Cheers or Tears As Commerce Takes TD's Money?

Implications: Commerce Bank's Board and Management decided to take TD's cash and stock deal, valued at $8.5 billion, barely 90 days after founder Vernon Hill was ousted as Chairman and CEO. The deal is estimated to be worth about $42/share, less than $1 above CBH's all time high. Was the price right for shareholders at  Commerce and TD Bank Financial Group? Can TD Banknorth profitably leverage the Commerce Bank branch deposit gathering network? Who will be the winners and losers from this deal?

Analysis: One group that should be cheering is Commerce shareholders - they should take the cash and TD stock and then keep on cheering for TD Banknorth to be a success (to help TD's stock appreciate). Reasons for this perspective should add a level of concern, if not tears, for TD shareholders as they may wonder if the price is too high in spite of the strong Canadian dollar.

1. Commerce's business model had no long term future as the bank could not sustain the branch and deposit growth without any real organic interest income earning capacity, or loans and fee income, that matched deposit growth. Investing deposits in investment securities is a thin margin game with interest rate risk that has affected its earnings.

2. With limited loan interest income earning capacity to match its deposit liabilities, Commerce was about to become a poor performer with its high operating costs. Ironically, TD Banknorth is not a strong performing bank. Can two below average earning banks combine to become a superior earning bank in the next two years?

3. TD expects to take out $310 million of annual operating costs by 2009. That represents about 20% of Commerce's operating costs. While TD Banknorth claims experience integrating acquisitions, none have ever approached the size and brand-demanding operating profile of Commerce. 10% would be a more reasonable target since there are no overlapping branches to close and TD will probably need to invest in loan generating capacity in Commerce's markets.

Who else benefits or suffers from this deal?

1. Key suppliers, particularly the major IT vendors for TD Banknorth and Commerce will be affected. In this deal, as with many others of late, Fidelity Information Services should be a big winner as FIS is the outsourcing host for TD Banknorth. Metavante should be the loser as Commerce has been a long time, and the biggest, customer of Metavante's Kirchman Bankway core processing application, running on an IBM zSeries mainframe. Conversion fees and additional processing fees from Commerce's accounts will provide a boost to gross operating margins for FIS.

2. Competitor banks in the Commerce footprint will benefit. Big (Bank of America, JP Morgan Chase), medium (Astoria Financial, Hudson City Bank, NY Community Bank, and NY Private Bank) and smaller bank competitors will get some relief until TD Banknorth closes the deal in the middle of 2008 and its future plans are implemented. In particular, Florida and Washington DC area competitors will be spared the Commerce blitz attack for depositors.

3. Commerce customers and employees will have to wait and see what happens. Odds favor a change away from the legacy Commerce model, which will erode the customer "fan" base. New branch expansion is far more likely to follow TD Banknorth's experience to reign in operating cost growth.