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...
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