Fearing that directors of mutual holding companies could be tempted to siphon off capital for their own purposes, regulators are making it harder for them to forego dividends from thrifts.
The move is a sign of how life is getting tougher for companies formerly regulated by the Office of Thrift Supervision, which closed its doors last month.
That agency had long allowed mutual holding companies to waive dividends from the thrifts they majority-own. Waiving dividends cut a company's income tax bills. But rather than staying at the thrift, some of the money saved was often redirected to its outside shareholders, who could include the directors of the MHC — the same people who authorized the waiver.
The Federal Reserve issued new rules on Aug. 12 that, among other things, require more cumbersome disclosures for mutuals seeking to waive dividends. (Although thrifts themselves are now regulated by either the Office of the Comptroller of the Currency or the states, oversight of their parent companies went to the Fed.) Critics say the move could scare off potential investors and hurt a mutual's ability to raise capital.
"You almost think the rule was drafted in such a way that no MHC ever waives a dividend again," said Eric Luse, a partner at Luse Gorman Pomerenk & Schick. If the rule stands, mutuals "should be valued less and there will be more of a separation in how these trade compared to full stock companies."
Failure to get a waiver can reduce the bank's potential value to outsiders. It also gives more ammunition to activist investors who have become increasingly vocal in pressing mutuals to do full-stock conversions.
"This is a problem because waiving dividends is one of the few things that investors like about MHCs," said Richard Lashley, a principal at PL Capital, one of the most active investors in mutuals. "This is one more reason why all MHCs should convert to fully public companies, or do a re-mutualization."
All of the biggest quarterly dividends to outside shareholders among 23 mutuals were ones that had deferred dividends to the holding companies based on the most recent quarter, according to Sandler O'Neill & Partners LP.
Such mutuals paid outside investors dividends as high as 18 cents a share; the one that did not waive a holding company dividend — Prudential Bancorp Inc. of Pennsylvania — paid out 5 cents a share to public shareholders.
"This is not a question of suspending or deferring, it's a question of paying at such a level that keeps stock price high," said Doug Faucette, a partner at Locke Lord Bissell & Liddell. "If investors project in the future that [there will be] dividends, there is a significant value to the stock."
The Fed has long argued that since directors of MHCs can also be outside investors, waiving the dividend could bolster their personal investments. Since the Fed's stance was different from that of the OTS, many mutuals preferred to be regulated by the latter.
"Over the years we've advised uniformly all MHCs to make sure the holding company was regulated by the OTS because they had a different policy on dividend waivers," Luse said. "We believe the Fed has always had a bias against mutuality" and the new requirements "reflect that bias."
Under the new Fed rules, mutuals "can't simply say 'we waived the dividend because we thought it was good for investment purposes.' They're going to have to say why," Faucette said. "In light of the Fed's hostility to dividend waivers … that's a significant problem."
The new rules were also disappointing for mutuals on the verge of a second step, including Investors Bancorp Inc. The $10.2 billion-asset company, which has not yet started paying a dividend, has petitioned the Fed for a waiver so it can pursue more investors when it converts. Given the added disclosures, the company is reconsidering whether it should pay a dividend.
The Fed rules "will have an impact in our decision to pay a dividend," said Kevin Cummings, Investors' president and chief executive. "As we move forward in the second step process, it's important to be paying a dividend."
Investors has found other ways to deploy capital, buying back more than 14 million shares of its common stock since 2006 and acquiring failed banks such as last week's purchase of Brooklyn Federal Bancorp Inc. in New York.
To be sure, the rule does not completely end dividend waivers, though more legwork is required. The rule outlines different requirements for mutuals based on whether they waived dividends before Dec. 1, 2009. For instance, if a non-grandfathered mutual's board is comprised mostly by outside shareholders, then those directors must forfeit their personal dividends before voting for a waiver. And all mutuals must also have a majority vote by all members of the mutual within 12 months of the declared dividend. Observers say it will be difficult and costly to track down every member.
"It's relationship banking, that's what the members care about. It's not about who's running the board nor are they affected by the dividend waivers," Luse said. "The Fed basically said 'we're going to elevate the rights of the depositors in effect over the rights of the shareholders."
Though the requirements may be cumbersome, some lawyers said the result will put investors and board members at ease.
The Fed is "adding formality to the process" and "a corporate governance level to" waivers, said Philip Smith, president of Gerrish McCreary Smith. "You could say it will actually help the directors because there is no concern about being challenged for a breach of their fiduciary duty."
Some observers said the rule may go largely unnoticed since it would only alter the plans of mutuals that have not already fully converted and were OTS regulated. "There's not many MHCs left," said Frank Schiraldi, a Sandler O'Neill senior analyst. "It may be an issue for a couple individuals but it certainly is not going to be catastrophic."
Smith said the fallout will remain unclear until the rule takes full effect after being published in the Federal Register. The Fed is accepting comments through Oct. 27, but said it expects to publish the rule in the register soon.
"The rule doesn't say there's just one box" to fill out, Smith said. "It's confusing. But it's one of those things where it will have to bear itself out."
