State Banks vs. National Bank Charters

Where Is The Grass Greener?

By Peter G. Weinstock

There are a number of options when it comes to selecting a bank charter, the existence of which begs the question 'How do I know which one is right for my bank?' The decision is one you should reach after carefully evaluating the relative strengths of each type of charter. The grass is not always greener on the other side of the fence.

For those chartering a commercial bank the advantages and disadvantages between national and state bank charters must be scrutinized before a decision is made. This requires understanding of the operations of a national bank's primary regulatory authority, the Office of the Comptroller of the Currency (OCC), and the operations of a state-chartered bank, governed primarily by the law of the state of incorporation or organization as applied by the state banking authority (Banking Department). The operations of a national bank are governed primarily by the National Bank Act of 1864. The operations of state banks are regulated on a federal basis by the applicable Federal Reserve Bank if they are a member of the Board of Governors of the Federal Reserve System, or by the Federal Deposit Insurance Corporation (FDIC) if they are a nonmember. Thus the rules and regulations of either the Federal Reserve or FDIC will apply to state-chartered banks.

With regard to state-charted banks the advantages are as follows:

Dividends. Generally, state law regarding the payment of dividends is much less restrictive than the provisions governing dividends by national banks. The restrictions on a national bank's ability to pay dividends arise principally from two National Bank Act sources: 12 U.S.C. 60 and 12 U.S.C. 56. Title 12 U.S.C. 60(b) places a recent earnings limitation on the payment of dividends by a national bank by requiring prior OCC approval of a dividend if the total of all dividends declared by a national bank in any year exceeds the total of its "net profits" of that year combined with net profits of the two preceding years, less any required transfer to surplus. The OCC further restricts the ability of national banks to pay dividends on common stock by preventing national banks from including provisions for loan losses in "net profits," and thus, in the funds available for payment of dividends.

Perhaps most significantly, 12 U.S.C. 56 prohibits a national bank from paying dividends on its common stock from its stated capital and surplus accounts. All dividends on common stock must be paid out of net profits after making deductions for expenses, including losses and bad debts. Thus, a national bank with negative retained earnings must "zero out" retained earnings before it may pay dividends. The OCC does not possess the statutory authority to waive this requirement.

This limitation is significant in the case of a new national bank, which must "expense" its organizational costs for generally accepted accounting principles. As a result, a new national bank must earn back such costs before it may pay a dividend.

Fees and Assessments. The OCC has an extensive fee schedule for transactions, such as mergers and branch applications. In contrast, the Banking Department charges filing fees on fewer types of transactions, and, in cases when filing fees are charged, those fees tend to be less than those of the OCC. Currently, national banks are charged higher assessments annually than are state banks in most states.

Lending Limit. Generally, the legal lending limit for a state bank tends to be higher than for a national bank. In many states, a state bank is entitled to a legal lending limit of 25 percent of capital. In contrast, the general lending limit under the National Bank Act equals 15 percent of total equity capital plus the allowance for loan losses.

The OCC has adopted a three-year pilot program to raise the legal lending limit of national banks domiciled in certain states with regard to certain types of loans. Specifically, the pilot rule provides special lending limits for loans secured by 1-4 family residential real estate, loans to small businesses and unsecured loans in states in which the lending limit authority is higher for state banks than the current federal limit. For purposes of the pilot program, "residential real estate loans" are defined to mean loans secured by perfected first-lien security interests in 1-4 family residential real estate in an amount that does not exceed 80% of the appraised value of the collateral at the time the loan is made. The term "small business loan" is defined by cross-reference to the definition of "loans to small business" from the Call Report instructions (without the $1,000,000 cap that is part of the definition in the instructions). The definition includes loans secured by nonresidential real estate and certain commercial and industrial loans.

The new regulations provide that a national bank domiciled in the state that has a higher lending limit than the federal limit can loan funds to a borrower in excess of the federal limit without the excess representing an overline. The calculation of the increased limit under the pilot program is the lesser of (a) 10% of the national bank's capital and surplus or (b) the percentage of the bank's capital and surplus that a state-chartered bank could lend. The OCC, however, desires to limit the applicability in the special lending limit to circumstances consistent with safe and sound banking practices. Accordingly, the higher limits are only available to "eligible banks" who apply to receive approval to use such limits. "Eligible banks" are defined as banks that are "well capitalized" and have a CAMELS-rating of 1 or 2, on a composite basis and for both the management component and the asset quality component. The program is also limited to banks with fewer than $1 billion in total assets.

The OCC also imposed aggregate limits with regard to any bank in the program. There is an overall cap of $10,000,000 on loans to any single borrower. The final rule also provides that the total outstanding amount of a national bank's loans and extensions of credit to any one borrower cannot exceed 25% of the bank's capital and surplus. The regulation also added a limit which provides that the aggregate amount of all loans made in reliance on the pilot program cannot exceed 100% of the bank's capital and surplus.

The pilot program extends until September 10, 2004. In the event the OCC decides to end the pilot program at any point, any loans outstanding that otherwise would be lending limit violations would be deemed to be nonconforming. In this way, such loans will not become illegal, but the national bank could not advance additional funds while the amount outstanding to any one borrower exceeded the federal limit.

The pilot program makes national banks more competitive than they would have been otherwise. Nonetheless, state banks will have a higher limit in general than national banks irrespective of the pilot program.

Working Relationship. An intangible factor to be evaluated is the working relationship between the primary regulatory authorities and the officers and directors of the bank.

With regard to a national bank charter the advantages are as follows:

Legal Certainty. The statutes, regulations and interpretive letters governing national banks tend to be more numerous and more explicit than those governing state banks. Accordingly, a national bank may be able to obtain clearer guidance concerning the extent of its permissible activities than a state bank.

Single Regulator. A national bank has one primary regulator. In contrast, a state bank is subject to examination and supervision by either the Federal Reserve or the FDIC and the Banking Department. This will have a cost in the form of overlapping regulatory authority. Obviously, multiple regulators will increase the "soft" cost of a state charter relative to a national bank charter.

The impact of the overlapping regulatory authority is not as easily identifiable. For example, there may be times when the Banking Department, on one hand, and the FDIC or the Federal Reserve, on the other hand, disagree upon an issue, such as the classification treatment of a loan. Generally, the bank will be required to abide by the less favorable treatment.

Prestige/Name Change. In a metropolitan market, there may be a perception that national banks are sturdier than state banks. In addition, various ethnic groups may associate national with the federal government, and thus, provide such a bank with greater credibility than a comparably sized state bank. Lastly, the larger commercial banks, those with a national presence, tend to be national banks.

Obviously, the officers of a bank are more familiar with the statutes and regulations to which their former bank was subject. Accordingly, organizers will want to consider the charter with which the proposed officers are comfortable. Otherwise, the officers and directors will need to be reeducated regarding the different statutes and regulations that will become applicable if the bank becomes a differently-chartered bank.

In conclusion there are both advantages and disadvantages to state and national charters. Careful evaluation will help you select the one that will best serve your business plan, thus avoiding the time-consuming and costly process of switching from one to another should you initially choose the wrong one.

Mr. Weinstock is a shareholder in the Dallas office of the law firm of Jenkens & Gilchrist, a Professional Corporation. Mr. Weinstock speaks and writes frequently on topics concerning community banks. He may be reached at (214) 855-4746.

Home  |   I Am A Banking Professional  |   I Am A Business Professional  |   How To Start  |   Who We Are
Bank Management  |   Directors & Organizers  |   Our Portfolio  |   Our Associates  |   Key Issues