Managers of mutual savings banks who are considering forming a mutual holding company should not be dissuaded by the March action of the Federal Deposit Insurance Corp. that prohibited mutual holding companies from waiving dividends for the benefit of minority shareholders.
In a mutual holding company conversion, a mutual savings bank converts to stock ownership. A mutual holding company is formed, and it is issued a majority stake in the new, stock-owned bank. Investors purchase a minority stake in the bank.
Formerly, when subsidiaries of mutual holding companies declared dividends, the holding companies would "waive" their portion, either leaving the funds with subsidiaries or using them to augment dividends paid to minority owners.
Opponents cite two specific concerns about the FDIC's move to block this practice:
*Dividend increases for minority shareholders will be limited because the subsidiary can no longer distribute any portion of the dividends waived by the mutual holding company.
*Minority shareholders' ownership position will be diluted upon subsequent conversion to 100% public ownership, owing to the new method of crediting waived dividends to the mutual holding company.
While both statements are true, neither event is necessarily detrimental to minority shareholders.
The first criticism of the new FDIC policy is that it reduces the appeal of mutual holding company investments, since dividend increases will be restricted. Under the new policy, dividends waived by the mutual holding company can not be paid to minority shareholders.
However, these waived dividends still accrue as retained earnings of the subsidiary thrift. In favorable markets, higher retained earnings generally result in higher earnings growth, which is a major determinant of shareholder value.
In turn - assuming the ratio of dividends to earnings is held constant for the subsidiary thrift - higher earnings result in higher future dividends to minority shareholders. In fact, as long as a thrift's return on equity meets investors' required rate of return, shareholder value is not affected by dividend policy.
So, even though minority shareholders no longer receive the portion of retained earnings that accrues due to the mutual holding company's waived dividends, minority shareholders are equivalently rewarded by the increased future dividends derived from the higher level of retained earnings.
The second criticism of the FDIC's new conversion policy - that it dilutes minority shareholders' ownership position in a second-stage conversion - is equally tenuous.
Under prior conversion rules, if minority shareholders purchased 49% of the original mutual holding company conversion offering, for example, they would retain 49% ownership in the event of a second-stage conversion - regardless of dividends the holding company had waived between offerings.
Minority shareholders, in effect, were being allowed to have their cake and eat it too.
Not only did they receive their share of the thrift's earnings paid out as dividends prior to full conversion, but they were granted 49% of that portion of retained earnings accruing by virtue of the company's policy of waiving dividends.
The new FDIC policy sets aside this portion of retained earnings for the exclusive benefit of the mutual holding company. The remaining book value of the thrift is then prorated, based on the ownership distribution between minority shareholders and the holding company in the initial offering - 49% and 51% respectively, in this example.
Under the new guidelines, minority shareholders own a smaller percentage of the fully converted thrift than they purchased in the initial offering, because they have been refunded part of their initial ownership in the form of dividends. In this sense, the new FDIC policy preserves the original ownership distribution.
Some would still consider this a "penalty" to minority shareholders: Even though it restores parity, it eliminates an advantage to the minority shareholders, that of gaining a larger percentage ownership of the fully converted company.
However, so long as the secondary-stage offering is not underpriced, minority shareholders receive no financial benefit for owning a larger proportion of the fully converted mutual holding company.
This point is frequently misunderstood, perhaps because people view the value of the fully converted institution as a pie of fixed size, to be divided between the second-stage investors and the original minority shareholders.
In reality, the size of the pie - or the value of the pro forma, fully converted mutual holding company - varies inversely with the percentage ownership of the minority shareholders prior to the second-stage offering.
If minority shareholders own a large stake, proceeds from the second- stage financing, and the equity base of the resulting 100% public holding company, will be smaller than if minority shareholders held a smaller stake.
Whether it is a larger percentage of a smaller company or a smaller percentage of a larger company, the dollar value of the minority shareholders' position does not change, however, assuming the second-stage offering is not underpriced.
Yes, the new FDIC policy will change some measures of ownership of a fully converted mutual holding company, but it will not affect the most important measure, shareholder value. And it does not threaten the efficacy of the mutual holding company as a valuable structure for raising capital.
Mr. Loomis and Mr. Jones are officers of Northeast Capital and Advisory Inc., an investment banking and consulting firm based in Albany, N.Y.