Bank Holding Companies

Overview

Most U.S. banks are owned by bank holding companies (BHCs). The Federal Reserve supervises all BHCs whether the bank subsidiary is a state member, state nonmember, or national bank. This section provides information to assist in deciding whether and when to form a BHC.

Bank Ownership by BHCs

Currently, about 84 percent of commercial banks in the U.S. are part of a BHC structure. Relatively few BHCs, however, are formed by banks while the bank itself is in the organizational phase. Typically, the formation of a BHC is made at some future point in the bank's operations.

The following charts demonstrate the prevalence of BHC ownership of banks in the U.S.:

• Bank Ownership by BHCs December 1980 to December 2007
• Bank Ownership by BHCs Based on Bank Assets: December 31, 2007

More than 75 percent of small banks with assets of less than $100 million are owned by BHCs, while this percentage increases to 100 percent for large banks with more than $10 billion in assets. About 60 percent of minority-owned banks are owned by BHCs.

Judging from the large number of BHCs, the question for most banks appears to be when to form a BHC, not whether. It should be noted, however, that some banks have been acquired by a BHC, as opposed to having made an active decision to form their own BHC.

Starting in 1980, only six out of 202 new banks opened with BHCs, or about 3 percent. But by 1985, this percentage had jumped to about 18 percent, with 56 out of 306 new banks forming BHCs. The percentage continued to increase slightly over the next decade, and since the mid-1990s, it seems to have stabilized near 25 percent. In 2007, for example, 40 out of 162 new banks opened under a BHC structure. View the accompanying chart for more detailed information.

Should an Organization Form a BHC?

There is no easy answer to this question. Each organization is unique and should make its own determination.

The Federal Reserve is neutral on the question of whether banks should form BHCs, and it does not actively market or encourage the formation of BHCs. The BHC provides a structural alternative that may be appropriate given a bank's circumstances, priorities, and business plan. The Federal Reserve will consider BHC applications if they meet the established financial and managerial standards.

The Fed has taken steps over the years to streamline the applications process and to reduce regulatory burden in supervision and reporting, particularly for small BHCs. To the extent possible, the Federal Reserve wants to take regulatory burden out of the equation, so organizations can base their decision strictly on business considerations.

Pros and Cons of BHC Formation

Pros

A BHC has the ability to raise capital in forms other than common stock. The prime example of this is the issuance of trust preferred securities (TPS). The ability to issue TPS has been a main driver of many BHC formations over the past 10 years. View the accompanying chart for more information on a TPS transaction.

The advantages of TPS include the following:

• The instrument is a relatively low-cost source of tier 1 capital owing to the tax treatment.
• The subsidiary bank ends up with new common equity (if this is the purpose of the TPS issuance)—an advantage from the bank regulator's point of view.
• There is no dilution to the BHC's existing shareholders.
• Investment bankers often pool a trust preferred issuance, which provides funding to 10 or 12 small BHCs. The pooling aspect has served to open the trust preferred market to BHCs that might otherwise find the transaction and marketing costs too high.

For a de novo organization, however, the issuance of TPS is something to plan for several years down the road. The TPS market has not been receptive to issuances by new organizations that have no track record. A BHC in satisfactory condition might begin to consider issuing TPS as assets approach $100 million.

Finally, it is important to note that the TPS market has been shrinking due to the general market turmoil stemming from the subprime mortgage crisis, resulting credit crunch, and other factors. TPS investors are now harder to find, and required interest rates have increased substantially. However, the recent disruption of the TPS market is likely temporary.

Another factor in favor of forming a BHC is that BHCs have considerable latitude in assuming or incurring debt. This might be done, for example, to fund a capital injection to the subsidiary bank or to pay for an acquisition. Debt is always limited, however, by the BHC's demonstrated debt servicing and retirement capability. Also, substantial levels of debt in a de novo organization are discouraged.

