FED NOTES: Originally published in the Winter 2020 edition of Bank Owner magazine.
By Julie Randall
Filing requirements for bank holding companies (BHCs) proposing to acquire nonbanking assets or directly engage in nonbanking activities can be perplexing. Some nonbanking assets/activities are permissible and some are not, many are subject to restrictions, and some require a BHC to become a financial holding company. Furthermore, while BHCs generally must obtain permission from the Federal Reserve System under section 4 of the Bank Holding Company Act (BHC Act) before acquiring nonbanking assets or directly engaging in nonbanking activities, there are a number of exceptions to the filing requirements.
This article describes several of the most common exceptions, which are often misunderstood but account for a significant amount of nonbanking activities conducted by BHCs in the Ninth Federal Reserve District. You can find the remaining exceptions in section 4 of the BHC Act or section 225.22 of the Board of Governors’ Regulation Y.
At the end of the article, please see a note from Rachel Robison regarding faster turnaround times for BHCs that consult with the Federal Reserve System regarding proposed dividends.
BHCs, either directly or through one or more nonbank subsidiaries, can hold or operate properties for their subsidiary banks, provide accounting, data processing, and similar operational or administrative services to these banks, and liquidate certain assets they hold. Servicing activities often will not require a BHC to file notice under section 4. However, a BHC may be expected to file under section 4 if it is purchasing assets from its subsidiary banks for liquidation, particularly if the BHC is in less than satisfactory condition. Even when a BHC is not required to file notice under section 4, BHCs should be aware of restrictions on the servicing activity. For example, a BHC that holds property for the use of a subsidiary bank must be in compliance with the BHC Act’s requirement that the property must be “used wholly or substantially” by the subsidiary bank. If the property is held by the BHC, the subsidiary bank is typically expected to use at least 50 percent of it, which is more than what the bank may be required to use if it directly holds the property.
Debts previously contracted
A BHC can acquire a nonbanking asset (e.g., a loan, property, or voting shares of an entity) in the course of foreclosing upon or collecting a debt previously contracted and can hold the asset for up to two years before divesting of it. If circumstances warrant extensions of the holding period, the Federal Reserve Bank of Minneapolis (Reserve Bank) can extend this period for up to a total of 10 years. Often, a subsidiary bank will transfer assets it has acquired through the foreclosure or collection process to its parent BHC to strengthen the subsidiary bank’s books. These transfers are generally permissible, although they must comply with the requirements of sections 23A and 23B of the Federal Reserve Act and follow appropriate accounting principles. However, if the subsidiary bank plans to transfer the asset to its parent BHC because it has exceeded a holding period under state law, note that the Reserve Bank will deem the BHC to have held the asset since the date that the subsidiary bank acquired the asset, not the date of the transfer.
Acquisitions of securities by a subsidiary bank
Securities acquisitions by a subsidiary bank generally do not require its parent BHC to file if the securities are permissible for BHCs under section 4(c)(5) of the BHC Act. (This section permits BHCs to acquire
securities that are eligible for investment by national banks.) However, this general exception does not allow state-chartered banks to make certain investments in operating subsidiaries. If a BHC’s subsidiary bank is a state-chartered bank and it acquires less than 100 percent of the shares of an operating subsidiary, the BHC may be required to file under section 4 of the BHC Act. This situation commonly arises when a state-chartered bank has partnered with other banks or third-party firms to invest jointly in an entity. For example, a state-chartered bank may enter into a purchase agreement with other banks in the area to establish a data-processing subsidiary or with third-party firms to own an asset-based lending company.
These are only a few of the filing exceptions associated with nonbanking acquisitions and activities permissible under section 4 of the BHC Act. Whether or not an exception applies to a potential acquisition or activity frequently depends on the particular facts and circumstances. Because of the complexity involved in making these determinations, we strongly encourage BHC management and their representatives to consult with Mergers and Acquisitions staff of the Reserve Bank early in the decision making process. Inquiring whether a filing is required, before the acquisition is completed or the activity is conducted, can not only spare BHCs from needless filings but can also prevent inadvertent violations of the BHC Act.
Julie Randall is Senior M&A Analyst with the Federal Reserve Bank of Minneapolis.