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F ederal reserve Ba n k DALLAS. TEXAS of Dallas 75222 C ircular No. 80-72 April 15, 1980 POLICY STATEMENT BANK HOLDING COMPANY ACT (Formation of Small One-Bank Holding Companies) TO ALL MEMBER BANKS, BANK HOLDING COMPANIES, AND OTHERS CONCERNED IN THE ELEVENTH FEDERAL RESERVE DISTRICT: The Board of Governors of the Federal Reserve System has issued a policy statem ent for assessing the financial factors in the formation of small one-bank holding companies pursuant to the Bank Holding Company Act. The Board's press release and order relating to this m atter, are printed on the following pages. The policy adopted by the Board in consideration of the formation of small one-bank holding companies is essentially the same as th at previously proposed for comment and which was attached to Circular No. 80-2, dated January 7, 1980. The policy statem ent adopted by the Board, which was effective March 28, 1980, applies to one-bank holding companies th at would not have significant leveraged nonbank activities and whose subsidiary bank would have to tal assets of approximately $150 million or less. Any questions concerning the enclosed documents should be referred to Mr. Robert Hankins, Director of Applications, of our Holding Company Supervision Departm ent, Ext. 6120. Sincerely yours, Robert H. Boykin First Vice President Banks and others are encouraged to use the following incoming W A T S numbers in c ontacting this Bank: 1-800-442-7140 (intrastate) and 1-800-527-9200 (interstate). For calls placed locally, please use 651 plus the extension referred to above. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) ..vjbfco*;-. FEDERAL RESERVE press release , . Tiu For immediate release March 28, 1980 The Federal Reserve Board today issued a policy statement designed to facilitate the change of ownership of small banks and to help maintain the safety and soundness of the banking system by amending the criteria applied in considering applications for one-bank holding company formations. The new policy applies to one-bank holding companies meeting both of the following conditions: total assets of approximately $150 million or less and no significant nonbank activities that use large amounts of debt in their businesses. It permits acquisition by one-bank holding companies of small community banks under revised terms. The new terms continue in more flexible form the Board's standing policy of permitting transfer of ownership of such banks on less demanding terms than those the Board applies in considering appli cations involving larger banks. The Board gave this background to its proposal: In acting on applications filed under the Bank Holding Com pany Act, the Board has adopted, and continues to follow, the principle that bank holding companies should serve as a source of strength for their subsidiary banks.... The Board believes that a high level of debt at the parent holding company level impairs the ability of a bank hold ing company to provide financial assistance to subsidiary bank(s), and in some cases the servicing requirements on such debt may be a significant drain on the bank's resources. For these reasons, the Board has not favored the use of ac quisition debt in formations of bank holding companies. Nevertheless, the Board has recognized that the transfer of ownership of small banks often requires the use of acquisi tion debt. The Board, therefore, has permitted the forma tion of small one-bank holding companies with debt levels higher than would be permitted for larger or multibank hold ing companies. While continuing to adhere to these principles, the Board has re examined the factors which apply to small one-bank holding company applications with a view to improving the flexibility of these companies in dealing with their debt obligations. Past policy called for repayment of all acquisition debt within 12 years, while maintaining a satisfactory level of capital in the company's bank subsidiary. The revised policy provides that the holding company's debt to equity ratio be reduced to no more them 30 percent within 12 years, which isapproxi mately the level maintained by many multibank holding companies. This can be accomplished by direct debt repayment, or by building up equity through the retention of earnings, or both. The new policy requires that capital in the subsidiary bank be main tained at no less than 8 percent of assets, and allows for reasonable holding company dividends and the use of preferred stock as equity under certain condi tions . The Board's policy statement is attached. -0 - FEDERAL RESERVE SYSTEM POLICY STATEMENT FOR ASSESSING FINANCIAL FACTORS IN THE FORMATION OF SMALL ONE-BANK HOLDING COMPANIES PURSUANT TO THE BANK HOLDING COMPANY ACT (Docket No. R-0265) AGENCY: Board of Governors of the Federal Reserve System ACTION: Policy Statement SUMMARY: In the interest of improving the transferability of ownership of small community banks and facilitating local ownership of such institutions, as well as helping to maintain the safety and soundness of the banking system, the Federal Reserve Board has adopted a policy for assessing financial factors in the formation of small one-bank holding companies. DATE: The policy statement is effective March 28, 1980. POLICY OF THE BOARD OF GOVERNORS FOR ASSESSING THE THE FORMATION OF SMALL PURSUANT TO THE BANK STATEMENT OF THE FEDERAL RESERVE SYSTEM FINANCIAL FACTORS IN ONE-BANK HOLDING COMPANIES HOLDING COMPANY ACT In acting on applications filed under the Bank Holding Company Act, the Board has adopted, and continues to follow, the principle that bank hold ing companies should serve as a source of strength for their subsidiary banks. When bank holding companies incur debt and rely upon the earnings of their sub sidiary banks as the means of repaying such debt, a question arises as to the probable effect upon the financial condition of the company and its subsidiary bank or banks. The Board believes that a high level of debt at the parent holding com pany level impairs the ability of a bank holding company to provide financial assistance to its subsidiary bank and in some cases the servicing requirements on such debt may be a significant drain on the bank's resources. For these reasons the Board has not favored the use of acquisition debt in the formation of bank holding companies. Nevertheless, the Board has recognized that the transfer of ownership of small banks often requires the use of acquisition debt. The Board therefore has permitted the formation of small one-bank holding companies with debt levels higher than would be permitted for larger or multibank holding com panies. Approval of these applications has been given on the condition that the small one-bank holding companies demonstrate the ability to service the acquisi tion debt without straining the capital of their subsidiary