A variety of financial and nonfinancial companies either have obtained or are considering obtaining the market share, low-cost funding, and revenue benefits available from a full service bank charter, i.e., a charter that permits deposit-taking and lending. A bank charter allows a business organization to capture more of a customer’s "wallet" by offering a broader range of services, including: (1) sweeps/retention of customer funds that otherwise would go to banks not affiliated with the organization; (2) loans, including margin loans; (3) escrow services; and (4) trust services.
For example, broker-dealers acquire banks to hold excess cash from brokerage activities, mortgage companies acquire banks to reduce licensing requirements and hold escrow funds, and automakers acquire banks to finance auto loans. Several issues of the Alert have been dedicated to discussing the relative advantages and disadvantages of various traditional bank and federal savings bank ("thrift") charter types (referred to herein collectively as "classic" charters) and how they can be best deployed within larger organizations. See, for example, the following Alert analyses: Broadening Opportunities with a Bank/Thrift Charter (3/5/02); Broadening Opportunities: Utilizing Referrals in Connection with Trust, Deposit and Loan Products (9/10/02); and Broadening Opportunities: Expanding a Banking Institution’s Geographic Scope Without Major Outlays of Capital (9/17/02).
This article focuses on the comparative advantages and disadvantages of a special type of bank charter we are increasingly discussing with financial and nonfinancial organizations that are not bank holding companies, but that want a full-service bank charter – industrial loan companies ("ILCs"). More specifically, Section I below provides a context by summarizing the regulatory framework for "classic" (i.e., non-ILC) charters. Section II then describes the relative benefits of, and concerns associated with, the ILC charter. Finally, Section III summarizes the formation process for an ILC charter in our experience.
I. Context-Classic full service charter options. A "classic" full service bank charter is the typical full-service state or federally chartered bank. The benefits of the classic full service bank charter generally come at a regulatory price. This charter generally results in the parent company being deemed a bank holding company ("BHC") subject to Federal Reserve Board ("FRB") oversight and regulation. Such regulation includes capital requirements and limitations on the permissible activities of the organization to those that are financial in nature. The requirement that a BHC not engage in any significant nonfinancial activities, either directly or through nonbank affiliates, prevents nonfinancial companies from acquiring banks in the U.S. Despite these regulatory issues, many historically "nonbank" institutions, such as MetLife, Schwab and Countrywide, have determined it worthwhile to establish or acquire a classic bank charter.
Another classic type of charter is a full service thrift charter. Indeed, previously, a full service thrift charter was available to both financial and nonfinancial companies via the so-called "unitary thrift" exemption. A number of institutions, including State Farm and USAA, were able to establish full service thrift affiliates using this exemption without having to limit the activities in which their organization could engage. The federal Gramm-Leach-Bliley Act of 1999 ("GLBA") largely closed this avenue, however, for organizations that wish post GLBA to establish or acquire a thrift so as to be able to offer banking products. Acquiring a thrift now still does not subject the parent organization to FRB regulation or holding company capital requirements (it is subject to OTS oversight), but the organization’s activities would be limited to the same extent as a company that has a subsidiary with a classic bank charter.
II. ILCs. Relative Benefits. The ILC charter increasingly is gaining attention as an option for organizations that want a full service charter but that, because of the regulatory issues involved, do not want to (or because of nonfinancial activities cannot) acquire a classic full service bank or thrift. The ILC fundamentally is a state chartered bank that, by virtue of a particular provision of federal law, does not cause its parent company to be a bank (or thrift) holding company or its parent or affiliates to be limited by federal law to engaging in financial activities. (Notably, as an FDIC-insured bank, the ILC itself nonetheless must comply with certain federal banking regulations, including the Community Reinvestment Act, capital requirements, lending limits, anti-tying requirements and restrictions on transactions with affiliates).
The ILC charter thus is unique in permitting a large degree of full-service banking without subjecting its parent and affiliates to federal banking regulation. Merrill Lynch, American Express, UBS, Volvo and BMW are among the companies that have chosen to provide banking services through an ILC. In addition, Wal-Mart has been reported to be considering a Utah ILC charter. Moreover, even organizations that already have either (i) a grandfathered classic full-service bank or thrift (i.e., one that does not subject them to the consolidated regulatory oversight of a classic bank charter, such as banks grandfathered under a 1987 federal law and unitary thrifts established prior to the GLBA), or (ii) a limited purpose (e.g., trust only) bank or thrift, also are considering establishing ILCs to allow them to offer a wider variety of bank products and services than is permissible under their current charters while still remaining outside of the BHC or thrift holding company regulatory framework. For example, organizations with grandfathered full-service thrifts may wish to acquire an ILC to allow them to engage in a greater degree of commercial lending from a bank vehicle than would be permissible for their thrifts because of the Qualified Thrift Lender limits.
