BHC Flashcards
Three areas do we analyze when determining the impact the parent company has on the depository institutions in the organization?
Leverage, Cash Flow, Liquidity
The Federal Reserve can require a nondepository institution to transfer capital to a depository institution?
FALSE
What financial areas of a nonbank subsidiary can an examiner analyze to help assess the financial condition of the nonbank subsidiary?
Capital, Earnings, Liquidity, Asset Quality
A nonbank subsidiary generates break?even earnings, which meet the purpose of the company. Due to the lack of profitability, an examiner intends to criticize earnings?
No
A material nonbank subsidiary has capital on par with its peers. Examiners conclude the nonbank has adequate capital. Do you agree?
Yes
The laundry list 225.28(b) of Regulation Y contains approved activities that are deemed closely related to banking and produce public benefits.
TRUE
Most nondepository activities may be performed by a bank?
TRUE
The BHC Act permits selected nondepository activity?
TRUE
ABC Corporation has an asset securitization subsidiary, which is very small in relation to consolidated assets (less than .5% of capital). Should this subsidiary be inspected onsite?
Yes
Section 106(b) of the BHC Act
Prohibits a bank from conditioning the availability or price of one product or service (the tying product) on a requirement that the customer obtain another product or service (the tied product) from the bank or an affiliate of the bank.
“A subsidiary engaged in working out loans has material advances from the parent company, which it
cannot repay on a demand basis. The debt to equity ratio is low; therefore, the examiner will assess
funding as satisfactory. Should the examiner go further in this analysis?”
No
A BHC’s fixed contractual obligations consist of?
(1) interest expense; (2) lease and rental expense; (3) contractual longterm debt payments; and (4) preferred stock cash dividend payments.
Fixed Charge Coverage Ratio Metrics
If the FCCR exceeds 100%, fixed charges are covered by after‐tax cash earnings, a sign of cash flow strength. However, if the FCCR is less than 100%, the BHC must rely on external sources of cash or cash reserves to meet its contractual obligations.
Measures the ability of the BHC to pay common stock cash dividends from residual cash earnings?
Common Stock Cash Dividend Coverage Ratio
Common Stock Cash Dividend Coverage Ratio Metrics
If the CSCDCR exceeds 100%, the BHC’s common stock dividends are covered by its residual cash earnings. However, if the CSCDCR is less than 100%, common stock cash dividends must be funded from other external sources or excess cash reserves.
This ratio measures the BHC’s level of salaries and other expenses that are covered by management fees and other income from subsidiaries?
BHC Fees and Other Income Ratio
BHC Fees and Other Income Ratio Metrics
The best scenario for this ratio would be for it to approximate 100%. However, if the ratio exceeds 100%, it would suggest that BHC could be overcharging its subsidiaries for the services provided. If the ratio is less than 100%, it would suggest that the BHC is bearing some of the cost for the services it provides.
What is the major factor in determining the financial strength of a BHC?
cash flow
Definition of a company per Reg Y?
Bank, Corporation, Association, Partnership, Business Trust, or Similar Organization. An individual cannot be a BHC!
BHC Act of 1956
prohibit monopolies in the banking industry and ensure the separation of banking and commerce by restricting BHC activities
BHC Benefits
- Financial Flexibility 2. Economies of scale 3. non-bank activities
Primary responsibility of BHC to its sub
to serve as source of strength
BHCs are permitted to invest in and engage in activities that
are closely related to banking
Transactions affect the cash account and would appear on the BHC’s cash flow statement
Equity in Undistributed Earnings (subtract), Depreciation (add), Amortization of Prepaid Expenses (add), Impairment of Goodwill (add), Purchase of Treasury Stock
The level of debt has little impact on the cash flow of the organization?
FALSE
Restrictive covenants typically enhance the cash flow position of a BHC by providing
additional opportunities to borrow funds that previously were unavailable?
FALSE
Measures the BHC’s ability to cover its operating expenses and dividends with operating income?
Cash Flow Match Ratio
Cash Flow Match Ratio Metrics
If the ratio exceeds 100%, operating income adequately covers operating expenses and the payment of preferred and common dividends. If the ratio is less than 100%, the BHC would have to rely on cash reserves or externally provided sources to meet its operating expenses and pay dividends on its preferred and common stock.
This ratio measures the BHC’s ability to pay for FIXED contractual obligations with after‐tax income?
Fixed Charge Coverage Ratio
Disadvantages of using Leverage
- high debt levels may force a BHC to rely heavily on its subsidiaries to provide debt service funds 2. high debt may strain cash flow and force mgmt to make poor operating decisions to conserve fund 3. high debt levels may prevent a BHC from taking advantage of new investment opportunities 4. lenders may impose restrictive covenants.
Advantages of leverage
- raises funds quickly 2. shifts the financial risk of a project from shareholders to lenders 3. LT debt improves a BHCs liquidity position b/c it extends maturity of obligations 4. interest pmts on corp debt are tax-deductible 5. debt does not dilute stockholders equity 6. debt usually less expensive than equity (tax education) 7. debt increases the ROR on investment (equity) 8. LT debt can be retired from cash flow
Well capitalized level for FHC?
T1LC 5%, T1RBC 6%, TRBC 10%
Well Capitalized level for BHC
T1RBC 6%, Total RBC 10%
Bank Holding Company Rating System
RFIC(D) RISK MGMT (Compency BOD & Sr. Mgmt Oversight; Policies/Procedures/Limits; Risk Monitoring & Mgmt Info Systems; Internal Controls); FINANCIAL CONDITION (Capital Adequacy, Asset Quality, Earnings, Liquity) IMPACT of parent company and nonbanks on the subsidiary depository institutions.; COMPOSITE (reflects primary regulator’s assessment of bank subsidiary) DEPOSITORY INSTITUTIONS. *For non-complex institutions w/less than $1billion in assets, only the R and C are addressed.
