A Tax Savvy Solution for Addressing Liquidity Needs

Supernova Technology’s Loan Operations Manager, Austin Mead, recently shared trends, and insights that he has seen during tax time, as well as tips on how banks can support their clients as they navigate what solutions are available to them for paying their tax bill.

There is a growing trend of clients expecting more from their financial advisor. The share of investors looking to simplify their financial relationships by having banking and wealth management under one roof has risen from 13% in 2018 to 22% in 2021, according to consultancy McKinsey & Co. It’s increasingly important that banks take a holistic approach and have a wide range of solutions. Clients are looking for more than investment advice; they are looking for proactive tax planning, estate planning and debt planning, to name a few.

A Trending Solution for Taxes
Mead recalls the record number of service requests and new lines or draws that Supernova saw the last couple of years during tax time, particularly last year. “We saw about 50% of all draw requests being used for tax payments from April 1 to April 18.” Since 2020, each tax season has gotten busier and busier for his team. “New lines and balances were growing daily due to the reactive demand for a securities-based line of credit or SBLOC, which was mostly driven by capital gain tax obligations.”

Mead says he’s concerned about the down market but was still optimistic since Supernova data is still showing a steady increase for the first several weeks of the year — though not quite as high as last year.

Typically, in a down market, many advisers encourage their clients to hold on to their investments and ride it out verses selling them off, staying true to investing for the long-term strategy. Regardless of what strategy a client may have, if a client has liquidity needs, securities-based lending has been a trending solution banks can recommend at tax time. When talking about the measures Supernova’s partners put in place to ensure their clients avoid elevated risk, Mead says lending partners have proactive credit policies in place to hedge against their clients falling into a collateral call. Advisers are also in close communication with their clients through the adviser and client portals.

“Advisers can have educated conversations with their clients about where their portfolio stands versus the outstanding loan balance. Having insight to advance rates on certain securities plays a huge role in those conversations around rebalancing, paying down the loan, and even raising cash,” he says.

Mead says the top three most common reasons clients open or use a line during tax season is general liquidity, followed by strategic ways to avoid capital gains from the market and capital gains from real estate sales over the past few years. After the beginning of the year, there is a steady increase for line openings and/or usage through Tax Day, but he says the most active time period was April, leading up to Tax Day.

As Mead says, since the beginning of the year, there has been a steady, weekly increase in line opening and usage. It’s important banks start having conversations early with clients to ensure they are prepared for Tax Day and have access to liquidity when they need it.

Why Banks Need to Control the M&A Process

manda-process-8-15-16.pngAll transactions are not created equal. At the end of the day, the party that has the better understanding of the transaction and has actively controlled the process from the start wins and unlocks maximum value. The bank that is better equipped to enter negotiations with all of the information will likely get the better end of the deal. From a practical standpoint, this means that the bank’s management and third-party advisor(s) have driven the process and timeline, and have clearly articulated expectations. It is imperative to have a single, centralized point of contact to control information, communications and negotiations. For most banks a third-party investment banker is the primary contact, allowing key executives to focus on running the bank. In these instances, it is incumbent upon the CEO to control the M&A process through logistics, modeling assumptions and strategy.

This begins with M&A process documentation. A CEO should work early on with the investment banker to identify key dates and contacts. For a seller, this will also include potential buyers to contact, confidential information memorandum recipients, dates on which access to data room and due diligence materials were granted, as well as comprehensive notes on when and why institutions exited the bidding process. The board of directors should participate periodically in status updates to ensure that it has fulfilled its fiduciary responsibilities through regular involvement in the process. The importance of documenting meetings and formal discussions, both internally and with the counterparty, cannot be overemphasized.

From a modeling perspective, every assumption in a pro forma model should have a corresponding status column. FinPro Capital Advisors (FCA) utilizes three levels of assumptions: information based on public filings for preliminary analysis, assumptions from due diligence and assumptions that have been formally signed off on by management. Below are ways you can control the process and assess the merits of a transaction to proceed with confidence to closing.

Retain a financial advisor that you can trust and have the discipline to walk away from a deal. FCA actively advises its clients to pass on deals that do not make sense, from either a financial or strategic perspective. Even a highly accretive deal can create social issues or be detrimental to the bank or its stockholders in the long run. Examples may include franchise dilution, conflicting corporate cultures, lack of a surviving brand or poor market reception.

Identify M&A parameters based on your strategic objectives. FCA makes the following recommendations:

  • Tangible book value per share (TBVS) dilution less than 10 percent, and preferably 7 percent or less.
  • TBVS work back period of five years or less. Three years or less is recommended.
  • Immediately accretive to core earnings, excluding one-time charges.
  • Internal rate of return equal to or greater than 10 percent.

Understand your bank’s risk profile. Opportunities must be assessed on a transaction-by-transaction basis, and there can be instances when a transformative deal can make sense with the rationale clearly explained to investors and the market. That said, here are some guidelines that potential acquirers should keep in mind:

  • Acquirer must be able to demonstrate an in-depth understanding of its risk profile.
  • Pro forma combined entity should be no less than a CAMELS 2 rated institution.
  • Tier 1 leverage ratio must be greater than 8 percent.
  • Coverage ratio (defined as total classified loans as a percentage of Tier 1 capital plus the allowance for loan and lease losses) of less than 40 percent.
  • Proactive and strong relationship with the regulators.

These guidelines are not a one-size-fits-all proposition. Some banks have a higher tolerance for TBVS dilution while others have strict parameters on the work back period (TBVS dilution divided by earnings accretion created by the deal, or the time it takes to “earn back” TBVS dilution) or minimum hurdles for earnings accretion. Banks with a clear idea of cutoff points for pricing, TBVS dilution and EPS accretion are generally better prepared to control the process and negotiate a transaction that adheres to their strategic principles.

Know your value. An accurate value assessment for both the buyer and the target is critical for any analysis. Require your advisor to incorporate trading valuation analyses in any pro forma analysis with a stock consideration component to determine a reasonable value for buyer currency. Require a comparable acquisition analysis to determine a valuation range for the target. These two analyses are standard in all FCA pro forma analyses and a critical discussion point with CEOs. It is also vital for targets to know their independent stand-alone value to help determine whether a sale at this time is a stronger strategic option than remaining independent. This can help evaluate whether the consideration price offered is likely fair, from a financial standpoint, to stockholders.

Understand what is going into your transaction adjustments. The transaction adjustments column is often the black box of pro forma analysis. An array of assumptions, including interest rate and credit marks, purchase price allocation, cost savings and transaction expenses are usually shown aggregated into a single column and it can be extremely difficult to identify the exact adjustments. FCA includes a detailed breakout of every single adjustment so that CEOs can track and understand the assumptions driving the deal. Management should critically review and sign off on all assumptions.

Request that your advisor incorporate custom sensitivity analyses with all pro formas. FCA incorporates single and multi-variable sensitivity analyses with all pro formas to show the impact of changes to buyer currency, consideration price and mix, and cost savings to stress test the impact of changing variables across a range of values.

By following these steps and proactively controlling the M&A process you can unlock maximum value in your transaction.