The Biden administration's proposal to raise the capital gains tax is accelerating timelines for some banks looking to sell and could push sellers to command higher prices, deal advisers said.
If the plan becomes law, it would boost the long-term capital gains tax on households earning more than $1 million per year to nearly 40% from its current 20% rate. Since capital gains taxes are levied if a stock is sold, the higher tax rate could discourage all-cash deals and cash-and-stock deals in favor of all-stock transactions where companies swap stock. Deal advisers also noted some sellers could demand higher prices to compensate for the higher tax bill and that some bankers appear to be speeding up their timing to beat the tax change.
"If you have a big shareholder, they're going to recognize more than $1 million in capital gains since they were paid cash," said Christopher Hargrove, chairman and CEO of ProBank Austin, a consulting, education and investment banking firm. "That could really affect those transactions."
There are a handful of deals in the pipeline that might be susceptible to a potential capital gains tax hike. All-cash deals are most likely to be affected by the change. In 2020, 18 all-cash bank deals were announced. So far in 2021, an additional nine all-cash deals have been announced.
If Biden's plan for higher capital gains taxes becomes law, it's still unclear when it would go into effect, and rushing through deals now might be a lost cause. The Biden's administration's budget assumes the tax would be retroactive to the end of April, according to a report in The Wall Street Journal.
Sellers already have a tight timeframe to get a deal done by the end of this year and potentially beat the new tax law taking effect. Given typical deal closing timelines, deals would need to be signed by end of July to be finalized by year-end, Hargrove said, adding that several of ProBank Austin's clients are "really pushing hard" to get deals announced as soon as possible.
Houston-based Prosperity Bancshares Inc. has been on the lookout for a potential acquisition. CEO David Zalman said on the bank's earnings call that he expects banks may accelerate their deal plans due to a potential increase in the capital gains tax.
"I still think something should happen this year, just because of the tax situation," Zalman said.
The pressure to close deals quickly is coming more from sellers than buyers, said Michael Bell, partner and co-leader of the financial institutions practice group at Honigman LLP, who specializes in credit unions purchasing banks.
"Definitely, you would expect that there would be a spike in acquisitions towards the end of this year, if the legislation is passed with an effective date [at] the beginning of [2022]," said Benjamin Ayers, an accounting expert and dean of University of Georgia's business school.
Advisers said a capital gains tax increase could also affect pricing, giving sellers a reason to demand a higher price.
"Capital gains are basically a transaction cost," said Ayers. "Selling companies will require compensation for accelerating the capital gains tax that they otherwise could defer."
Community banks are less likely to be publicly traded and therefore more likely to do all-cash deals, Hargrove said, while credit unions that purchase banks only have the option to use cash.
Many community banks have shareholders with over $1 million in stock holdings that would be affected by this new tax rate if the banks were to sell. Three banks with under $10 billion in assets have one owner that holds over 50% of the bank's stock. Bloomington, Ill.-based HBT Financial, Inc.'s Chairman and CEO Fred Drake owns 63.2% of the bank's stock. The bank had $3.87 billion in total assets at March 31, and has four additional owners with over $1 million in total holdings. Chicago-based Byline Bancorp Inc. has nine insiders who own over $1 million in the company's stock. Carmel, Ind.-based Merchants Bancorp's Chairman owns $401.2 million in the bank's stock, with four additional owners with over a $1 million stake.
Although the tax rate may affect deals, a complete halt in activity is unlikely, Hargrove said. "There's never going to be anything more powerful than shareholders desiring a liquidity event," Hargrove said. "All these other factors mostly factor in on what they can sell their bank for, or what a buyer can afford to pay."
