The Pros and Cons of Bank Holding Companies

Last week, Northeast Bank became the fourth banking organization in two years to eliminate its holding company. Previously, ZB, N.A. (now Zions Bancorporation, N.A.) (September 2018), BancorpSouth Bank (October 2017), and Bank of the Ozarks (June 2017) also eliminated their holding companies.

All of the transactions were motivated, at least in part, by the desire to improve efficiency by eliminating redundant corporate infrastructure and activities, as well as the associated supervision and oversight of the holding company by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Other reasons may also drive the decision to eliminate a holding company. Zions successfully petitioned to be de-designated as a systemically important financial institution in connection with its holding company elimination. Northeast replaced commitments made to the Federal Reserve Board with policies and procedures relating to its capital levels and asset portfolio composition that would permit more growth in the loan portfolio.

Many banking organizations continue to maintain their holding companies. Some have made an affirmative decision to maintain the holding company structure in order to engage in powers and activities not permissible at the bank level. Others may not have considered the issue. Now may be a good time to ask the question: Is the holding company worth it?

The Bank Holding Company
Pros	Cons
Well-developed corporate governance	Costs associated with compliance with additional corporate governance and recordkeeping requirements
Flexibility in strategic transactions, activities, and investments	Additional regulatory oversight for non-member banks
Existing dividend reinvestment plans (DRIPs) and grandfathered trust preferred issuances can serve as useful capital management tools	Capital structuring advantages have diminished over time

Well-Developed Corporate Governance

Bank holding companies are typically organized as business corporations under state law, which can provide more certainty with respect to corporate governance matters, including indemnification, anti-takeover protections, and stockholder rights. These concepts are better developed under state corporate law, through statutory and case law, than banking law. Some states expressly apply their business corporation law to banks; however, many more do not. Similarly, national banks may elect to follow the corporate governance procedures of the law in which the bank is located, the Delaware General Corporation Law, or the Model Business Corporation Act, to the extent not inconsistent with federal banking statutes or regulations, or bank safety and soundness; however, in practice, provisions of the National Bank Act or regulations of the Office of the Comptroller of the Currency may restrict certain aspects of a national bank’s corporate governance.

Flexibility in Strategic Transactions

A bank holding company provides flexibility in structuring strategic transactions: a bank holding company can acquire additional banks and operate them as separate subsidiaries. While such sister-bank structures are no longer necessary to address interstate banking limitations, they may be desirable to potential strategic partners as a means of maintaining an acquired institution’s legal and corporate identity, board, and management structure. Even without a bank holding company, though, a bank may preserve the identity of a strategic partner by operating it as a division of the surviving bank.

Additional Corporate Governance Requirements

The advantages of the bank holding company structure, such as they are, come at a cost. Because a bank holding company is a separate legal entity, organizations maintaining bank holding companies are subject to additional corporate governance and recordkeeping requirements. For example, among other things, the bank holding company must hold separate board of directors and committee meetings, create separate minutes for such meetings, enter into expense sharing and tax sharing agreements with its bank subsidiary, and generally observe other corporate formalities designed to maintain the separate corporate existences of the bank holding company and the bank. In addition, the relationship between the bank holding company and its subsidiary bank is subject to Section 23A and Section 23B of the Federal Reserve Act, an additional regulatory compliance burden.

Additional Regulatory Oversight

Bank holding companies are subject to supervision and related examination and reporting requirements of the Federal Reserve Board. Unless a bank is a state member bank, the bank holding company structure introduces the Federal Reserve Board as an additional supervisory regulator and subjects the organization to additional examinations and reporting requirements that often overlap with those of the bank’s primary regulators. The incremental regulatory burden carries attendant compliance costs and consumes significant management attention. The Federal Reserve Board also expects a bank holding company to serve as a source of financial strength to its subsidiary bank, an expectation that was formalized in Section 616 of the Dodd-Frank Act.

