In his column on Nov. 18, 1991 ("Mutuals should Play 'Price is Right'"), Paul S. Nadler questioned the wisdom of the Comment we published in this newspaper last Aug. 22 on mutual-to-stock conversions of thrift institutions ("Low Prices Make Time Ripe for Stock Conversion").
We felt an obligation to respond because Mr. Nadler's article failed to recognize some of the fundamental elements of the mutual-to-stock conversion.
Mr. Nadler failed to recognize that: (1) there is no book-value-per-share dilution in a mutual-to-stock conversion; (2) there are comprehensive statutes and regulations protecting the rights of depositors in mutual thrifts; (3) return on equity is important to an investor; and (4) people buy stock because they hope it will appreciate in value.
There's Nothing to Dilute
A key concept is that it is a mutual that is converting, not a stock entity. The principle of dilution does not apply because there are no shares outstanding to be diluted.
There are certain legal principles underlying conversions that have been established by statute, regulation, and case law. Depositors of a mutual thrift are provided by law with two rights in conversion: the right to buy stock and the right to approve or reject the plan of conversion.
Mr. Nadler's concerns about depositors' interests are misplaced. The primary interest of most depositors at both mutual and stock institutions, as one might imagine, is the return on their deposit with a decent rate of interest.
Depositors Have Priority
Furthermore, in the mutual-to-stock conversion process, depositors are, contrary to Mr. Nadler's suggestion, not deprived of their right to receive the thrift's "surplus."
In fact, depositors are given first priority to buy all of the stock offered by the thrift - a type of preemptive right.
The regulations also require that a liquidation account be established to protect depositors' interest in the surplus that exists at the time of conversion, in the event of a subsequent involuntary liquidation.
Mr. Nadler does make one good but obvious point: If prices move lower, depositors who invest in the conversion stock can lose money.
There is, however, a greater risk of prices moving lower if the offering is priced at the top of a speculative market.
The best examples of this situation are New England thrift conversions that were priced aggressively during a speculative frenzy in 1985 when prices were at 80% or more of pro forma book value. The stock prices could only go down.
For a conversion to be successful, there must be a strong possibility that the stock will appreciate in value. To ensure fairness, the Office of Thrift Supervision regulations strictly control the appraisal process that determines the amount of stock to be issued.
It seems Mr. Nadler does not understand what has become the most difficult question for managers who receive this new capital - how to put it to use.
Gauging Capital Needs
A large majority of thrifts going public are not, as Mr. Nadler implies, undercapitalized. He suggests that the higher appraisals and the resulting larger stock offerings would be beneficial and does not recognize that this may place many institutions above optimal capital levels.
In this regard, he has ignored a fundamental principal that all corporate managers understand - return on equity is key. High conversion appraisals will require thrifts to take more risks to achieve an adequate return.
The market rewards companies that perform, and it measures performance based in significant part on return on equity.
Why not give thrifts a chance, like other publicly traded companies, to pay their investors back with a decent rate of return?
Paul S. Nadler replies: To say that there would be no dilution because there are no stockholders is my key point. No one is there to protect the surplus built up over the years from being raided by today's depositors and managers.
Mr. Breyer and Mr. Zinski go further and say that if the bank got a high appraisal on its surplus when it went public, then it would bring capital above optimal levels. That would lead to risky investments, so why not pass it out below optimal value to avoid this?
It's like saying to your boss, "Why don't you cut my salary, since all I'll do is spend the money on beer."
My point is that higher appraisals and larger stock offerings help the bank, though they do mean a less attractive deal for investors.
Since the surplus was built by the bank over more than a century in many instances, it is the bank that should benefit, not just those who happen to be involved with it in 1992.
Mr. Breyer and Mr. Zinski are partners in the law firm of Breyer & Zinski in Washington.