Lawsuit Could Stall Thrift Conversions
Two depositors in Bell Federal Savings have filed a lawsuit that could have far-reaching implications for thrifts that intend to raise capital by converting to stock-company form.
The conversion of depositor-owned thrifts to stock institutions has been the thrift industry's primary conduit of capital this year. During the first nine months, 43 mutual thrifts together raised $511.4 million of equity through initial public offerings of common stock.
Alleging that managers of Chicago's Bell Federal have disguised their true purpose and understated asset values, the lawsuit asks a federal judge to halt plans for conversion. The depositors claim that the deal is intended to "take" the institution's $159 million of equity "without compensation and to place much of it in the hands of senior management."
OTS Is Concerned
An adverse ruling would be "bad news for the one program bringing capital into the thrift industry," said Rosemary Stewart, the former director of enforcement for the Office of Thrift Supervision.
Normally, corporations try to maximize the proceeds of a stock offering. But in a thrift conversion, the price may be set a bit low to to increase the likelihood that investors, mostly depositors, employees, and insiders, will show a profit after the issue is distributed. Without such pricing, conversions could be more difficult under some market conditions.
In fact, some advisers argue that a period of weak prices may be the best time to do a conversion.
What riled the two Bell Federal depositors were the terms of the proposed conversion. Although no outside group of depositors can buy more than a 1% stake in successor Bell Bancorp, directors and officers could walk offwith 14.5% of the stock in the restructured company.
Imbalance Charged
Any appreciation in the newly issued shares, therefore, would disproportionately reward insiders, said Aron Robinson, a lawyer representing Bell depositors. And an apparent undervaluation of a key asset seems certain to provoke such an outcome, his clients allege.
For example, management values the lease on its downtown headquarters at $2.5 million; the two litigants, $25 million.
It was this sort of apparent pricing disparity that touched off controversy in the June conversion of Cragin Federal Bank for Savings, also of Chicago. A number of officers became overnight millionaires as the newly issued shares of Cragin Financial more than doubled.
Possibility of Problems
Nevertheless, the lawsuit may not be on the firmest ground.
Ms. Stewart cautioned that Bell Federal depositors could be overstating the thrift's value and understating its need for capital.
Most mutual conversions, said the veteran thrift regulator, "are done in anticipation of trouble." And, in fact, more than 60% of Bell Federal's loans consist of participations secured by homes in California, where many financial institutions are trembling from weakening realty loan portfolios.
The architect of both the Cragin and Bell conversions said the Bell Federal litigants would have to prove that the laws and rules governing the transactions themselves were unfair, given his company's strict compliance.
"This is a lawsuit against the legitimacy of the OTS conversion regulations," said Robert M. Adams, a managing director of Adams Cohen Securities Inc.
Market Influence Noted
Mr. Adams said the stock market surged dramatically during the months between the time when the Cragin deal was priced and when it was brought to market. And in recognition of the changed environment, he said, Bell Federal is priced at nine times expected 1991 earnings, compared with 4.5 at Cragin.
Allegations of insider enrichment in the deals, he said, are "ridiculous."
Depending on demand, the Bell initial public offering would be priced at between 51% and 64% of the institution's post-offering book value. That compares with a 40% ratio in the Cragin transaction. Many larger thrifts are selling for close to book value these days, and the strongest command premiums.
According to a filing with the Securities and Exchange Commission, Adams Cohen Securities and participating stock dealers would be paid up to $2.7 million in the conversion.
Ironically, Bell Federal appears to have no need for the maximum $210 million of equity that would be raised in the conversion: The $1.9 billion-asset mutual had a towering 8.3% ratio of tangible capital to total assets as of Sept. 30.
