Forming a Bank Holding Company - Structure, Governance, and Regulations Understanding Banks

Forming and Expanding a Bank Holding Company

Financial Holding Company Requirements

BHC Regulations

Capital Building Options for Bank Holding Companies

Pros and Cons of Forming a Bank Holding Company

Stocks and Governance

Corporate Governance and Banking Law

The Role of Bank and Holding Company Audit Committees

Data Gathering Method

Database of Study

Summary, Conclusions and Recommendations

Forming a Bank Holding Company - Structure, Governance, and Regulations

This research paper describes the process of forming a bank holding company in the United States. The behavior of a bank holding company is strongly linked to the success of the banks it holds. Therefore, if business leaders can pinpoint how to set up a successful holding structure, they may have a better chance of successfully progressing their business.

Chapter 1 - Introduction

Statement of the Problem

Over the past few decades, the banking industry has undergone some difficult economic times. In the 1980s, banks were failing, and capital was scarce (Kolveit and Owens, 2000). However, today's industry reports relatively high profitability, and capital is more widely available. Many banks face the challenge of growing fast enough to leverage the increased capital generated by earnings.

Bank holding companies that qualify as S corporations can manage capital levels by paying significant amounts of current income as dividends to their shareholders (Kolveit and Owens, 2000). This can be a positive alternative for many banks. However, the current limitations make this alternative impossible for many community banks. Banks and bank holding companies with excessive capital that cannot elect S corporation status have limited choices. They can: (1) continue to hold capital and increase capital levels; (2) distribute capital as taxable dividends; (3) buy a bank or bank-related business; or (4) some combination of all of these.

The challenge of appropriately leveraging capital is ongoing for all banks. Banks seeking high returns on assets often find it difficult to leverage capital, because adding incremental loans and deposits with lower interest margins reduces return on assets, even though return on equity increases. Consequently, return on equity is likely to become a more common measure of success than return on assets. Thus, forming a bank holding company seems to be an excellent option for institutions with an abundance of capital.

However, according to experts, one of the most common mistakes made by institutions is forming holding companies prematurely (Dalton, 1997). Many community banks are eager to acquire, buy back company stock or boost earnings per share. Still, many also fail to do their homework on the subject.

Purpose and Importance of the Study number of institutions are forming holding companies prematurely," said John Carusone, president of the Hartford, Conn.-based Bank Analysis Center Inc. (Dalton, 1997). "If it's tied to expansion or stock buy back, it can work, but otherwise it can be very labor-intensive and expensive. A lot of banks are jumping in when they shouldn't."

The holding company structure, under which the bank becomes the subsidiary, offers flexibility and tax advantages, but also brings more regulation, expense and red tape. The holding company also can be used as a way to buy community banks, while preserving the historic community bank names.

In this light, it can be beneficial to form a holding company, and in a healthy economy, it can be an excellent business strategy, but only if it is done for the right reasons. "A lot of banks feel their stock is undervalued in the market, but they should think long and hard before buying back stock," according to Carusone (Dalton, 1997).

Many community banks and thrifts form holding companies as part of cash management strategies. When an industry has a great deal of capital, one way to manage growth is to repurchase stock, and current tax laws make it nearly impossible for a bank to buy back its own stock without forming a holding company.

Basically, repurchasing stock has two purposes. First of all, it enables a bank to improve return on equity, a key ratio used by analysts. Second, a buyback lessens the number of shares in circulation without affecting a company's earnings, so earnings per share increase.

The earnings per share ratio (EPS) has several implications. According to Dalton (1997), "Thrifts' stock usually sells for 10 times EPS, therefore, boosting EPS can nudge stock prices up to increase shareholder value. If another bank buys a thrift, the stock usually is valued at about 15 times EPS. In this case, increasing EPS can drive up the acquisition price and possibly hold off an unwanted merger." On the other hand, tax laws prevent a bank from acquiring another financial institution for two years after buying back stock, so their opportunity to acquire is reduced.