bank and, further, that such companies restore their ability to serve as a source of strength for their subsidiary bank within a relatively short period of time. In the interest of furthering its policy of facilitating the transfer of ownership in banks without diluting bank safety and soundness, the Board has reexamined the analytical framework and financial criteria it applies when con sidering the formation of small one-bank holding companies and has adopted cer tain revisions in its procedures and standards as described below. The revised criteria shift the focus from debt repayment to the rela tionship between debt and equity at the parent holding company. The holding company will have the option of improving the relationship of debt to equity by repaying the principal amount of its debt or through the retention of earnings, or both. Under these procedures, newly organized small one-bank holding com panies will be expected to reduce the relationship of their debt to equity over a reasonable period of time to a level comparable to that maintained by many large and multibank holding companies. In general, this policy is intended to apply only to one-bank holding companies that would not have significant leveraged nonbank activities and whose subsidiary bank would have total assets of approximately $150 million or less at the time the application is filed. Small one-bank holding companies formed be fore the effective date of this policy may switch to a plan that adheres to the intent of this policy provided they comply with criteria 2, 3, and 4 set forth below. The criteria are as follows: General In evaluating applications filed pursuant to Section 3(a)(1) of the Bank Holding Company Act, as amended, when the applicant intends to incur debt to finance the acquisition of a small bank, the Board will take into account a full range of financial and other information, including the recent trend and stability of earnings of the bank, the past and prospective growth of the bank, the quality of the bank's assets, the ability of the applicant to meet debt ser vicing requirements without placing an undue strain on the bank's resources, and the record and competency of management of the applicant and the bank. In addi tion, the Board will require applicants to meet the minimum requirements set forth below. As a general rule, failure to meet any of these requirements will result in denial of the application; however, the Board reserves the right to make exceptions if the circumstances warrant. 1. Minimum Down Payment The amount of acquisition debt should not exceed 75 percent of the purchase price of the bank to be acquired. When the owner(s) of the holding company incur debt to finance the purchase of the bank, such debt will be con sidered acquisition debt even though it does not represent an obligation of the bank holding company, unless the owner(s) can demonstrate that such debt can be serviced without reliance on the resources of the bank or bank holding company. 2. Maintenance of Adequate Capital An applicant proposing to use acquisition debt must demonstrate to the satisfaction of the Board that any debt servicing requirements to which the bank holding company may be subject would not cause the subsidiary bank's ratio of -2 - gross capital to assets to fall below 8 percent during the 12-year period fol lowing consummation of the acquisition. Gross capital is defined as the sum of total stockholders' equity, the allowance for possible loan losses, and subor dinated capital notes and debentures. 3. Reduction in Parent Company Leverage The applicant must demonstrate to the satisfaction of the Board that the parent holding company's ratio of debt to equity will decline to 30 percent within 12 years after consummation of the acquisition. The holding company must also demonstrate that it will be able to safely meet debt servicing and other requirements imposed by its creditors. The term "debt," as used in the ratio of debt to equity, means any bor rowed funds (exclusive of short-term borrowings that arise out of current trans actions, the proceeds of which are used for current transactions), and any se curities issued by, or obligations of, the holding company that are the functional equivalent of borrowed funds. The term "equity," as used in the ratio of debt to equity, means the total stockholders' equity of the bank holding company adjusted to reflect the periodic amortization of "goodwill" (defined as the excess of cost of any ac quired company over the sum of the amounts assigned to identifiable assets ac quired, less liabilities assumed) in accordance with generally accepted account ing principles. In determining the total amount of stockholders' equity, the bank holding company should account for its investments in the common stock of subsidiaries by the equity method of accounting. Ordinarily the Board does not view redeemable preferred stock as a sub stitute for common stock in a one-bank holding company formation. Nevertheless, to a limited degree and under certain circumstances the Board will consider re deemable preferred stock as equity in the capital accounts of the holding company if the following conditions are met: 1) the preferred stock is redeemable only at the option of the issuer and 2) the debt to equity ratio of the holding com pany would be at or remain below 30 percent following the redemption or retire ment of any preferred stock. Preferred stock that is convertible into common stock of the holding company may be treated as equity. 4. Dividend Restrictions The bank holding company is not expected to pay any corporate dividends on common stock until such time as its debt to equity ratio is below 30 percent. However, some dividends may be permitted provided all of the following conditions are met: a) the applicant has begun making scheduled repayments of principal on the acquisition debt; b) such scheduled repayments of principal are reasonable in amount, will be made at least annually, and will allow for the retirement of the acquisition debt over a period not to exceed 25 years; and c) the applicant can clearly demonstrate at the time the application is filed that such dividends will not jeopardize the ability of the holding company to reduce its debt to equity ratio to 30 percent within 12 years of consummation of the proposal or cause the gross capital to assets of the subsidiary bank to fall below 8 percent over the same period. Also, it is expected that dividends will be eliminated if the hold ing company is not meeting the projections made at the time the application was -3 - filed regarding the ability of the holding company to reduce the debt t o e q u i t y ratio to 30 percent within 12 years of consummation of the proposal. Board of Governors of the Federal Reserve System, March 28, 1980. (signed) Theodore E. Allison Theodore E. Allison Secretary of the Board