Bankers and Wall Street lawyers are looking for ways to help companies buy back shares next year without having to pay millions of dollars in extra taxes, a move that risks blunting one of the main revenue generators of President Joe Biden’s climate and health package.
Central to their efforts is the use of Accelerated Share Repurchase (ASR) programs, a commonly used mechanism for companies to complete buybacks worth billions of dollars. Although the programs are recorded as having been executed in a single day, it often takes several months for the banks to complete the transactions.
Plans hinge on whether upcoming Treasury guidelines will count the day the company disburses the money and receives its shares on the buyout date, or whether they will have to wait for investment banks to actually buy the shares on the free market.
Wall Street bankers have sought legal advice from law firms including Davis Polk on how the Treasury might handle the fast-track programs, according to multiple people briefed on the discussions.
Joe Kronsnoble, a partner at Latham & Watkins, said investment banks were “very interested” in the Treasury’s upcoming guidance, though he warned the department or the Internal Revenue Service may not provide an answer. complete before the entry into force of the 1% tax. in just over four months.
The new tax will generate $74 billion in revenue over the next decade, according to official estimates, but bankers warn that figure could explode if the 1% level is the lower end of the range and ends up being increased in subsequent years.
“The hypothesis, and it is still quite early. . . it’s that a 1% tax by itself is not enough to significantly change behavior,” said a New York-based banker who works on corporate stock buybacks. “One percent now isn’t a big deal, but what if that 1 becomes 3, 5, or 10 percent to increase revenue or score political points?”
Banks and legal experts have coalesced around the idea that companies won’t have to pay tax on the shares they receive through accelerated buybacks launched this year, a person involved in the talks said.
If the Treasury takes a similar view, the programs would be particularly attractive to companies looking to make early buyouts in future years if Congress decides to raise the tax rate.
“Whenever there’s a new tax on the horizon and people know it’s going to apply next year but not this year, it’s no surprise that companies look for ways to try to get things done as soon as possible,” said a person involved in the talks. “ASRs are just one example.”
The stock buybacks have been targeted by politicians on both sides of the aisle, drawing criticism from Republicans including former President Donald Trump and Florida Sen. Marco Rubio, as well as Democrats such as the Chief Senate Majority Chuck Schumer and Massachusetts Senator Elizabeth Warren.
Critics accuse boards of directors of using share buybacks to artificially inflate their stock price and benefit executives, who are often paid based on share price performance, instead of using their money for long-term investments, job creation or salary increases for their employees.
S&P 500 companies spent $281 billion on stock buybacks in the first three months of 2022, according to S&P Global, setting a new record for the third straight quarter.
The data is expected to show a slight drop in activity in the second quarter after companies, including lenders JPMorgan Chase and Citigroup, suspended their buyback programs in response to tighter capital needs and concerns about the slowdown in Economic Growth.
Traders at Goldman Sachs’ dealing desk responsible for executing buybacks estimate firms have authorized $856 billion in buybacks so far this year, but said buyback growth is lagging behind spending in capital and dividends.
Alice Bonaimé, an associate professor of finance at the University of Arizona, said there was evidence that companies that just underperformed analysts’ forecasts were “willing to sacrifice investment and employment for buy back shares and stimulate [earnings per share] about a penny.
However, she added that the flexibility of redemptions gave them many advantages over dividends, which management teams are reluctant to cut if they discover new investment opportunities or encounter unexpected challenges.
Bonaimé said that at its current level, the tax “might push companies a bit to divert some of their distributions away from buyouts and maybe into dividends,” but that “a 1% tax will be enough to dramatically change the corporate behavior”.
Equity trading desks have yet to see a resurgence of interest in executing buybacks. However, bankers said they expect activity to pick up in the final months of the year, with companies planning takeovers in early 2023 moving some purchases into 2022.
Accelerated share buybacks shouldn’t be a panacea for companies hoping to avoid tax, however, given the relatively short time they take to complete. While banks can structure longer-term programs — including contracts with exotic derivatives to hedge against stock price swings — one dealer said they could “start to get expensive” quickly, causing them to would make it less attractive.
The mechanics of an ASR
In a simplified accelerated share buyback program, an investment bank agrees to buy the outstanding shares of a publicly traded company in the future under a forward contract. The bank is prepaid by the company to buy the shares. It then borrows shares in the public market from securities lenders, delivering the shares to the company. The company can then treat these shares as retired, which helps increase its earnings per share. The bank, which is effectively short on the shares, will spend several months buying back the shares in the public markets, eventually returning them to the securities lenders.
Wall Street is looking for ways to circumvent Biden’s stock buyback tax