Small Bank Holding Companies: Regulatory Update & Key Considerations

During 1980 the Federal Reserve issued the Small Bank Holding Company Policy Statement (“Policy Statement”), which recognized from a regulatory perspective that small bank holding companies have less access to the capital markets and equity financing than large bank holding companies. Although the Fed has sought to limit holding company debt so that the parent can serve as a “source of strength” to its subsidiaries, especially the deposit-taking bank subsidiaries, the Policy Statement allowed small bank holding companies to utilize more debt to finance acquisitions and other ownership transfer-related transactions than would be permitted by large bank holding companies. The Policy Statement initially applied to bank holding companies with assets less than $150 million; it was amended in 2006 to include bank holding companies with assets up to $500 million. Effective May 15, 2015, the threshold increased to consolidated assets of less than $1 billion for both bank holding companies and savings and loan holding companies, provided that the company complies with the Qualitative Requirements and does not:

1. engage in significant nonbanking activities either directly or through a nonbank subsidiary
2. conduct significant off-balance sheet activities (including securitization and asset management or administration) either directly or indirectly through a nonbank subsidiary
3. have a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the SEC

Holding companies that meet the above requirements may use debt to finance up to 75% of the purchase price of an acquisition, but are subject to the following ongoing requirements:

1. parent company debt must be retired within 25 years of being incurred
2. parent company debt-to-equity must be reduced to 0.30:1 or less within 12 years of the debt being incurred
3. the holding company must ensure that each of its subsidiary insured depository institutions is well capitalized
4. the company is expected to refrain from paying dividends until it reduces its debt-to-equity ratio to 1:1 or less

The primary benefit of small bank holding company status is that it creates a larger universe of bank and now savings and loan holding companies that are not subject to the Federal Reserve’s risk-based capital and leverage rules, including the Basel III rules. As of year-end 2014, 454 bank holding companies with assets between $500 million and $1 billion filed a Y-9C according to SNL Financial LC. From a functional standpoint, small bank (and S&L) holding companies do not file a quarterly Y-9C or Y-9LP; instead these companies only file a Y-9SP semi-annually. Regulatory capital rules for these companies continue to apply to their bank subsidiaries, which represents no change from past practice.

Implications

Expansion of Policy Statement eligibility is likely to affect strategic and capital planning for small BHCs.

• Companies that now fall under the Policy Statement oversight can use traditional debt at the holding company level and potentially generate higher returns on equity with a lower cost of capital. Senior debt may be used to replace existing capital such as SBLF preferred stock or fund stock repurchases or dividend distributions.
• Higher capital requirements for larger bank holding companies, coupled with relaxed capital regulations for small bank holding companies, may provide smaller companies an advantage when bidding on acquisition targets inasmuch as the ability to fund acquisitions with a greater proportion of debt results in a lower cost of capital.
• S corporation bank holding companies should remain particularly cognizant of the 1:1 debt/equity ratio constraint that should be maintained in order to declare dividends. For S corporations, the inability to declare dividends may result in shareholders being responsible for their pro rata share of the BHC’s taxable earnings with no offsetting distributions from the BHC. Since the debt/ equity ratio is calculated using equity determined under Generally Accepted Accounting Principles, significant volatility in securities carried as available-for- sale may impair the BHC’s ability to declare dividends.
• If the subsidiary bank holds assets with more onerous risk weightings under the Basel III regime (such as mortgage servicing rights), the holding company may wish to evaluate whether holding such assets at the holding company, rather than the bank, may be more capital efficient.

For more information or to discuss a valuation or transaction advisory issue in confidence, please do not hesitate to contact us.