Capital Structuring Advantages of Bank Holding Companies Have Been Diminished Over Time

Historically, bank holding companies could issue Tier 1 capital instruments that were not feasible or permissible for banks to issue, such as trust preferred securities and cumulative perpetual preferred stock. The Dodd-Frank Act grandfathered Tier 1 treatment for existing non-qualifying Tier 1 instruments issued before May 19, 2010, by banking organizations with less than $15 billion of consolidated assets as of December 31, 2009, and those that were mutual holding companies as of May 19, 2010, including trust preferred issuances (subject to certain limitations), and eliminated it for new capital issuances. 

A bank holding company with existing grandfathered trust preferred securities or with registered DRIPs may find them useful capital management tools.

Bank holding companies that qualify under the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (i.e., those with less than $3 billion in consolidated assets and that meet other requirements described in the policy statement) are not subject to the Federal Reserve Board’s risk-based capital rules and are permitted to have higher levels of debt than other bank holding companies and banks.

Bank holding companies historically have also enjoyed additional flexibility to redeem capital, but this advantage has largely been eliminated by the Basel III rulemaking and Federal Reserve Board supervisory requirements.

Bank Holding Companies May Engage in a Broader Suite of Activities and Investments Than Banks

Bank holding companies, especially those that elect to be financial holding companies, can engage in non-banking activities and activities that are financial in nature through non-bank subsidiaries that are bank affiliates. In some cases, these activities may not be bank permissible, such as insurance underwriting and making merchant banking investments. The Federal Reserve Board, in consultation with the Treasury Department, also has authority to approve additional activities that are financial in nature or incidental or complementary to a financial activity on a case-by-case basis.

Bank holding companies can make passive, non-controlling minority investments (not exceeding 5% of any class of voting securities) in any company, regardless of the types of activities in which the company is engaged. Banks are not permitted to make such investments, though they are typically permitted to invest in companies whose activities consist solely of bank permissible activities. Banks may also rely on other authorities for investments, such as the community development or public welfare authority, or, if available under applicable state law, limited leeway authority or authority to invest in specific securities or types of securities designated under the applicable banking law or by the applicable banking regulator.

While eliminating a bank holding company may not materially restrict the future business activities of a bank that does not intend to pursue the activities or investment opportunities afforded to bank holding companies, an organization that engages in activities at the holding company level that are not bank permissible activities or that wishes to retain flexibility to engage in such activities may not wish to eliminate its holding company. Many of the considerations addressed in this article are relevant to savings and loan holding companies. However, a unitary savings and loan holding company with grandfathered rights under the Gramm-Leach-Bliley Act to engage in activities that are not financial in nature should think twice about eliminating a holding company, because it would lose its grandfathered rights.

Other Considerations: Public Company Reporting Obligations and Benefit Corporation Status

Bank holding companies that are public companies must make quarterly and other filings and public disclosures with the Securities and Exchange Commission. Banks with an outstanding issuance of securities must make similar filings and disclosures directly with the primary federal regulator. Additionally, bank holding companies, unlike most banks, may be able to elect public benefit corporation status under the laws of the state in which they are organized, if the state is one with a public benefit corporation statute. While banks are not necessarily precluded from making that same election, a banking regulator’s involvement is required.

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Operating without a bank holding company would result in more streamlined regulation, corporate governance, and recordkeeping processes. On the other hand, operating with a bank holding company would provide the flexibility to engage in activities, to make investments, and to create sister-bank structures that a bank may not.

We Can Help Evaluate Your Organization’s Options

Whether to form or to retain a bank holding company is an important decision requiring careful consideration of your organization’s unique activities and needs. Let our team of experienced banking attorneys help you evaluate the structure that best suits your organization, formulate a detailed action plan, and navigate you through its execution. For more information, contact Samantha M. Kirby, William E. Stern, or Alexander J. Callen.

About Goodwin:

Goodwin’s financial services practice is one of the most highly regarded and largest financial services practices in the United States. Our clients include most of the largest global banks on Wall Street and throughout the world, including full-service and specialty banks; bank and financial holding companies; credit card, mortgage and other lenders, servicers and insurers; companies offering mutual, hedge and private equity fund products; investment advisers; broker-dealers; institutional investors; and providers of technology and other consumer financial services.