Implemented another way, forming a holding company can ease acquisitions. The parent company can hold several banks as subsidiaries without having to merge them or...

"It can be an attractive way to facilitate a merger as the community banks are staking out their turf," according to Carusone (Dalton, 1997).
For example, in 1995, Lexington Savings Bank and Waltham-based The Federal Savings Bank jointly formed a holding company, Affiliated Community Bancorp Inc. The holding company, now the parent of both banks, then bought Newton-based Middlesex Bank & Trust Co. Each of the three banks, and any subsequent acquisitions by Affiliated, has its own board of directors and president. They were able to both preserve localness and grow.

This study will examine the positive and negative aspects of forming a bank holding company. By reviewing existing literature and conducting an empirical study, the author aims to provide recommendations about the structure and governance of bank holding companies to help interested parties determine the best way to form a bank holding company.

Scope of the Study

Assumptions affect the scope of the study by describing the factors that were believed to be true to interpret and validate the results. Limitations describe factors excluded from the study by choice or circumstances.

Assumptions

The following conditions were assumed to be true:

The sample drawn for the study is of sufficient size to provide valid and comprehensive questionnaire responses for this type of project.

The professionals surveyed in the study completed the questionnaire accurately and honestly.

The data requested was interpreted in an objective manner that were beneficial to institutions forming bank holding companies.

Limitations of the Study

The study and questionnaire were limited only to those professionals who had been involved in the process of forming a bank holding company.

The clientele used in the questionnaire process were chosen from press releases, white papers and research papers discussing bank holding companies.

The results of the study were based solely on the response created from the questionnaire. Each response was that of a professional who had been involved in some aspect of forming a bank holding company. The responses were that of each respondent's personal opinion about the topics discussed.

Rationale of the Study

The study is conducted to provide rational basis for forming a bank holding company. The study thoroughly examines existing literature and solicits the opinions of professionals to reveal a series of conclusions and recommendations regarding the process of forming a bank holding company.

Definition of Terms bank holding company is an entity whose principal business purpose is holding shares of stock in a bank. If the holding company is a corporation, the holding company is itself owned by the holders of its stock.

Bank holding companies exercise control over and provide additional support to banks in the form of management and monetary resources. In addition, following enactment of the Gramm-Leach-Bliley Act, a bank holding company may elect to become a financial holding company in order to participate in a broad range of financial activities, including securities underwriting, insurance sales and underwriting, and merchant banking. The top ten United States bank holding companies are listed below.

Table 1 -- TOP TEN U.S. BANK HOLDING COMPANIES, 2002 ($ http://www.financialservicesfacts.org/img/pxl.gif http://www.financialservicesfacts.org/img/pxl.gif

Assets

Citigroup Inc.

J.P. Morgan Chase & Co.

Bank of America Corporation

Wells Fargo & Company

Wachovia Corporation

Bank One Corporation

Taunus Corporation

Fleetboston Financial Corporation

U.S. Bancorp

ABN AMRO North America Holding Company

1) Ranked by assets.

Source: Board of Governors of the Federal Reserve System.

SOURCE -- U.S. Small Business Corporation. (2003). Financial Services Fact Book. Financial Services Fact Books.

Overview of the Study

This research paper describes the process of forming a bank holding company in the United States. The behavior of a bank holding company is strongly linked to the success of the banks it holds. Therefore, if business leaders can pinpoint how to set up a successful holding structure, they may have a better chance of successfully progressing their business.

Chapter 2 - Literature Review

Understanding Banks

Because there are so many misconceptions as to the definition of bank mergers and acquisitions, it is important to understand certain terms in order to fully understand how to form a bank holding company. The following terms are often heard in the banking world:

Merge-to unite: to lose identity by being absorbed or combined;

Merger: combining two or more companies into one;

Bank Merger: consolidations of two or more banks' charters (there are two types of mergers).

Bank-Bank Mergers: the…