The U.S. government may have just ushered in the next era in bank mergers and acquisitions.

Toronto-Dominion Bank's announcement Monday that it plans to purchase South Financial Group Inc. is as notable for what it is not — a failed-bank deal with the Federal Deposit Insurance Corp. — as for what it is: an acquisition featuring key Treasury Department concessions on Troubled Asset Relief Program-related securities held by the target.

Analysts said to expect more preemptive purchases where the buyer gets a discount from the Treasury and avoids the frequent free-for-all for failed banks. The deal could serve as the new blueprint for acquisitions at a time when the FDIC is taking a more-rigid stance on loss-sharing, covering as little as half of a failed bank's assets.

"Things are wide open in that we're using each deal as a building block for the next deal," said Christopher Marinac, an analyst at FIG Partners LLC, who said other banks could point to Monday's arrangement in negotiating with the Treasury. "All that's needed is for a couple of deals to happen, and people will begin to think that banks are worth more than what they previously thought."

Kevin Fitzsimmons, an analyst at Sandler O'Neill & Partners LP, said "this brings more optionality." He said acquirers will absolutely lobby the Treasury for similar terms if they are considering buying so-called zombie banks. The message: "If someone is really in trouble, then the government will work with the buyer."

No one would say with certitude that South Financial was poised to fail, but all agreed the $12 billion-asset Greenville, S.C., company faced hefty challenges, after nearly two years of losses depleted capital levels. The Federal Reserve on May 4 placed South Financial under a written agreement, giving it 60 days to craft a capital plan and barring it from paying dividends without approval.

South Financial also had until early September to boost its leverage ratio to 8%, from 6.87% at March 31, following a consent order from the South Carolina State Board of Financial Institutions and the FDIC.

H. Lynn Harton, a former Regions Financial Corp. credit officer who has been South Financial's president and chief executive since November 2008, said the company would have faced substantial hurdles had it remained independent, which was validated by a "complete and exhaustive" review of capital-raising options. "The amount of capital we needed to work through the legacy loans was significant," he said in an interview Monday.

"Given our current market cap, it would have been impossible to raise capital [through a common stock offering] and difficult in any fashion, frankly," he said. "It took someone like TD with the vision to see beyond the problems and see the potential as well as the balance-sheet strength to take the risk."

Bharat Masrani, head of Toronto-Dominion's U.S. banking operations, said the company did not want to wait for a resolution process to begin to make its play.

"There is a lot of franchise damage when you buy a failed bank," he said.

Analysts said buying troubled banks before they fail presents strategic advantages, despite the risks. Failed-bank auctions have been getting more competitive, so Toronto-Dominion may have avoided being an also-ran. The downside is that it will assume all $8 billion of South Financial's loans, much of them concentrated in commercial real estate, without a federal loss-sharing agreement.

The Treasury had no immediate comment.

Analysts said a sign of South Financial's sickness may have been the steepness of the discount the Treasury granted to part with its Tarp holdings. TD was allowed to buy all of South Financial's preferred stocks and warrants for $130.6 million in cash, or roughly 37.6% of the preferred shares' value. The Treasury also agreed to discharge the buyer from paying any of South Financial's overdue dividends on the shares.

"Treasury should have felt that there was a chance to get their money back," had South Financial been viewed as a survivor, Marinac said. He thought a discount of 10% to 15% might have seemed reasonable, rather than the huge cut that actually took place.

Fitzsimmons said the Treasury was at least "getting something just like other shareholders" and was "limiting its potential loss" compared with what would have happened if the FDIC stepped in and seized the institution. "The situation seemed to get ratcheted up with the regulatory agreement that had been put in place."

The Treasury has shown similar flexibility in recent weeks, agreeing to take a 75% haircut on its investment in Sterling Financial Corp. in Spokane and an 80% discount for its holdings in Pacific Capital Bancorp in Santa Barbara, Calif. Both institutions had deals in place to sell large stakes to outside investors.

It is difficult to tell how many deals comparable to the South Financial sale could take place. There are more than 630 banks that are still participating in Tarp, and 13 are behind on at least four dividend payments, according to data from SNL Financial in Charlottesville, Va. It is unclear how many, if any, are among the 702 "problem" banks being watched by the FDIC as of mid-February.

The deal ends the prolonged pain for South Financial, which had been an active buyer of community banks in the Sunshine State, withmany were heavily concentrated in residential construction and land development. Nonperforming loans in such portfolios rose sharply as the housing market unraveled and valuations plummeted.

The company's fall 2008 participation in Tarp also drew controversy when its former chairman and CEO, Mack I. Whittle Jr., accelerated retirement plans by three months to a date that came just days after South Financial applied for Tarp funds. Parties ranging from irate shareholders to South Carolina Gov. Mark Sanford accused South Financial of planning to use the capital injection to cover Whittle's $18 million retirement package. (South Financial settled several shareholder lawsuits last year tied to the matter.)

"It has been a difficult period, and I could not be more proud of our team, and how they have responded during a difficult time to make improvements and address our credit issues head on," Harton said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.