quarters of weak performance, said Theodore Kovaleff an analyst at New York-based Sky Capital LLC.

"The problems may well have made the price what it is," Mr. Kovaleff said.

TD is taking advantage of a slumping TD Banknorth stock price. TD Banknorth shares had risen just 1% since TD acquired a majority stake. The latest offer is 19% below TD’s original purchase price of $40 a share in stock and cash.

TD Banknorth has seen its margins squeezed by intense competition in the banking sector in the U.S. northeast. The bank has also been unable to integrate acquisitions as smoothly as some observers had hoped; TD Banknorth spent US$2.5-billion to buy two banks this year, including US$1.9-billion on Hudson United Bancorp, described by Mr. Clark as "a fixer upper."

TD Banknorth delivered a return on capital of only 4.8% in the first three quarters of 2006. During that same period, TD’s domestic retail banking and wealth management businesses had return on capital of 24.3%.

Most bank analysts agreed that the deal is positive for TD.

Genuity Capital Markets analyst Mario Mendonca said the transaction simplifies the reporting structure at TD and signals that U.S. acquisitions are on hold for now.

UBS Investment Research analyst Jason Bilodeau called the deal "a reasonable move" that reduces "near-term uncertainty."

TD’s Mr. Clark said Canada’s second-largest lender will focus on improving customer service at TD Banknorth. "There’s simply no question that owning 100% will facilitate us driving even harder to do the things you have to do in Banknorth for it to be competitive three or four years from now," said Mr. Clark.

He said the sought-after improvements will rolled out in the next 18 months and will include "a lot [of measures] that are not that costly."

Mr. Clark also said further acquisitions at TD Banknorth will be on hold until the end of 2007.

Mr. Clark reaffirmed that TD Banknorth chief executive Bill Ryan will be staying with the bank until 2010. Mr. Ryan is stepping down as CEO in March, 2007, and will be replaced by TD veteran Bharat Masrani.

Mr. Clark said Mr. Ryan will focus on potential acquisitions and dealing with the bank’s commercial clients.

Shareholders still have to approve TD’s purchase of the remaining TD Banknorth shares in a vote.

However, it is unlikely shareholders will oppose the deal or that TD will sweeten their offer given the low potential for a rival bidder when TD already owns 53% of the shares.