The Wall Street Journal and Bloomberg News reported May 9 the U.S. regulators’ concerns about the way Toronto-Dominion Bank handles suspicious transactions was at the root of their reluctance to approve the Canadian bank’s US$13.4 billion takeover of First Horizon, adding a layer of mystery to TD’s decision to bail earlier this month on what would have been its biggest acquisition.

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TD “works diligently to prevent criminals from using the bank for illegal activity, to strengthen its risk management programs on an ongoing basis, and to protect the interests of our customers, the bank, and the financial system,” spokesperson Elizabeth Goldenshtein said when asked to comment on the reports, which cited unnamed people familiar with the matter.

Here’s what you need to know about the latest twist in TD’s failed expansion bid:

There’s more than one ‘hot button’ issue

TD and First Horizon weren’t specific about why they called off the merger on May 4, saying only that they were ending the transaction because of “uncertainty” over the timing of regulatory approvals. That remained TD’s response after the Wall Street Journal and Bloomberg stories. It reiterated that the deal was terminated because of “the uncertainty in the timing of regulatory approval” and “not in any way related to TD’s good faith dealings with our customers.”

Controls related to money laundering might have played a role, but observers said there were other variables, including potentially a desire by TD to reset the price amid the recent collapse in value of U.S. regional banks such as First Horizon.

Michael Driscoll, who leads the North American financial institutions group at Morningstar Inc.’s DBRS Morningstar, cited anti-money-laundering controls among a few “hot button” areas of concern to U.S. regulators. He noted, too, that U.S. Senator Elizabeth Warren raised concerns about TD’s treatment of customers in mid-2022 following a media report that was disputed by the Canadian bank. 

A spokesperson for the Office of the Comptroller of the Currency, one of the financial regulators that was reviewing TD’s purchase of First Horizon, declined to discuss whether TD’s money laundering controls were an issue, saying the OCC does not comment on specific banks and supervisory activities.

Why the reports are ‘baffling’

Driscoll said the decision to call off the First Horizon transaction, more than a year in the making, was a “head scratcher,” especially given TD’s previous success in the U.S., where it is already the eighth-largest commercial bank.

“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,” Driscoll 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.

“I would just point to M&T’s delayed acquisition of Hudson City as a reference point that this could take a long time to resolve,” he said, adding that there are parallels to TD’s situation with First Horizon even though the reasons for the regulatory snag aren’t public like they were in the case of M&T and Hudson City. In that case, the Federal Reserve said it had found deficiencies in M&T’s internal controls related to compliance and anti-money-laundering controls shortly after the deal was announced in 2012, but these were eventually remedied to the regulator’s satisfaction and the transaction was allowed.

“M&T was also a bank we thought highly of, including their risk management,” Driscoll said, adding that the multi-year delay raised questions about whether there were more issues, but the deal was ultimately allowed to close.

Buying a U.S. bank takes time

More recent examples of bank mergers and acquisitions taking a long time to close include one involving a Canadian buyer. It took Bank of Montreal more than a year to conclude its purchase of Bank of the West in February 2023.

In another example of a protracted deal, U.S. Bancorp and Mitsubishi UFJ Financial Group Inc. were forced to delay closing of a deal by three months. Yet U.S. Bancorp eventually completed its acquisition of MUFG Union Bank’s core regional banking franchise from Mitsubishi in 2022. Regulatory approval took more than a year.

Against that backdrop, and amid concerns for the health of the wider U.S. regional banking system following the collapse of Silicon Valley Bank and Signature Bank in March, Driscoll said he found it puzzling that U.S. regulators would take a stance that would push TD away from a deal with First Horizon.

First Horizon’s share price had tumbled from a 52-week high of close to US$25 in February 2022 to below US$15 in March, when SVB and Signature failed. After the deal fell apart, First Horizon shares sunk again, now hovering between US$10 and US$11.

“When we look at this current environment, it’s like, ‘Wow, the U.S. (regulators) would rather throw this U.S. regional bank back into the mix in this environment than approve,” Driscoll said. “It’s a head scratcher.”

That’s why Driscoll thinks there could be more to TD’s decision to end its pursuit of First Horizon than regulatory issues. Many observers had expected market conditions would cause the two banks to renegotiate the sale price.

“It could be as simple as TD approaching them for a lower price, First Horizon balking at it, and then TD is like, ‘Well, we don’t have a timeline on our regulatory approval, so we’re walking.’”

If there’s a problem, TD will fix it

But if it turns out that TD is facing scrutiny over the way it guards against money laundering, Driscoll said he would expect the bank to act quickly and decisively to resolve them.

Without the First Horizon deal, Canada’s second-largest bank has the heftiest regulatory capital cushion among the country’s big banks. That means it has a pile of cash that isn’t earning a good return. With limited expansion prospects domestically and a stated aspiration to grow in the United States, failing to address regulatory issues could jeopardize TD’s strategy and, ultimately, weigh on profits.

TD’s pro forma excess capital position stood at approximately $17.5 billion in the first quarter of 2023.

“If (the anti-money-laundering concerns are) accurate, I am sure TD is throwing a lot of resources to rectify issues,” Driscoll said.

Regulators in the U.S. take money laundering seriously and have taken significant action against foreign-based financial institutions operating there. 

HSBC Holdings PLC, for example, operated under a Federal Reserve enforcement “consent order” for 10 years, through August of 2022, after the U.S. Department of Justice accused the London-based bank in 2012 of allowing drug cartels and others to launder hundreds of millions of dollars through HSBC subsidiaries through “stunning failures of oversight,” in addition to facilitating transactions with sanctioned countries.

HSBC forfeited more US$1 billion in a deferred prosecution agreement with the Department of Justice in 2012, in addition to civil penalties, and pledged to improve its anti-money laundering controls and financial crime risk management.

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