Regulators’ censure of a Massachusetts thrift for investing too much capital in trust-preferred securities has reignited tension between the thrift and investors who have urged it to merge with a larger bank.

Peoples Bancshares in New Bedford, the holding company of $1.1 billion-asset Peoples Savings Bank of Brockton, revealed last week that it has entered an informal agreement with the Federal Deposit Insurance Corp. and the Massachusetts Division of Banks. Officials at both regulatory agencies refused to discuss the agreement, but in its second-quarter 10-Q report Peoples said it had agreed to “reduce over time the level of investment in trust-preferred securities to less than 100% of its Tier 1 Leveraged Capital.”

In addition, regulators are requiring Peoples to boost its core capital to 6.5% of assets, but they did not say if this was related to the thrift’s investments in trust-preferred securities. In its 10-Q report, Peoples said it would meet the new core-capital level by yearend.

In June, Peoples narrowly defeated a proxy campaign aimed at electing three dissident shareholders to its board of directors. Spearheading the proxy effort was RCG Kingston LLC, a New York investment partnership that owns 5% of Peoples stock and is now threatening to mount another challenge. On Aug. 8, six days before Peoples revealed the FDIC agreement, RGC managing directors Thomas F. Gillen and Donald B. Jennings dispatched a letter to the holding company’s board of directors criticizing their reliance on trust-preferred securities.

“I feel like saying, ‘We told you so, and now the regulators agree with us,’ ” Mr. Gillen said. “We were waving this flag a year ago,” he added, referring to thrift’s investments in trust-preferred securities.

But Colin Blair, chief operating officer of Peoples Bancshares, said the agreement with the regulators would have little or no impact on its operations and that the company would hit its 2000 earnings target of $3.09 per share.

“We expect to be able to do this without any materially adverse financial effect,” he said.

In a phone interview Thursday, Mr. Blair said Peoples was close to meeting the 6.5% capital ratio called for in the agreement.

“Basically, we are already there,” said Mr. Blair, adding that Peoples’ performance in the second quarter, when it posted earnings of 73 cents a share, “was better than what we expected.”

Mark Schmidt, associate director for policy at the FDIC’s division of supervision, said investments by banks in trust-preferred securities is not seen as a widespread problem.

“It has not bubbled up … but it is something we are aware of,” Mr. Schmidt said. “Investing in trust-preferred securities is not a problem per se, but if you do not do your homework, and do not invest right, it can lead to pitfalls.”

James T. Hill, director of the banking institutions group at Sutro & Co. in Los Angeles, said many banks have raised capital in recent years through issues of trust-preferred securities but relatively few have invested in them. The securities, he said, are “perceived to have a market risk” because of fluctuations in interest rates.

“If interest rates go up, the portfolio goes down in value,” said Mr. Hill. “If I were a regulator” and saw a large percentage of a bank’s capital invested in trust-preferred securities, “I’d be less than enthusiastic.”

Regulators are ordering Peoples to scale back its trust-preferred investments at a time when many banks are selling stakes in their investment portfolios.

“Sophisticated investors assign little or no value to the earnings stream from wholesale leverage,” wrote David H. Winton, an analyst at Keefe, Bruyette & Woods in New York, in a recent newsletter. “It’s simply not creating franchise value.”

In an interview Mr. Gillen said he expects Peoples’ board of directors to hold management accountable for the thrift’s regulatory difficulties.

“If the board does not hold management accountable for this mess, we will hold the board accountable,” he said. “Next year there is a high probability of another proxy fight if this situation is not resolved.”

In their Aug. 8 letter, Mr. Gillen and Mr. Jennings urged that Peoples eliminate dividends and curtail its stock-buyback program in order to boost capital, but Mr. Blair rejected that advice.

“That would really make it easy for them at their next proxy challenge,” he said.

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