A growing portfolio of problem assets will unfavorably impact a bank’s earnings performance and capital adequacy. Asset workouts can take time and, thereby, affect financial performance for several reporting periods. For this reason, some banking organizations are considering the sale or transfer of problem assets from the bank to the parent holding company. Assets could include whole loans, loan participations, securities and other real estate owned (OREO).
If you’re considering such a move for your organization, you should keep in mind the following:
The Federal Reserve System’s Board of Governors’ Regulation Y states that a bank holding company should be a source of financial and managerial strength to its subsidiary banks and not conduct bank holding company operations in an unsafe and unsound manner. Therefore, if handled properly, a bank may transfer problem assets to its parent, as long as the bank clearly benefits from the transaction.
Problem loans, securities and OREO typically are non-earning assets. By removing non-earning assets from the bank’s balance sheet, earnings performance indicators should improve at the bank level. Asset quality should also improve by reducing the volume of problem assets and replacing them with cash and/or performing assets. If replaced with cash, then liquidity will also improve.
The Board of Governors’ Regulation W stipulates that a bank may not be disadvantaged as a result of any covered transaction with its parent company. Regulation W also requires that the terms and conditions of any covered transaction are consistent with safe and sound banking practices. Therefore, the transfer of assets from a bank to its parent company must be at fair value. Fair value should be established prior to the transaction and be supported with appropriate documentation. You should use a third-party valuation for the transfer of real estate.
The transfer of loans or securities from a bank to its parent company may constitute a non-banking activity for the parent company. The transfer would require prior approval under Regulation Y if the parent company had not previously received approval to engage in lending activities and intends to engage in lending on an ongoing basis. No prior Federal Reserve System approval is required if the parent company is a financial holding company in compliance.
There are two simple methods for transferring assets from the bank to the parent company:
Dividend in kind involves a dividend of the assets to the parent company. The assets should be booked at fair value, and the bank should fully recognize any gain/loss versus book value. The bank should consult with its regulator for any possible dividend limitations, restrictions or filing requirements.
Sale or transfer involves consideration paid by the parent company to the bank. The transaction must be at fair value, and the bank should fully recognize any gain or loss. The bank should not fund the parent company’s purchase of the asset from the bank. With respect to assets acquired in satisfaction of debts previously contracted, the required divestiture period is not altered by virtue of the transfer from bank to parent company.
If you have any questions or would like additional information, contact
Patrick Pahl at 314-444-8858 or Tim Bosch at 314-444-8480.