Assessing Commerce: Tax Hit Alters View of Deal: Buzz Persists: Did Cultural Issues Scare off Other Suitors?

Article excerpt

If everything goes according to plan, Commerce Bancorp Inc. will cease its remarkable run next March or April in a transaction that is unusual, controversial, and possibly trend setting - in other words, in a fashion almost entirely consistent with the corporate identity it has forged since it was founded in 1973.

There is, however, one element missing that Commerce has come to expect: A show of support from its substantial base of shareholders whose enthusiasm for the Cherry Hill, N.J., company has occasionally bordered on fanaticism. At first blush, Toronto-Dominion Bank's $8.5 billion deal to buyCommerce failed to impress investors. As they dig deeper, they are finding even less to like.

The deal price of $42 a share represented a thin premium to its market value, leading investors to wonder what pressing priority compelled Commerce's board and managers to sell what has been heralded as the most formidable model in retail banking at a bargain-basement price. And the agreement comes with what some shareholders see as an unexpected kick in the pants: They will be taxed on the entire price of the deal, even though 75% of the consideration will come in the form of TD stock.

The tax treatment is rare in an industry with a long history of consolidation through tax-free share exchanges.

"There may be a lot of shock when shareholders have to pay tax even on the stock part of the consideration," said Robert Willens, a managing director at Lehman Brothers Inc. who specializes in corporate taxation. "It has been done a few times before, but I don't know that it has ever been done in the financial space. It's almost unheard-of."

He concludes that "the board was in no position to argue - likely because there was no other competitive offer."

Commerce's apparent lack of leverage at the bargaining table is a surprising result for one of the most admired banking franchises in the country. While its competitors relied on acquisitions for scale, Commerce under the direction of founder Vernon W. Hill 2nd hewed to an organic-growth mantra that propelled it from a start-up to a $48.2 billion-asset retail bank.

It cultivated a reputation as a ruthless competitor that entered new markets without fear of established, deeper-pocketed rivals, casting aside traditional banking methods in favor of a convenience-first, customer-friendly model. It pointed to record-breaking deposit growth and surveys of customer loyalty as measures of its success. From its home New Jersey market, an aggressive start-up strategy carried it into Pennsylvania, New York, Florida, and Washington, D.C.

Investors rewarded Commerce's growth with stock valuations that far exceeded that of most banks, despite a committed cadre of skeptics who thought its model - which relied almost exclusively on the liability side of the balance sheet to generate value - was fundamentally flawed. The company's net interest margin remained beneath some investors' expectations, as it dumped billions of dollars of deposits into Treasury and asset-backed securities.

But even the naysayers acknowledged the transformative power of the Commerce model in new markets, forcing change-resistant companies to update branch designs, stay open later, and recommit to making customers happy. The company was hailed by some as the crown jewel of retail banks, and the new paradigm in banking competition. And yet, the chief question asked by investors since the Oct. 2 deal announcement is why Commerce wasn't worth more.

"It looks as if they forgot where the value is in the franchise," said Gary Townsend, an analyst at Friedman, Billings, Ramsey & Co. "In my view, they left a lot of money on the table."

Rob Rutschow, an analyst at Deutsche Bank Securities Inc., said he was "surprised" by the thin valuation accorded the company.

"It is not a hugely compelling transaction," he said. "I have a hard time justifying a sale right now at this price. …