In late 1992, the Office of Thrift Supervision adopted revisions to its regulations governing "voluntary supervisory conversions" from mutual to stock form.

The changes substantially increased the number of institutions that qualify for voluntary supervisory conversion and reduced the burden associated with such transactions.

The thrift agency regulations apply to federal savings associations and, subject to applicable state law, state savings associations.

Under these regulations, a mutual thrift can convert to stock form without seeking the approval of the members (customers) and in many cases without offering stock subscription rights to these members.

In Combination with a Merger

A voluntary supervisory conversion can be effected in conjunction with a merger into another institution or an acquisition by a holding company. This combination of elements offers an enticing opportunity to acquire institutions without the payment of any out-of-pocket consideration.

An example was the recent acquisition of New Jersey Savings and Loan Association, a mutual in Atco, N.J., by Covenant Bank, a stock savings bank in Haddonfield.

Covenant added strategically placed offices to its branch network, gained entree to the deposits and loan demand of a community it did not formerly serve, and realized a significant increase in its retail loan portfolio -- all without the payment of cash or stock consideration.

Savings on Expansion Costs

By virtue of the merger, Covenant assumed liabilities roughly equal to the assets acquired, on a book value basis, but it expanded by over 30% without incurring the costs of de novo branching or even the payment of consideration to the acquisition target or its shareholders, as would usually be required for a branch acquisition or merger.

The keys to the transaction were the revised regulations regarding voluntary supervisory conversions and related provisions of New Jersey law.

The principal benefit of the supervisory conversion is that no approval by the members of the converting association is required.

In addition, a conversion combined with an acquisition can often be accomplished without offering to the members of the converting association any rights to purchase the acquirer's stock. Thus, the voluntary supervisory conversion mechanism enables a quicker and less costly acquisition.

To Qualify

Under the revised regulations, any mutual association that is significantly undercapitalized and would be a viable entity following the conversion qualifies for a voluntary supervisory conversion.

If an association is undercapitalized but not significantly undercapitalized, it can undertake a voluntary supervisory conversion if it can demonstrate that a standard conversion -- one that would raise enough capital to enable the association to be adequately capitalized -- is not feasible, and that it would be a viable entity following a voluntary supervisory conversion.

Prior to the recent revision to the regulations, the voluntary supervisory conversion mechanism was only available if the association's liabilities exceeded its assets, calculated in accordance with generally accepted accounting principles on a going concern basis.

Much More Widely Available

Thus, the revisions to the regulation have made the supervisory conversion mechanism available to a much wider class of institutions.

Furthermore, other developments in the law have opened the door to cross-industry acquisitions, so that the opportunities for acquisitions of mutual savings associations presented by the supervisory conversion procedures are potentially available to banks and savings banks as well as to other savings associations.

The Federal Deposit Insurance Corporation Improvement Act of 1991 expanded the so-called Oakar amendment to permit virtually any cross-industry combination, notwithstanding the general moratorium that exists on transactions resulting in a movement of deposits from one deposit insurance fund to the other.

The Oakar amendment avoids that moratorium in a case like the acquisition of New Jersey Savings and Loan -- an institution insured by the Savings Association Insurance Fund -- by Covenant -- an institution insured by the Bank Insurance Fund -- by providing for the continued treatment of deposits attributable to New Jersey Savings as SAIF-insured deposits.

Cross-Industry Mergers

The 1991 banking reform law specifically, provided for the power and authority of federal savings associations to merge with or otherwise be acquired by any insured depository institution. Previously, federal savings associations could generally only enter into such transactions with other savings associations.

A bank interested in acquiring a thrift should be aware, however, of the tax consequences potentially implicated by such a transaction. Loan-loss deductions may be subject to recapture if the surviving institution, as successor to the acquired thrift institution, is not a qualified thrift lender.

The voluntary supervisory conversion regulations specifically contemplate that a conversion might be undertaken in conjunction with an acquisition of the converting institution by merger with another institution or by issuance of stock to an acquiring holding company.

If Stock Is Issued

The conversion and acquisition transactions occur simultaneously in such cases. If stock is to be issued in such cases to the members of the converting association or to the public, it would be the stock of the acquiring institution or holding company.

For regulatory purposes, the conversion and the acquisition transactions are distinct, and separate application and approval requirements must be met with respect to the acquisition aspect of the transaction.

For instance, in the Covenant acquisition of New Jersey Savings, Covenant was required to file a Bank Merger Act application with the FDIC, and a "transfer" application was required with the Office of Thrift Supervision in addition to the application for approval of the conversion.

Under proposed revisions to regulations, the thrift agency would no longer require a separate "transfer" application to be filed with it for acquisitions of thrifts by entities not regulated by the thrift agency. Rather, the agency will require only that it receive a copy of the Bank Merger Application submitted to the appropriate federal banking agency.

Applicable State Law

When state-chartered institutions are involved in the transaction, applicable state law must also be consulted to determine the ability of the institutions to enter into the proposed transaction.

In the case of Covenant's acquisition of New Jersey Savings, state law provided a convenient mechanism for effecting the transaction, available where an institution has less than 2% capital.

These provisions of New Jersey law, like the Office of Thrift Supervision's supervisory conversion regulations, authorize conversion mergers without approval by the members of the mutual to be acquired and without the issuance to such members of subscription rights to the acquirer's stock.

This provision of New Jersey law also authorizes combinations among institutions not otherwise authorized to combine, such as savings banks and savings associations.

Liquidation Accounts

In connection with conversions from mutual to stock form, a liquidation account generally is required.

The liquidation account provides members of the converting association with priority rights to any distribution in the case of a complete liquidation of the converted institution. Where the converted institution is merged into another institution, the liquidation account carries over to the surviving entity.

The Office of Thrift Supervision regulations regarding voluntary supervisory conversions authorize the waiver of the liquidation account requirement where the converting institution has a negative net worth. However, the liquidation account is necessary in a solvent situation, to meet the "continuity of interest" requirement for treatment of the transaction as a tax-free reorganization.

It is our understanding that the thrift agency has not yet processed a transaction in which the liquidation account was waived.

To sum up, a voluntary supervisory conversion provides a mechanism for troubled thrifts to find a buyer. And as a result of developments in the law, these acquisition opportunities are increasingly available to banks as well as to savings associations.

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