Expert Witness Advice on Bank Holding Company Structure Issues Important in Banking Litigation

When I worked as a banking executive, it was commonplace to hear bankers complain about the excessive level of regulation under which we had to do our job. The complaint was legitimate then and it is even more so today since the level of regulation has increased tremendously.

This is why it is always amusing to me to see a non-bank financial corporation willingly agree to walk into this morass of regulation by seeking a bank charter that will then be housed within a bank holding company structure. In addition to the advantage of the bank – not the holding company - being able to borrow from the Fed at the discount

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window at bargain basement interest rates, here is a look at what they can expect on the other side of the ledger:

Problems Caused by Being a Bank Holding Company

• Restrictions on paying dividends.
• Restrictions on repurchasing common stock or other securities.
• Restrictions on engaging in other transactions that could affect its capital.
• Restrictions on change of control – Federal Reserve must approve.
• Increases in FDIC insurance premiums.
• Restrictions of Basel II.
• Restrictions of Basel III.
• Inability of bank holding companies to include trust-preferred securities as part of their Tier 1 capital.
• Living Will, or more accurately, a Plan-Your-Funeral-in-Advance program, to borrow a term from a slightly more morbid industry.
• Oversight, Supervision, Examination by OCC and the Consumer Financial Protection Bureau and secondarily by the Federal Reserve, the FDIC, and state banking oversight if the bank is state chartered.
• Federal Reserve - capital plan rule requires all bank holding companies with assets of more than $50 billion to submit annual capital plans which include projections of the company’s capital levels under baseline and stress scenarios over a nine-quarter period. The Federal Reserve will approve or object to a company’s proposed capital actions, such as dividends and stock repurchases.
• Consumer Financial Protection Bureau - The CFPB’s jurisdiction includes authority to regulate consumer services provided by the bank.
• Periodic Stress Tests if over $50 billion in assets.
• Dodd-Frank’s restrictions might grow as the implementation rules are written.

As the owner of a bank, a corporation is viewed as a bank holding company and financial holding company, and is subject to the regulation, inspection, examination and supervision of the Federal Reserve under the Bank Holding Company Act of 1956.

This Federal Reserve regulation encompasses areas such as:

● Chartering activities to carry on business as a bank.
● The permissibility of certain activities.
● Maintaining minimum capital ratios.
● Capital management in relation to the bank’s assets.
● Dividend payments and repurchases of securities, including common stock.
● Safety and soundness standards.
● Loan loss reserves and other related liabilities.
● Liquidity levels.
● Financial reporting and disclosure requirements and standards
● Counterparty credit concentrations.
● Restrictions on transactions with related parties and affiliates.
● Lending limits.
● Relationships and interactions between the bank and the holding company.
● Various other areas.

Suddenly, that cheap and easy discount window doesn’t look so good after all.

Bank Holding Company Structure

The typical structure of a bank holding company is for the holding company corporation to own the stock of the bank (or banks) and issue stock in the bank holding company. Accordingly, when you buy stock in, let’s say JPMorgan Chase & Co. for example, you are buying stock in the bank holding company that owns the bank or banks. As an example, in the case of JPMorgan Chase & Co., its 10-K for December 31, 2011, states:

“JPMorgan Chase ’s principal bank subsidiaries are JPMorgan Chase Bank, National Association (“ JPMorgan Chase Bank, N.A. ”), a national bank with U.S. branches in 23 states, and Chase Bank USA, National Association (“Chase Bank USA, N.A.”), a national bank that is the Firm’s credit card–issuing bank.”

In addition to a few banks, it is not at all unusual for a bank holding company to own many (maybe even a hundred or more) other subsidiaries in all types of businesses such as insurance, consumer lending, investment banking, securities activities, property ownership, etc.

Dividends are upstreamed from the bank to the holding company and distributed to the shareholders of the bank holding company.

The bank holding company essentially owns the income stream of the bank or banks and other subsidiaries.

Trust Preferred Securities

In addition to regular common stock and preferred stock, starting around ten years ago, bank holding companies acquired the ability to raise capital by issuing Trust Preferred Securities (sometimes called TPS). In order to create Trust Preferred Securities, a bank holding company creates a trust (usually in Delaware or Connecticut due to favorable tax treatment) issuing debt to the trust; and then the trust issues the Trust Preferred Securities.

Trust Preferred Securities are hybrid securities that possess both debt and equity characteristics, and offer many unique advantages over other types of securities (see list below). The ability to offer Trust Preferred Securities has been a major factor in the formation of many bank holding companies.

Advantages of Trust Preferred Securities include:

• The instrument is a relatively low-cost source of Tier 1 capital.
• The bank holding company’s subsidiary bank (or banks) obtains fresh common stock equity that beefs up the bank’s balance sheet.
• There is no dilution to the stockholders’ equity owned by the bank holding company's existing shareholders.
• Trust Preferred Securities possess characteristics of both preferred stock and subordinated debt in that they can be issued for a very long time – even thirty years or so.
• Trust Preferred Securities make set periodic interest payments to the holders.
• Trust Preferred Securities mature at their face value, like a bond.
• Trust Preferred Securities often allow the deferral of interest payments for up to five years.
• Investment bankers often combine and pool a Trust Preferred Securities issued by a dozen or so small bank holding companies making it cost effective for the smaller bank holding companies, large enough to produce a favorable transaction for the investment banker, and take advantage of risk spreading over several bank holding companies. This allows smaller bank holding companies to cost effectively take advantage of the benefits offered by Trust Preferred Securities.

Update: In a June 2012 ruling, Trust Preferred Securities will lose their Tier I capital status as of January 2013.

Conclusion

● Just keep in mind that typically the stock you see is that of the bank holding company that owns the stock in the subsidiary bank or banks and all of the other subsidiaries.
● Seek experienced expert assistance if you are involved in bank holding company litigation.

© 2012 by Don Coker.

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ABOUT THE AUTHOR: Banking Expert Witness and Consultant Don Coker
Expert witness and consulting services. Over 500 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ. Clients have included numerous individuals, 80 banks, and governmental clients such as the IRS, FDIC.

Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, B of A, Regions Financial, and a two-year term as a high-level governmental banking regulator.

B.A. degree from the University of Alabama. Completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School. Called on by clients in 31 countries for work involving 61 countries. Widely published, often called on by the media. Don Coker serves clients worldwide from his Atlanta metro area office.

Copyright Don Coker

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.