The activist investor Richard Lashley believes that the mutual holding company structure should be extinct and that all mutuals should operate as fully public companies. He's happy to assist in any way he can.

Earlier this week, for example, PL Capital said it had sent a letter to the board of Polonia Bancorp in Huntingdon Valley, Pa., demanding that the company pursue a second-step conversion.

"The world is changing, the regulators are changing and the need for capital is clear," said Lashley, a principal at PL Capital Group. "All MHCs will be under pressure to do a second step and full conversion."

Lashley had been relatively quiet until March, when PL Capital tried to oust the CEO of Magyar Bancorp Inc. in New Jersey. Though unsuccessful, Lashley said he plans to call for Magyar to find another MHC partner.

Other outside shareholders are likely to step up their activism. The market for conversions has improved this year, and shareholders have become increasingly nervous about the ability of MHCs to grow in a new, more costly era of banking. Sensing an opportunity, Lashley's firm has invested positions in nine such institutions. "We will be more active," he said.

In early April, the holding company of Baltimore County Savings Bank, BCSB Bancorp Inc., said it applied to convert to a Maryland-chartered commercial bank. Less than a month later, PL Capital, the company's largest outside shareholder, requested Lashley have a seat on the board, threatening a proxy battle that remains unresolved.

Because of their closely held structure and limited board accountability, mutuals "are kind of orphaned," organized unattractively, Lashley said. It is difficult, however, for an outside shareholder to go against a mutual and its board, because typically a majority of the overall shares are closely held within the MHC.

"Frankly, the MHC structure is still invulnerable to a takeover," said Kip Weissman, a partner at Luse Gorman Pomerenk & Schick. He said that, for any dissident shareholder, "the only strategy is to yell and scream."

Observers agreed that the MHC structure makes growth an issue, in that capital-raising is difficult.

Such concerns are acute for MHCs because most hold smaller institutions, with assets of less than $1 billion. The boards of MHCs have also recognized this concern; an increasing number are converting this year. Five conversions were completed in the first three months of this year, compared with only one in the first three months of 2010, according to data provided by Sandler O'Neill & Partners LP. Conversions picked up the most in December, when eight were completed among a total of 24 for the year.

Typical pricing of $8 to $10 per share is also driving conversions. "It appears to be a good time to convert to a stock company or complete a second step because valuations are low, so investors get better value for their money," said Frank Bonaventure, a partner at Ober, Kaler, Grimes & Shiver.

In March, the noted activist investor Lawrence Seidman increased his holdings in Fox Chase Bancorp Inc. in Hatboro, Pa., which converted to a stock company from a mutual in June. Seidman specifically targets undervalued institutions.

Conversion proponents have another compelling argument: an appreciation in the pricing and valuation of recently converted MHCs.

The five conversions that took place in the first quarter averaged a 63.8% price-to-tangible-book value, slightly higher than the 60.8% average a quarter earlier, in which 10 conversions were completed.

To be sure, appreciation remains a mixed bag, ranging from a negative 3.4% after Rockville Financial Inc.'s second step in February, to the 26% gain recognized by Eureka Financial Corp.'s second step the same month based on Wednesday's closing price, according to SNL Financial data.

"Recently second steps and conversions have appreciated from the $10 and $8 number but, and this is a big but, the number of shares received by the existing shareholders has been cut back," said Theodore Kovaleff at Horowitz & Associates.

"I don't think it's a bad time [to convert], but the thing you have to bear in mind is that for conversions and second step, you have to have capital markets that are liquid enough," Kovaleff added.

Even Polonia last December called off its common stock repurchase plan, saying that it wanted to preserve capital for its subsidiary, Polonia Bank, after buying the failed Earthstar Bank.

The termination of the repurchase plan emboldened PL Capital to take aggressive action. Lashley acknowledged that "the jury is still out" on whether Polonia could pull of a successful second step.

But with a lack of profits, no dividend payouts and the need for added capital after making an acquisition, a second step conversion is a logical move, Lashley said. A second step "would unlock some of the value … and allow them to get back into the stock-repurchase game and dividend payments," he said.

In a May 6 letter to Polonia's board, PL Capital said a second-step transaction at 65% to 70% of pro forma book value would generate an exchange ratio of about $8.30 to $9.30 a share, compared with the current price of $5.75.

Though a conversion is compelling today because of valuations and pricing, Kovaleff said two questions remain: Can the second step be completed, and what happens to valuations after the conversion takes place? "If you overprice the shares, you will not have the propelled strong price appreciation that you would have if you priced them correctly," Kovaleff said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.