Experts predict that the already swift rate of conversions to Subchapter S corporations could accelerate as banks move to take advantage of looser federal laws.
More than 2,350 banks now use the S Corp structure, nearly quadruple the number at the end of 1997, according to the Federal Deposit Insurance Corp. The agency's senior banking analyst, Ross Waldrop, predicts another uptick, because banks have had time to whittle the number of shareholders since the American Jobs Creation Act was enacted in 2004.
That law raised the threshold on the maximum number of shareholders a company could have to qualify as an S Corp to 100, from 75. It also allowed up to three generations of family members to be counted as one shareholder.
"The restrictions were liberalized quite a bit, and now more institutions are availing themselves of the opportunities," Mr. Waldrop said.
Jeffrey C. Gerrish, the chairman of Gerrish & McCreary Consultants LLC in Memphis, expects the number of banks operating as S Corps to double in the next five to 10 years, bringing the total to nearly half of the country's 8,800 banks.
"A lot of banks will take advantage of it, because it's a way to stay independent and provide a cash cow for shareholders," Mr. Gerrish said.
S Corps are small, closely held companies that pass a portion of their earnings on to shareholders. Unlike more conventional C corporations, whose income is taxed at the corporate level, S Corps pass on a portion of their income (and the tax obligations) to their shareholders in the form of dividends, called "distributions."
The $84 million-asset Fife Commercial Bank in Washington converted to an S Corp at the end of 2003. Typically, S Corps pass on about 35% to 40% of their earnings each year to shareholders. However, last year Fife Commercial was able to pass on more than 70% of its earnings, or about $1.36 million, while maintaining its capital ratios, said Jim Davis, its president and chief executive.
That worked out to about $9 a share, a nearly 50% return on the $20 price that Fife's original shareholders paid for each share in 1998, when the company raised its initial capital before opening.
"So everyone in our bank won last year," Mr. Fife said.
But Mr. Gerrish said S Corps are not for every bank, particularly not fast-growing ones that need a lot of capital to finance acquisitions.
"You always hear about the go-go banks in Florida, Texas, or California, but there's a lot of banks in parts of the country that are happy if they can get 10% earnings growth a year," he said. For those banks, S Corp status makes more sense.
Curtis D. Carpenter, a managing director at Alex Sheshunoff Investment Banking Inc. in Austin, said that banks considering selling themselves also should steer clear of S Corps. Not only would the conversion process be a needless hassle, but minority shareholders squeezed out to meet the requirements would be angered if they later discovered an acquirer would have paid more for their shares, he said.
Mr. Waldrop cited a third group of banks that should steer clear of the structure. Banks with strong ties to their communities may opt to maintain a broader shareholder base as a C Corp, he said. "The public relations benefits may outweigh the tax benefits."
