Financial Institutions and Banking

Do you need a bank holding company?

Do you need a bank holding company?

For years, the vast majority of U.S. banks have used a bank holding company (BHC) structure. Recently, however, several prominent regional banks have elected to shed their BHCs by merging them into their subsidiary banks. This development has many community banks wondering whether the BHC model has become obsolete.

Pros and cons

The answer to this question: It depends (big surprise). Some banks may find that eliminating the BHC structure simplifies financial reporting, streamlines regulatory oversight and reduces administrative expenses. Others — particularly those that qualify as “small bank holding companies” — may find that the benefits of the BHC structure outweigh its costs.

It’s important to keep in mind that recent legislation expanded the definition of small BHC to include those with consolidated total assets of $3 billion or less (up from $1 billion). (See “Advantages of small BHC status.”) Here are some of the possible reasons for eliminating a holding company, along with a review of the continued benefits of the BHC structure.

Reasons for discarding your BHC

Potential advantages of eliminating a BHC include the following:

Reduced regulatory oversight. Banks without a holding company are no longer supervised by the Federal Reserve (the Fed) — except for Fed member banks. This can reduce compliance costs. The Fed strives to rely on an organization’s primary regulator and scales its supervisory approach depending on that organization’s complexity, risk and condition. So the cost savings from reduced regulatory oversight will likely be insubstantial for smaller organizations.

Lower administrative costs. Eliminating the BHC simplifies financial reporting and reduces costs associated with maintaining separate legal entities. These costs include additional taxes, fees, and accounting expenses; dual boards; and duplicative policies and procedures.

No need to deal with the SEC. Some BHCs must report to the SEC, but banks are generally exempt from the SEC’s registration and reporting requirements. However, it’s important to note that, in the absence of a BHC, some securities-related reporting requirements will shift to the bank’s primary regulator.

Benefits of BHC structure

Although the Dodd-Frank Act eliminated some earlier advantages of BHCs, most notably the inclusion of trust-preferred securities in Tier 1 capital, the BHC model continues to provide significant benefits for many banks, including:

Liquidity. BHCs have greater flexibility to repurchase stock. The ability of banks to create a market for their own stock is limited by state and federal law, and reducing capital usually requires prior approval.

M&A flexibility. BHCs (particularly small BHCs) have significant flexibility in structuring and financing M&A transactions. Plus, they can maintain acquired banks as separate institutions, allowing them to be integrated more deliberately with other subsidiary banks.

Increased permissible activities. BHCs may engage in specific business and investment activities that are off limits to banks. For example, a BHC may invest in up to 5% of any entity’s voting securities without prior regulatory approval.

Purchasing problem assets. BHCs can purchase problem assets from their subsidiary banks, helping them improve their capital ratios and otherwise strengthen their financial performance.

Dividend flexibility. BHCs have more flexibility than banks in paying dividends.

Leveraging debt. Small BHCs have the ability to use debt to raise capital for their subsidiary banks. (See “Advantages of small BHC status.”)

Long-term needs

If you’re considering eliminating your BHC, be sure to carefully weigh the potential cost-savings and other benefits compared with the benefits of maintaining the BHC structure. This is especially necessary if your organization has total consolidated assets of $3 billion or less. Also consider the costs and administrative burdens of merging your BHC into its subsidiary bank, including shareholder and regulatory approval, modification of contracts and policies, and advisory fees.

Even if you conclude the pros of eliminating the BHC outweigh the cons, evaluate your bank’s long-term needs. If there’s a possibility that a BHC structure will become advantageous down the road, it may be wise to retain it. Creating a new BHC when a need arises in the future may be difficult — if not impossible — and costly.


Sidebar: Advantages of small BHC status

Banks whose holding companies qualify as small bank holding companies (small BHCs) under the Fed’s small bank holding company policy statement enjoy significant advantages, especially when it comes to raising capital. And last year’s Economic Growth, Regulatory Relief and Consumer Protection Act expanded these advantages to a greater number of banks by raising the threshold for small BHC status from $1 billion to $3 billion in total consolidated assets.

Small BHCs can incur greater amounts of debt than other BHCs. Plus, they’re permitted to measure capital adequacy at the bank level only, without considering the BHC’s consolidated capital. This allows the BHC to borrow money — using virtually any type of debt instrument — and “downstream” the proceeds to a subsidiary bank in the form of capital.

Greater access to debt also gives small BHCs greater flexibility in structuring and financing M&A transactions.

© 2018

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