Dozens of community banks are pushing hard to close acquisitions in the next few months because completing a deal could become much more costly in 2011.
If Congress does not extend tax cuts before the end of the year, the top tax rate for capital gains will jump from 15% currently to 20% on Jan. 1. That could affect a large number of banks with definitive sales agreements as well as the sellers' shareholders.
Given that an estimated 100 bank and thrift purchase deals announced this year have yet to close, according to data from SNL Financial LC, there's a lot of worry among institutions that they could be stuck with a big tax bill.
"The uncertainty is extremely frustrating," said Paul Merski, senior vice president and chief economist at the Independent Community Bankers of America. "These are businesspeople who like to act with certainty and have the numbers on the table."
Some bankers are preparing for a worst-case scenario. Because there is only so much that bank companies can do to rush a deal that is subject to regulatory approval, they are including stipulations in agreements that would allow them to walk away or raise the price to cover higher costs if a deal does not close by the end of 2010.
For example, Sam Houston Financial Corp. in Hunstville, Texas, which agreed in September to be acquired for $22.2 million by First Financial Bankshares Inc. in Abilene, has a clause in its agreement requiring that the deal close by Dec. 31. Though that requirement does not extend to the regulatory process, "if the buyer delays, then all bets are off," said James Baine, the chief executive of Sam Houston and its $164 million-asset banking subsidiary, the First State Bank. The deal recently received the blessing of regulators and is expected to close in November.
Likewise, First Commerce Bancorp in Encino, Calif., stipulated in its sales agreement with Grandpoint Capital Inc. that the price would rise if the deal does not close in 2010 and taxes increase. Grandpoint, of Los Angeles, under that scenario has agreed to pay First Commerce's shareholders 15 cents more per share, equating to about $1.5 million, said Jack Feldman, the president and CEO of the $357.8 million-asset First Commerce.
First Commerce shareholders approved the deal Oct. 21 and it is now awaiting regulatory approval. It is expected to close before the end of the year. Feldman said while the potential for higher capital gains taxes in 2011 was not the main reason behind the deal, the uncertainty over tax rates played a role in the deal's structure.
Other bankers in the middle of deals said concern over higher tax rates was just one factor that led to their decision to sell. "The top reasons these banks consider selling is the ominous regulatory environment and the uncertain economy," said David Rainbolt, the president and CEO of BancFirst Corp. in Oklahoma City.
The $4.6 billion-asset BancFirst has announced four bank purchases in Oklahoma so far this year. Two have closed and the other two are expected to close in December. "In the four acquisitions we did, a third reason for each bank was the uncertainty of the capital gains tax rate going forward," he said.
The tax situation has not been as much of a concern in states like Florida, California and Illinois, where distressed banks are selling at a loss rather than a gain. "In today's environment, when there are so many deals at little to no premium, it's less of an issue," said John "Jack" P. Greeley, a banking attorney at Smith Mackinnon PA in Orlando, Fla. "In Florida, if you can get a deal closed at any time, we're pleased."
Yet the capital gains tax is just one potential tax rise that could affect banks and their shareholders next year. They are also concerned about the potential for income taxes to rise on dividends or Subchapter S corporation earnings.
The qualified dividend tax rate will jump from 15% currently to ordinary income tax rates, with a top rate of 39.6%, if Congress does not act. The top tax rate for Subchapter S banks would increase from 35% currently to 39.6%.
The ICBA estimates that the change would affect more than 2,300 banks. Some analysts worry that M&A activity, which has been heating up, could cool off as a result. "It probably would [slow M&A down] because it could make the returns or cost of doing the deal more expensive," Merski said. "Lower tax rates facilitate more deals than higher tax rates."