Minimal capital levels for BHCs?
T1LC 4%, T1RBC 4%, TRBC 8%
BHCs should always attempt to maintain a current ratio > 100% or 1:1.
TRUE
Current Ratio
Current Assets / Current Liabilities Should be greater than 1
Current Ratio
Current Assets / Current Liabilities
Should be greater than 1
Decreases in the asset categories are reported as positive values onthe cash flow statement. When a BHC sells an asset, cash will be generated from the transaction
TRUE
The proceeds of parent company long‐term debt may be advanced to banking subsidiaries as debt.
Simple Leverage
Increases in the asset categories are reported as negative values on the cash flow statement because they represent a use of cash
TRUE
double leverage payback ratio
(Equity Investment in Subsidiaries - Parent Company Equity) / (Net Income - Dividends)
Double leverage, in conjunction with the increased asset base of the bank, can lower the company’s consolidated capital ratios since it increases the amount of consolidated assets without a corresponding increase in the amount of capital at both the parent and consolidated levels
TRUE
Primary Disadvantages of Leverage
May cause undue reliance on a company’s subsidiaries to service the debt; High debt levels may strain cash flow and force poor operating decisions; Leverage may prevent investment in other profitable opportunities; Lenders may impose restrictive covenants
For small bank holding companies (consolidated assets of less than $150 million)
“100% or greater is “highly leveraged,”
30% to 100% is “moderately leveraged,” and
less than 30% is “minimally leveraged.””
Because depreciation and amortization expenses are an income statement item, it is added back as an adjustment to reconcile net income to net cash provided by operating activities
TRUE
Primary advantages of leverage
Allows a company to raise funds quickly to fund a project; shifts the financial risk of a project to the lender; Long‐term debt improves liquidity; Interest payments are tax deductible; increases the rate of return on investment
debt‐to‐tangible‐equity ratio
Total debt / (equity - intangibles)
This represents the period of time in years that a bank holding company is expected to repay its double leverage based on current earnings performance
double leverage payback ratio
double leverage ratio
Equity Investment in Subsidiaries / Parent Company Equity
The proceeds of parent company long‐term debt invested inbanking subsidiaries as equity
Double Leverage
For large bank holding companies, (consolidated assets of at least $150 million)
“30% or more is “highly leveraged,”
10% to 30% is “moderately leveraged,” and
less than 10% is “minimally leveraged.””
Parent Company Income is the same as _____?
Consolidated Income
“BHCs tax deduction for
dividends received from its subsidiaries”
100% tax deduction when received from an affiliate in which the parent has an 80% or more ownership interest. An 80% dividend deduction is available when a subsidiary is between 20%‐80% owned, and a 70% dividend eduction is available when ownership in a subsidiary is less than 20%.
Disadvantages of BHCs
Minority shareholders are those that own less than 50% of stock; Additional Federal Reserve Regulations; Possible Securities Law Regulation (>500 shareholers); Possible Dealings with Minority Shareholders
The normal range for the ratio of “Bank Net Income/Parent Net Income”
90% to 105%. A ratio below this range (i.e., 85% or below) may indicate that the BHC is heavily relying on its nondepository subsidiaries for income. a ratio in excess of 105% may indicate that small nondepository subsidiaries are incurring losses or the BHC is incurring losses and undercharging for the use of intercompany funds
Parent Company capital is the same as _____?
Consolidated Capital
For small BHCs, the policy statement requires that the amount of acquisition debt should not exceed ___ percent of the purchase price of the bank(s) to be acquired?
75 Percent
Bank Holding Company Act of 1956
BHC is a company that has direct or indirect control of a bank
Small bank holding companies are required to reduce their parent company debt consistent with the requirement that all debt be retired within how many years of being incurred?
25 years
Small bank holding companies are required to reduce their parent company debt consistent with the requirement that all debt be retired withinhow many years of being incurred?
25 years
A small bank BHC whose debt-to-equity ratio is greater than what is generally not expected to pay dividends?
Ratio of 1.0 to 1
Two conditions must be met by the nondepository subsidiary to qualify for Federal Reserve System
approval to operate within a bank holding company structure
produce benefits to the public and activity must be closely related to banking
BHCs may file a consolidated tax return with the IRS
If it own 80% or more of a subsidiary bank
BHCs fund their asset portfolio in one of three ways:
short?term debt; long?term debt; or equity capital
BHCs major source of operating income
dividends received from its subsidiaries
This describes the bank holding company (BHC) rating system
SR 04-18
BHCs that are noncomplex and are $1 billion or less will typically be assigned only
Consistent with SR 02-1 Risk mangement and Composite ratings
Three main areas to analyze a BHC’s dependence on its subsidiaries
Balance Sheet Dependence; Income Statement Dependence - Cash Flow Dependence
This describes the bank holding company (BHC) rating system
SR 04?18
BHCs that are noncomplex and are $1 billion or less will typically be assigned only
Consistent with SR 02?1 Risk mangement and Composite ratings
A company that is not chartered as a bank and is engaged in activities other than banking
A nondepository entity
Who is responsible for issuing the assertion of the adequacy of internal controls on behalf of their company’s bank subsidiaries?
holding company CEOs and CFOs
What is defined as the use of debt to supplement the equity in a company’s capital structure?
Leverage
What is unsecured debt that is junior (subordinate) to senior claims against the company, such as deposits and taxes payable to tax authorities?
Subordinated Debentures
A company can retire (repay) subordinated debt in a variety of ways
Build cash reserve, refinance debt, or convert debentures into equity
debt-to-equity ratio
Total debt / total equity capital (including both common and preferred stock)
