In the wake of the Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155), the “small bank holding company” is now defined as having up to $3 billion in consolidated total assets. This is a very helpful development for community banking.
Why holding company structure helps
Before dealing with the advantages of a small bank holding company, particularly under the new law, let’s address whether a bank should even have a holding company. As of the end of the first quarter, approximately 76% of the banks in the country were in a bank holding company structure.
In my opinion, 100% should be. Yet, notwithstanding the prevalence of holding companies in the industry (and my opinion), two prominent smaller regional players both recently eliminated their holding companies. (This was Bancorp South and Bank of the Ozarks.) This caused a number of small bank holding companies to question whether they ought to follow suit.
My general advice: Just because one of the larger banks does something does not mean it is appropriate for small community banks to follow. More specific to the matter at hand, the benefits of a holding company for a small community bank significantly outweigh any costs or issues associated with maintaining that holding company.
Some thoughts on structure
Frankly, I suspect that if you discussed the decision to terminate the holding company with the CEOs and boards of the companies mentioned above, they would tell you that they had a variety of motivations. They might have included prior difficulty getting acquisitions by the holding company approved by the Federal Reserve.
If I was starting a brand new bank today, as a few people are, I would likely start it as a state-member bank. I’d get the bank open and running, and then put it under a holding company. That way you would have the Federal Reserve as the friendly federal regulator for both the holding company and the bank, in addition to the state for the bank. No FDIC. No OCC.
Why new law’s change matters
With that initial issue settled, what’s the big deal about the bank holding company for a community bank? And why does it make a difference that the small bank holding company definition has now moved from $1 billion to $3 billion?
The significance is a bank holding company provides significant flexibility as it relates to generating capital for the bank, creating liquidity for the shareholders, and engaging in acquisition transactions.
In regard to generating capital, the benefit of the Small Bank Holding Company Policy Statement is that now a small bank holding company is not considered on a consolidated basis for capital purposes until it exceeds $3 billion in consolidated assets. In other words, only the bank’s capital is tested for capital adequacy.
This means the holding company can borrow money and downstream it into the bank where it shows up “magically” as capital. (Do be aware there are some rules with respect to leveraging capital in the subsidiary bank. They are not terribly onerous.)
Because the company is not consolidated for capital purposes, it is immaterial whether the debt instrument used to raise capital qualifies as such under the Fed guidelines. Any way the company can generate cash is sufficient for any corporate purpose. Whether the cash is from an institutional lender, a bankers’ bank, a rich and smart director, another individual, or a variety of other sources, it doesn’t matter. Once downstreamed into the bank, it counts as capital at the bank level, and it may save the holding company as much as 300 basis points on the interest rate when compared to subordinated debt.
I’d say that’s worth consideration.
Why to consider this step
Let’s look at the key reasons to form a community bank holding company:
1. Leveraging capital. For most community bank holding companies, leveraging capital into the bank through a line of credit (i.e., incrementally growing the capital in the bank as needed), assuming it can be done profitably, is the number one advantage. In many cases, this advantage proves significant enough on its own to warrant restructuring. Now, that advantage is available to consolidated holding companies up to $3 billion.
2. Creating liquidity for shareholders. My mantra over the years has been that it is part of the board’s job to enhance shareholder value. One pillar of that is creation of liquidity—the ability of a shareholder to sell a share of stock at a fair price at the time they want to.
As a practical matter, most small banking organizations, even if they are traded over-the-counter, or even on NASDAQ, lack sufficient market liquidity to meet the needs of shareholders desiring to sell. For that reason, most small banking organizations will need to redeem shares from their shareholders as a way to create liquidity. This type of redemption transaction is much simpler for a holding company than it is for a bank.
For a bank, a stock repurchase technically means a reduction of bank capital for state and federal purposes. The bank not only has to receive regulatory approval for the repurchase, it also has to receive shareholder approval (typically two-thirds).
Not so for the small bank holding company. In that case, no shareholder approval is required. Nor is state approval is required. While the Fed also has some rules regarding share redemption, as a practical matter, as long as the holding company is well-capitalized and well-managed before and after the redemption, it basically can make the share redemption without Fed approval. (However, Fed notice is generally “suggested” under Federal Reserve supervisory guidelines.)
3. Facilitating acquisitions. This may be leveraging capital in the bank to make an acquisition. Or it may mean leveraging the acquisition of another bank and holding it separately so the holding company now becomes a multi-bank holding company. Or it could be some combination of the above.
For example, let’s say your bank wants to acquire $100 million worth of branches from another bank. In order to do that and maintain capital of say 9% or 10%, $9 million to $10 million in capital would have to be added to the company’s balance sheet to support the $100 million in asset growth. (That does not include any premium paid on deposits.) That can be all leveraged through the bank holding company.
The ability to leverage capital into the company, the ability to create liquidity for the shareholders, and the ability to facilitate acquisitions (and being able to hold the acquired bank separate) are all benefits of the small bank holding company. The recent law signed by President Trump will certainly enhance those abilities, particularly as it relates to leveraging capital into the subsidiary bank.
For now, the byword is keep your holding company in place and fully understand how to use it and maximize its benefit. If you do not have a holding company, give serious consideration to forming one.