Is the bank holding company structure obsolete or unnecessary? Some might believe that to be the case, but there are a number of reasons why banks should consider maintaining, or even enhancing the use of their holding companies. Most obvious among these reasons to resist eliminating the holding company is the flexibility to grow, diversify, and innovate offered by the bank holding company structure. This is also the same reasoning used to examine the potential benefits of establishing a bank holding company for a bank that does not currently have one.
Recent news has focused on just a few banking organizations merging their holding companies into the subsidiary bank, thereby shedding their holding companies in favor of a more streamlined banking structure, but it is not clear that this is a broader trend. Those particular banking organizations determined that their traditional noncomplex banking activities were not receiving real value from the holding company structure and the cost was not worth maintaining the holding company. However, these banks are in a unique position. They are larger, noncomplex banks with limited or no nonbanking activities. They were not exploiting the benefits of the holding company structure with regard to nonbanking activities, and because they exceed the asset threshold for the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (the “Small BHC Policy Statement”), they were unable to use the leverage and other benefits of the Small BHC Policy Statement. See Appendix C to 12 C.F.R. 225. By eliminating the holding company structure these banks were also able to eliminate an additional banking regulator, the Federal Reserve. However, the benefits these banks saw from eliminating their holding company appear to be unique to their activities and structure.
While there are no doubt additional costs to consider with the holding company structure, for most banks, the holding company structure is a supportive tool that can be utilized in a number of ways. However, there are certain costs identified with the establishment and maintenance of a holding company structure.
Costs/Disadvantages of a Holding Company
Since a holding company is a separate entity, with a separate regulator, the Board of Governors of the Federal Reserve System (the “FRB”), there are additional costs associated with maintaining a holding company as a separate, regulated entity. First among these costs is the cost for maintaining the corporate entity. Governance, recordkeeping and accounting costs are not insignificant, especially when considering the prospect of registration and filings with the Securities and Exchange Commission (the “SEC”), yet another regulator. However, many banking organizations are able streamline these corporate maintenance costs quite efficiently. There is also a cost to complying with Sections 23A and 23B of the Federal Reserve Act since the holding company and the bank will be “affiliates” for purposes of Sections 23A and 23B.
With the addition of the FRB as the regulator at the holding company level, assuming the subsidiary bank is a state-chartered, non-member bank, the banking organization will be subject to an entirely new supervisory regime that looks at things in a consolidated manner. There is an understandable hesitation to take on the new cost of additional filings and applications, recordkeeping, governance expectations, and examination expectations, but the FRB has been exploring ways to streamline and improve the efficiency of its reviews by increasing collaboration with the other regulatory agencies in order to minimize the regulatory burden. See, generally, and by example, SR Letter 13-21 (December 17, 2013) (updated March 6, 2019), SR Letter 16-4 (March 3, 2016), SR Letter 16-11 (June 8, 2016), and SR Letter 19-9 (June 3, 2019).
Benefits of a Holding Company
While cost and additional regulatory framework are factors to consider when evaluating the maintenance or establishment of a holding company, the holding company structure is not obsolete and, for most banks, the benefits of the holding company structure can far exceed the cost.
The key to unlocking the benefits of a holding company for any bank (large or small) is exploitation of the holding company’s flexibility. Flexibility in operations, activities, investments, financing, and acquisition strategy offer banking organizations the ability to facilitate more efficient growth and diversify and manage risk effectively. See, generally, Marsden, Madeline, The Costs and Benefits of the Bank Holding Company Structure, Federal Reserve Bank of Atlanta, April 19, 2018. These benefits are even more pronounced for banking organizations engaged in permissible nonbanking activities under Section 4 of the Bank Holding Company Act, or banking organizations below $3 billion in assets taking advantage of the flexibility offered by the Small BHC Policy Statement. Favorable state corporation laws can enhance these benefits.
Three practical benefits include:
1. Flexibility in Growth and Acquisition Strategy. Holding companies can be a significant benefit to a bank’s growth or acquisition strategy. Holding companies have greater flexibility to buy stock in other financial institutions, can issue debt to assist in strategic transactions by subsidiary banks, and have wide latitude to more deliberately integrate a newly acquired bank.
This includes the ability to siphon off certain assets (and the associated risk) to the holding company as separate holdings distinct and apart from a subsidiary bank. Getting certain assets off the books of a subsidiary bank can help with state law compliance and general financial management of the overall banking organization.
Finally, for smaller banks, a small bank holding company has the added ability to use significantly more leverage to engage in growth through acquisitions than is permissible for a small bank or a larger bank holding company.
2. Capital and Liquidity. Improving the capital position or liquidity of a subsidiary bank is one critical function of a bank holding company, and one that can be significant for shareholders. The ability to issue debt instruments and downstream the proceeds as capital for the subsidiary bank is one of the key benefits of the holding company.
The holding company is also a vehicle for liquidity that can be offered to shareholders by way of repurchases. Stock redemptions can be accomplished with limited regulatory approval requirements in many cases. See 12 C.F.R. 225.4. Regulation Y permits bank holding companies to redeem up to 10 percent of the holding company’s consolidated net worth (for the previous 12 months) without regulatory approval. Small bank holding companies experience the added benefit of an exemption from consolidated capital requirements so that the capital is evaluated at the bank level.
3. Diversification of Activities. Since bank holding companies are able to purchase up to five percent of the stock of any company, the holding company structure allows for a greater diversification of activities and investments. Section 4 of the Bank Holding Company Act also permits a number of nonbanking activities that allow banking organizations to diversify activities and risk.
The so-called “laundry list” of permissible activities for bank holding companies includes the ability to engage in: extending credit and servicing loans; activities related to extending credit; leasing personal or real property; operating non-bank depository institutions; trust company activities; financial and investment advisory activities; agency transactional services for customers; investment transactions as principal; management consulting and counseling activities; support services; insurance agency and underwriting (limited); community development activities; issuance and retail sale of money orders, savings bonds, and traveler’s check; and data processing (limited). See 12 C.F.R. 225.28.
In a time of critical innovation in financial technology and non-core revenue generation in the banking sector, the ability to diversify can be a significant benefit for banking organizations dealing with a low interest rate and restrictive lending limit environment. For well-managed and well-capitalized bank holding companies electing to become a Financial Holding Company, the expanded scope of permissible activities may create even more avenues for growth and diversification.
Conclusion
Each banking organization should carefully consider its overall strategic goals and periodically assess the utility of maintaining or establishing a holding company structure in light of those strategic goals, but on balance we believe that for most banking organizations the flexibility offered by a holding company structure continues to exceed the burden of maintaining a holding company.