Low Prices Make Time Ripe for Stock Conversion
Most mutual savings and loan associations and savings banks have at one time or another considered conversion from mutual to stock form.
More than 750 standard conversions have been completed in the United States. To qualify for a standard conversion, a mutual thrift must, with the additional capital raised, be in compliance with its capital requirements.
In a standard conversion, the mutual thrift converts to stock form by offering newly issued shares to members. Remaining shares are then offered to the local community.
In a hot equity market, many institutions rush to the market with conversion stock. Some may experience delays in regulatory approval because of the volume of applications. Others may find it hard to sell their stock because of competition among institutions in conversion.
Mostly because thrift stocks are now valued low, this may be an opportune time for mutual thrifts to consider conversion. Here are some important reasons.
Conversion values are at or near cyclical lows. Market prices of publicly traded savings institutions declined nearly 40% during 1990 and approximate the cyclical lows of 1982 and 1983, when earnings were under pressure from interest rates.
In first quarter 1990 the average pro forma price-to-book-value ratio was 53%; it is now about 40%. The average bottomed in the first quarter of this year, at 35%; some conversion appraisals dipped as low as 28%.
Shareholder returns increase dramatically with lower valuations, and the potential for stock price appreciation may be enhanced dramatically once the market environment recovers.
Takeover prices now range from book to 1.5 times book. Though prices have improved recently, this has not been reflected in conversion valuations.
This discount increases the potential return of an investor in a converting thrift. For example, a thrift converting at 40% of pro forma book value might conceivably sell out over the next several years at premiums of up to 1.5 times book.
Conversions bolster earnings. The environment for financial institutions is very competitive and will become more so.
Savings associations in stock form will be better positioned to compete against commercial banks, all of which are stock institutions.
Furthermore, the earnings on the additional capital raised in the conversion process will position a stock savings association well with respect to mutual institutions.
Merger and acquisition activity in the financial services industry has increased dramatically in the past several years.
This consolidation will continue as more financial institutions are unable to meet the higher capital requirements and the industry becomes more competitive.
Stock institutions will be much better positioned to take advantage of this consolidation. Stock can be used as consideration in acquiring another financial institution or other type of company.
And stock ownership brings greater value if the institution is acquired. Unlike stockholders, depositors in a mutual thrift are not entitled to any consideration if it is acquired.
Increased pressure on operating margins at most financial institutions has led to the elimination or reduction of many compensation plans. Stock ownership provides an alternative method of compensation, in the form of stock.
Stock-based compensation methods include stock option plans, employee stock ownership plans, restricted stock plans, management recognition plans, and 401(k) plans with employer stock as an option.
Such plans also are intended to provide employees with motivation and incentive for improved job performance.
Officers and directors of financial institutions should ask themselves whether conversion to stock form is inevitable. The increasing pressure on capital compliance and earnings, as well as the competition created by commercial banks, may force many thrift institutions to eventually convert to stock form.
If conversion is inevitable, today seems a sensible time. Furthermore, conversion on a stand-alone basis, as opposed to a merger-conversion, would ensure management and depositors of an opportunity to capitalize on an investment in the company.
Mr. Breyer and Mr. Zinski are partners in the Washington law firm of Breyer Zinski & DiNuzzo, which specializes in representing S&Ls and commercial banks.