BHCs also increase flexibility in merging with or acquiring additional banks. In addition to merging a bank into a BHC's subsidiary bank, a BHC can acquire an additional bank and operate as a multibank BHC. A BHC can also establish or acquire nonbank subsidiaries and operate them as entities separate from the bank.

Finally, even if the organization has no immediate plans to use the BHC in any of the ways discussed above, there is a school of thought that argues for establishing the BHC anyway—to act as a safeguard in case it is needed in the future.

Cons

For a de novo organization, there are additional costs and more complexity in the start-up phase associated with the formation of a BHC. Also, there are ongoing costs related to Federal Reserve supervision and reporting requirements, despite the Federal Reserve's efforts to minimize these burdens. Additionally, a BHC may be subject to additional cost and regulation related to Security and Exchange Commission (SEC) registration. However, SEC registration is not required if the BHC stock is sold through a private offering or sold only to residents of the BHC's home state.

Another con is that a de novo BHC would likely need to increase the organization's initial capital offering by at least several hundred thousand dollars in order to provide working capital for the BHC. (It is important to anticipate the BHC's funding needs because a de novo bank will not be able to pay dividends for the first few years.)

Based on the above considerations, BHC formation is often deferred until there is a clear purpose or need for it.

Policy Statement on Small Bank Holding Companies

In the 1980s, the Federal Reserve issued an important policy statement on small BHCs, which is Appendix C to Regulation Y. The policy statement recognizes the importance of community banking in the financial system and affords certain advantages to facilitate ownership and transfer of small banks by BHCs. A 2006 revision of the policy statement increased the asset threshold for a small BHC from $150 million to $500 million.

Small BHCs are exempt from the consolidated BHC capital guidelines to which larger organizations are subject. The capital adequacy of small BHCs is based on the bank's capitalization, just as if the BHC were not present. This means that the BHC, within reasonable parameters determined by its ability to service and retire debt, can use lesser forms of capital, or debt funding, to provide (for example) equity capital to the bank or to help fund an acquisition. In addition, small BHCs also enjoy simplified reporting requirements.

Application Process

The formation of a BHC requires the prior approval of the Federal Reserve through a formal application process, which, over the years, the Federal Reserve has streamlined and simplified. Most applications by well-run BHCs are acted on within 30 days.¹ Some noncomplex proposals are processed in just 15 days.² And the simplest proposals, such as engaging a de novo in a permissible nonbank activity, require only an after-the-fact notice.³

Given a proposal to form a de novo bank that meets the financial and managerial standards of the bank's regulators, a related application to establish a de novo shell BHC over the bank usually raises few issues.

Once the initial application is approved, additional applications are required in the future if the BHC proposes to acquire additional banks or engage in nonbanking activities. Each application is evaluated under established financial, managerial, and competitive standards. Generally, well-run organizations in satisfactory condition receive approval to expand, while others are discouraged.

Bank Charter Decision Within a BHC Framework

To establish a commercial bank, the organizers can file for either a national or state charter, and if they file for the state charter, they have a further option as far as being a member of the Federal Reserve or a nonmember. The chart above shows that all bank charter types are compatible within a BHC framework.

A BHC can be formed over a commercial bank regardless of the bank's charter type or member/nonmember status, and the policies, regulations, and supervision and reporting requirements for BHCs are not dependent on the bank charter type.

However, the BHC is always supervised by the Federal Reserve at the federal level, and if the organizers elect to become a state member bank, the Federal Reserve is also the federal supervisor at the bank level, rather than the OCC or FDIC. Therefore, some BHC organizations choose the state member bank charter in order to simplify regulatory relationships at the federal level. The Federal Reserve is then the single federal regulator responsible for supervision at both the BHC and bank levels.

Review Growing Shareholder Value for more information on BHCs, the legal framework, regulatory reporting requirements, and financial holding companies. View the accompanying chart on bank charter decision within a BHC framework.