Relative Disadvantages. However, as with each charter option, the ILC charter also has certain disadvantages when compared to the other charter types. Perhaps most fundamentally, the ILC charter is available only in a limited number of states: Utah, California, Colorado, Hawaii, Indiana, Minnesota, and Nevada. The focus of most ILC chartering activity has been Utah, with 35 active charters that represent the vast majority of commercially-owned ILCs. In addition, of the FDIC-insured ILC institutions chartered during the past few years, most have been chartered in Utah (with the remainder in Nevada and California). Moreover, recent pro-industry changes in Utah state banking law should serve to keep it an attractive choice for new ILC charters. Still, this need to charter the ILC in one of a limited number of states creates practical operational and expense issues. States discourage the organization of ILCs that exist on paper only, with management offsite and no local directors, facilities or staff. Nevada and Utah generally require representations that a majority of management and some directors (two-thirds in Nevada) will be residents or citizens of the respective states. California may be more flexible with regard to local presence, and will consider the particular facts and circumstances.
Moreover, the ILC charter is not quite as flexible as other charter types. The main limitation on an ILC compared with a classic bank charter is a federal law restriction on an ILC’s ability to offer demand deposit accounts. However, to mitigate this limitation, many ILCs offer NOW accounts, a form of transaction account, to non-commercial customers. An ILC also may issue CDs to any customers. In addition, an organization considering the ILC charter should keep in mind that exemption from federal holding company regulation does not exempt the organization from state banking regulation. Such regulations often consist of reasonably limited reporting requirements. But a more dramatic form of state holding company regulation also is possible, as evidenced by California’s enactment of the onerous so-called "Wal-Mart statute" in response to Wal-Mart’s ILC proposal in that state. This California statute currently prohibits organizations engaged in nonfinancial activities from establishing ILCs in California (although we understand California is considering changing this law to make its ILC charter more desirable).
Finally, compared with the federal bank charters, the ILC charter does not offer the same degree of preemption. As an FDIC-insured state bank, an ILC can export interest rates, and the FDIC recently has begun a regulatory initiative to clarify and expand the ability of all state banks (which should include ILCs) to operate more uniformly on an interstate basis. Nonetheless, state chartered banks operating across state lines still generally face a patchwork of state consumer protection laws. As a result, organizations seeking a bank charter for more efficient operation in a particularly regulated area (e.g., residential lending, with several states having predatory lending laws) may be better served with the broader preemption afforded by a federal charter. In this regard, the ILC charter generally has been considered more suited to Internet-based services such as deposit sweep accounts that do not rely on physical branches in multiple states. It should be noted that FRB Chairman Greenspan historically has been vocally opposed to the ILC charter (because it avoids the BHC rules), and certainly to any expansion of its powers. Congress, however, has shown no indication whatsoever of eliminating its benefits under federal law (and indeed has considered granting ILCs additional powers.)
III. Formation. For those organizations considering this type of charter, the formation of an ILC is similar to the formation of a state bank. A charter application based on a business plan and financials must be submitted to the state. Processing time for a new ILC is generally in our experience in the 4-6 month range. The states impose application fees in the range of $500 to $10,000 and annual assessment fees similar to those charged to state banks. ILCs that take deposits also must obtain FDIC insurance.
Conclusion. The ILC represents yet another option for organizations wishing to provide the broad financial services offered by a bank charter or to expand their bank product line by offering a second charter. As with all the other charter options discussed in previous Alerts, a thorough understanding of the banking business objectives and market opportunities of the organization, as well as its other activities, investments and initiatives, is necessary before the desirability of this charter properly can be evaluated.
Goodwin Procter LLP is one of the nation's leading law firms, with a team of 650 attorneys and offices in Boston, New York and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.
This article, which may be considered advertising under the ethical rules of certain jurisdictions, is provided with the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin Procter LLP or its attorneys. (c) 2005 Goodwin Procter LLP. All rights reserved.