The financial reform bill slated for enactment today has nudged a staid Midwestern thrift to get bigger and take more risks.
For years Capitol Federal Financial in Topeka, Kan., was content to write single-family mortgages in its low-growth markets and pay generous dividends to its public shareholders.
But then the $8.5 billion-asset thrift realized that it had the most to lose, among the 67 publicly traded mutual holding companies, under the Dodd-Frank bill. Its dividend policy was the most generous of any mutual holding company's, and when the legislation threatened to jeopardize this, Capitol Federal decided to fully convert to a stock company to protect the interests of its public shareholders.
So now the company is raising nearly $2 billion — by all accounts, reluctantly — in one of the biggest conversion deals ever.
For a company that has taken few risks with its balance sheet, the conversion will force executives into unfamiliar territory as they look for ways to use the fresh capital.
Mike Shafir, an analyst at Sterne Agee & Leach, said Capitol Federal would have preferred to remain a mutual holding company. But "I think Capitol Federal is looking out for its current shareholders, and the regulatory risk is too great for them not to proceed," he said.
The Kansas thrift focuses almost entirely on residential real estate loans and has bought only one bank since its founding in 1893.
The company historically did not hoard capital, returning millions of dollars in dividends to its public shareholders.
Now the conservative institution will explore loan repurchases, share buybacks and even expansion as it deploys a mother lode it had not sought.
A mutual holding company is owned by a thrift's depositors and holds the majority of voting shares in the holding company for a thrift. The rest of the thrift holding company's shares are publicly traded.
For years, the Office of Thrift Supervision allowed mutual holding companies to waive dividends. Instead, the thrift holding companies could distribute higher dividends to the public shareholders.
It is one of the major benefits of being a stockholder in a mutual-controlled thrift company, and Capitol Federal's shareholders — who hold about 30% of the outstanding shares — got higher dividends than any others.
The company has paid out nearly $20 in dividends per share — and at least $2 a year for the past several years — since going public in 1999. So shareholders who bought shares for $10 apiece that year have received their money back, plus $10 per share.
"The dividend was really very central to the story," said Daniel Arnold, an analyst at Sandler O'Neill & Partners LP. "Of all the MHCs I can think of, their dividend was absolutely the highest."
But with the financial reform abolishing the OTS, many companies worried that their new regulator, the Office of the Comptroller of the Currency, would end the thrift agency's dividend policy and make the thrifts pay dividends to the mutual holding companies, which would be held in an interest-bearing account.
In addition, companies were concerned that, if they ever fully converted to stock companies, public shareholders might be required to essentially return the waived dividends to the depositors, in the form of proportional ownership.
Under the OTS, public shareholders have maintained their percentage ownership in the company after conversions. But under the mutual-conversion policies of the Federal Reserve or Federal Deposit Insurance Corp., any dividends the holding company had waived would be designated as depositors' equity. And this would reduce public shareholders' stake.
Though the potential change could hurt public shareholders at all mutual holding companies, it was particularly worrisome for Capitol Federal.
The company had paid out such high dividends that nearly all the equity held by the minority shareholders would have been forfeited.
"Essentially, the public shareholders would be wiped out," said Theodore Kovaleff, an analyst at Horwitz & Associates.
Officials from Capitol Federal would not comment for this story, citing a quiet period while it completes the conversion.
But John Dicus, Capitol Federal's chief executive, has made no secret of the company's preference to maintain the status quo.
He told investors in February that the company was willing to convert if it had to but was fiercely lobbying Congress to keep the OTS policies in place.
"We could raise anywhere from $1 billion to $1.5 billion in additional equity" by converting, Dicus said at a regional bank conference held by KBW Inc.'s Keefe, Bruyette & Woods Inc. "And at this point, we don't have a business strategy or business reason to raise that [or] put that to work so that would be accretive to our shareholders in a fully converted company."
But by May, the company decided it was too risky for shareholders to wait and see how the legislation panned out. The company followed dozens of other mutuals — many of which had similar concerns — and made plans to convert. (The final version of the reform bill would grandfather-in companies that waived dividends but did not address how they would be treated in a conversion.)
Since the beginning of this year, 16 thrifts have converted to stock companies, compared to six conversions in 2009, and dozens more are in the pipeline.
When Capitol Federal converts, it will be the largest second-step conversion ever in the Midwest. And it ranks up there with the $61.1 billion-asset Hudson City Savings Bank in Paramus, N.J., which raised $3.9 billion when it converted in 2005, or the $21.3 billion-asset People's United Bank in Bridgeport, Conn., which raised $3.44 billion on its conversion in 2007.
Capitol Federal is "one of the best-run plain-vanilla thrifts out there," said Sandler O'Neill's Arnold. "They don't do anything too exciting."
As of March 31, 98% of the company's portfolio was in one- to four-family loans. But its markets, mainly in Kansas and Missouri, never experienced the housing bubble that distorted real estate values around the country, and the company managed to weather the storm despite its high concentration in residential real estate. Its nonperforming assets ratio was 0.43% at March 31, and its total risk-based capital ratio was 23.9%.
Arnold said the thrift may try to boost organic growth, though the company operates mostly in Kansas, a historically low-growth state. He said he could also envision the company moving into new markets, either through branch deals or whole-bank acquisitions.
"I don't think they're going to leapfrog and go anywhere too far from where they currently are," he said.
Capitol Federal has said it may increase its loan purchases. But Shafir, the Sterne Agee & Leach analyst, said he does not see the thrift straying far from the residential asset class it has favored for so many years.
"I don't think that they want to become a commercial institution," Shafir said. "Those are some of the decisions that lie ahead for the institution, and that's what they have to present as they get on the road to sell this deal."
