The Federal Reserve, the overseer of the US banking system, has issued a new set of guidelines that allow investors including private equity firms to buy up to a 33 percent nonvoting equity interest in US banks without being considered a controlling shareholder.
Though that limit previously stood at 25 percent equity interest, the Fed has broad discretion in determining what counts as a controlling stake, and in the past, even a 10 percent stake could be considered enough to trigger the designation. The new threshold applies as long as the investor does not own more than 15 percent of any class of voting stock. Otherwise, the 25 percent threshold applies.
Entities deemed to have controlling interests in banking institutions are required to register as bank holding companies in accordance with the 1956 US Bank Holding Company Act, which governs the activities of bank holding companies.
The act places stringent restrictions on such entities, including regulatory capital requirements, minimum leverage ratios and limitations on the kinds of non-banking activities that they and their subsidiaries may engage in. This has traditionally made it difficult for large, diversified private equity firms to take controlling stakes in banks without having to subject themselves to the provisions of the act.
In response, a number of US private equity firms – Castle Creek Capital, Belvedere Capital, Community Bank Investors of America and CapGen Financial – have set up shop as registered bank holding companies, focusing their investments primarily on small to mid-cap regional and community banks in the US. A fifth firm, JC Flowers, is reportedly establishing a separate entity for the same purpose.
However, with the relaxed threshold for control, more private equity firms will be able to undertake investment in banking entities without having to go through the trouble of registering as bank holding companies.
The Fed will also allow such investors to have greater board representation than in the past. It previously allowed an investor holding up to 15 percent of voting shares to have one director seat without being classified as a controlling shareholder.
Now, the Fed will allow non-controlling investors up to two board seats if the investor’s director representation does not exceed 25 percent of the board and another, larger shareholder who is represented on the board is already a bank holding company.
Additionally, the Fed eased its previous restrictions on non-controlling shareholders’ communication with company management. It had previously prohibited such investors from holding discussions with bank executives, fearing that they might use such communications to favor their personal interests.