Nontraditional Uses of a
Bank Holding Company
Most community banks view their bank holding companies as a shell they created for tax
purposes, but don’t use for anything else. Community banks typically form bank holding
companies to assume indebtedness from control shareholders, because they provide a
tax-advantaged mechanism for repaying the debt. After the indebtedness has been repaid,
however, many community banks view the holding company as an administrative inconvenience
they would like to eliminate.
But BHCs actually have many nontraditional advantages that community banks often
overlook. In this article, the first of two parts, I summarize those advantages. These advantages
more than offset the nominal costs of maintaining a BHC, and should encourage community
banks that don’t currently have BHCs to seriously consider establishing them.
Bank holding companies offer eight primary advantages to community banks:
Assumption of indebtedness. A BHC can assume indebtedness from shareholders on a
tax-free basis. Thereafter, the BHC can repay the interest portion of the indebtedness with
pre-tax dollars, and repay the principal portion with dollars that have been taxed only once. This
is the classic purpose of a BHC. But banks should be aware that the federal tax rules and the
Federal Reserve Board’s (Fed) regulations in this area have changed in the past two years.
Accordingly, debt assumption holding company formations must be carefully structured to
qualify as tax-free reorganizations. As a result, the tax treatment of “equalizers,” such as
preferred stock, in holding company formations, and the ability to pay dividends on such
equalizers, have changed.
Borrowing capacity. Unlike banks, BHCs can borrow money, which means they can
fund an acquisition, buy back stock, or raise capital for a subsidiary bank without diluting
shareholders’ interests. BHCs can service holding company debt with nontaxable bank
dividends and with the