United States: Under New Law, A Big Win For Small Community Banks

Last Updated: December 19 2014
Article by Michael E. Bleier and D. Patrick Yoest

Most Read Contributor in United States, October 2017

Under a law enacted this month, a small bank exemption to acquisition debt limits will cover a far broader group of banks. The measure, signed into law by President Obama Dec. 18, would extend the applicability of the Federal Reserve Board of Governors' (the "Board") Small Bank Holding Company Policy Statement ("Policy Statement") to bank and savings and loan holding companies with less than $1 billion in consolidated assets.

Background and Overview As the Policy Statement states, the Board historically "has not favored the use of acquisition debt in the formation of bank holding companies or in the acquisition of additional banks." 12 C.F.R. Part 225, Appendix C. The exemption, however, allows small bank and savings and loan holding companies ("small BHCs") to maintain up to a 3:1 debt-to-equity ratio when making acquisitions.

The Policy Statement was originally adopted by the Board in 1980, and most recently applied only to such holding companies with less than $500 million in consolidated assets. The Board now cannot lift the asset threshold without statutory authority, as the Collins Amendment to the Dodd-Frank eliminated such authority. 12 U.S.C. § 5371. Thus, Congress had to pass the law in order to raise the threshold to $1 billion.

The policy underlying the new measure is clear-cut: community banks must be able to access debt to raise their capital – and ultimately increase lending in the communities they serve. Federal Reserve Governor Daniel K. Tarullo offered similar reasoning in advocating for the measure in a Nov. 7, 2014 speech. Governor Tarullo reiterated the Board's rationale for the exemption, stating that "limited access to equity funding by small institutions means that the transfer of ownership of small banks often requires the use of acquisition debt." While the exemption results in increased leverage, Tarullo noted that subsidiary banks "remain subject to normal capital requirements," and that the Board retains oversight of small BHCs through its supervisory and applications approval processes and quarterly reporting requirements.

Applicability Board Governor Tarullo estimated that raising the threshold would allow 89 percent of bank and savings and loan holding companies to qualify for the exemption – up from the current rate of 75 percent. Independent Community Bankers of America has estimated that the new asset threshold will extend the exemption to an additional 515 bank and savings and loan holding companies.

As with the Policy Statement in its previous form, the exemption under the new law does not cover all small BHCs under the asset threshold. Rather, it applies only to companies that: (i) "are not engaged in significant nonbanking activities either directly or through a nonbank subsidiary"; (ii) "do not conduct significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary"; and (iii) "do not have a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the Securities and Exchange Commission."

The new law maintains the Board's discretion in applying the Policy Statement, providing that it may exclude any small BHC from the exemption, regardless of its size, if it determines that "such action is warranted for supervisory purposes."

Requirements for Exemption As noted above, the Policy Statement permits qualifying small BHCs to use debt to finance up to 75 percent of the purchase price of an acquisition (a 3:1 ratio) subject to a series of ongoing requirements. While the asset threshold is raised by the new law, the exemption itself remains the same. The Board has aimed to ensure that excess debt does not pose a risk to federally insured bank subsidiaries, and that higher levels of leverage are eventually reduced. Under the Policy Statement's requirements, a small BHC must:

  • Reduce its parent company debt in such a manner that all debt is retired within 25 years of being incurred
  • Reduce its debt-to-equity ratio to .30:1 or less within 12 years of the debt being incurred
  • Ensure that each of its subsidiary-insured depository institutions is well capitalized
  • Refrain from paying dividends until such time as it reduces its debt-to-equity ratio to 1:1 or less

Subordinated debt associated with trust preferred securities receives varying treatment in the Policy Statement. Trust preferred securities are considered debt for purposes of determining whether acquisition debt is 75 percent or less of an acquisition purchase price, and whether a small BHC's debt-to-equity ratio is greater than 1:1. Trust preferred securities are not, however, considered debt for purposes of determining compliance with the 12-year debt reduction and 25 year debt retirement requirements.

Expedited Applications and Procedures Qualifying small BHCs may also use expedited applications to engage in acquisition or nonbanking transactions, or obtain a waiver of the stock redemption filing requirements applicable to BHCs – both pursuant to the Board's Regulation Y. But a small BHC may only avail itself of these procedures if it has a pro forma debt-to-equity ratio of 1:1 or less.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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