The company that revolutionized stock conversions of mutual savings banks almost 20 years ago is abandoning the hybrid corporate structure it innovated - but the structure itself is not going anywhere, and neither is the controversy surrounding it.
People's Bank of Bridgeport, Conn., said last week that the mutual holding company that has held the majority of its stock since 1988 would sell its stake to the public. The announcement, which investors have long expected to hear, drove the stock up 6%.
The paths that mutual savings banks have taken to public ownership have frequently been controversial, and the mutual holding company remains perhaps the most persistent bone of contention. Its uneasy straddle of public and private interests has drawn criticism from an investing public increasingly wary of insider conflicts. A little-noticed change proposed in July by the Office of Thrift Supervision regarding stock-benefit plans has only deepened the suspicion.
But the benefits of the mutual holding company - for investors, regulators, and thrift executives and directors - virtually assure its continued viability.
"I sit here from the sideline knowing one thing: Mutual holding companies are a foregone conclusion - we are going to have them," said Michael Godby, a conversion specialist at FIG Partners LC in Atlanta. "The question is: How do we deal with them?"
Though the balance sheet of a mutual thrift is not markedly different from that of a public company - both have lending assets and deposit liabilities - the potential for controversy lies in the equity.
Depositors and occasionally some borrowers nominally own the mutuals' equity, but their claim is nebulous and of little tangible value outside of the rare liquidation. Stock conversions, in addition to raising additional capital, assign ownership to the existing equity. Members are given first crack but rarely claim all of it, leaving management, directors, and public investors to scramble for the lion's share.
The rewards are tremendous. Securing stock of a converting thrift before its inevitable "pop" on the first day of trading is as much a sure thing as any public investment available today. Claiming conversion spoils is occasionally messy; divvying up loot rarely brings out the best of the human spirit.
A converted savings bank finds itself with a new constituency - public shareholders - that invariably and fundamentally changes the bank's mission. Its responsibility is no longer chiefly to employees and the community.
By placing a majority of the converted savings bank's stock with a mutual holding company, thrift executives and directors can neuter the public shareholder constituency. The mutual holding company's board, which in most cases is identical to the bank's board, controls the bank's destiny.
Board elections are foregone conclusions, because the company controls the necessary majority to appoint whomever it sees fit. Basic questions of strategy and corporate governance are generally beyond the influence of public shareholders as well.
"You have a management group that effectively insulates itself and controls the mutual holding company," said John Coffee, a professor at Columbia Law School. "Across all financial institutions that use that structure, you have suboptimal corporate governance."
The one area over which the minority shareholders have retained some influence is stock-benefit plans - until, perhaps, now. The OTS published a proposal on July 20 that would allow mutual holding companies that have been in existence more than a year to seek a simple majority of all shares outstanding to approve employee stock-benefit plans. That's a change from existing rules, which require them to obtain approval from a majority of the public shareholders.
A comment period on the proposal closed last week, and the issue has divided investors and bankers, not surprisingly.
Supporters say that the current rules are unclear and that new ones are needed to protect mutual holding companies from shareholder activists. Eric Luse, a partner at Luse Gorman Pomerenk & Schick PC, a Washington law firm that has advised many converting thrifts, wrote in a Sept. 18 comment letter that activist investors use "their voting power over stock-benefit plans to weaken the mutual holding company charter for their own short-term financial gain."
Opponents of the plan have a different take.
The OTS proposal "removes the last vestige of management accountability that exists for these companies," said Spencer Schneider, an attorney for the longtime conversion investor Joseph Stilwell. "It's unseemly for the insiders to be able to pocket huge amounts of money without asking the public shareholders."
Larry Seidman, an investor whose battles against underperforming thrifts are well-documented, had a similar objection.
"I'm not against well-structured stock-option plans that incentivize people to make shareholders money," he said. "I'm against plans that have no basis as far as performance and are given to people that haven't yet proven they can do anything."
Mr. Schneider pointed out - as did a number of investors in comment letters - that the possibility of taking power out of the hands of public shareholders has emerged at a relatively delicate time in the annals of corporate governance. That delicacy is especially acute for stock-option plans, which have been tainted by recent revelations of backdating.
"You have the same federal government talking out of both sides of its mouth - the Securities and Exchange Commission upholding shareholder rights and the OTS walking away from them," Mr. Schneider said. "It basically turns the thrift industry into a safe haven for insider self-enrichment."
Investors say that the OTS has its own motivation for the proposal, and that the agency, too, is a constituency with a stake in the battle over thrift companies.
"In the face of declining budgets and layoffs, a management-friendly charter might just attract one more institution into the fold of OTS regulation and in so doing reduce the pressure on internal budgets," David Harvey, a principal in Hot Creek Capital LLC, wrote in an Aug. 21 letter. "How could any self-interested economic man choose another regulator when this one permits management to designate their own benefit plans unencumbered by the oversight of outside shareholders."
The OTS would not discuss the matter, except to say it was still reviewing the proposal and comments on it.
Bankers say investors have their own questionable motives, not the least of which is agitating for sales of converted institutions. Their arguments are in some cases more than a little personal.
"Mr. Seidman is a well-known stockholder activist who has eliminated many local financial institutions through hostile activities," David J. Warnemunde, the president of Madison County Bank in Nebraska, wrote in a Sept. 6 letter to the OTS. "He is one of the reasons that our association and other institutions have remained" in mutual form.
Ben Plotkin, the chairman and chief executive officer of BankAtlantic Bancorp Inc.'s Ryan Beck & Co., which has been an active investment bank for converting thrifts, said community banks have an obligation, enforced in regulations and corporate bylaws, to their community, and that obligation can be threatened by activism. He said that about 65% of fully converted institutions sell to acquirers roughly within three to five years of conversion.
Bankers also say that the capital-raising flexibility of the holding company structure can be essential to mutual banks that would choke on the capital raised by a full conversion. Overcapitalized banks struggle to provide acceptable returns on equity and in the past have made risky bets.
The targeted capital levels made possible by conversions therefore confer benefits on the same investor class that complains about them, according to Mr. Plotkin.
"There is a love/hate relationship, because if you can get stock of an attractive mutual holding company, that stock will perform very well," he said. The savings bank "can best produce returns for a smaller number of shareholders by being appropriately capitalized, as opposed to overcapitalized."
The OTS could offer to apply the new voting rules on benefit plans prospectively, so that an investor in a mutual holding company would know the rules of the game before the investment. The agency faces a certain fight if it does not.
"If the OTS says the rule applies retroactively - meaning that it applies to companies that have already converted, where people have already invested with the expectation of having a say in stock-benefit plans - then we would sue," Mr. Schneider said.
That won't eliminate all objections to the mutual holding company structure, but Mr. Plotkin warned investors against pursuing their case with abandon.
"As they push this issue," they risk "chilling mutual stock activity," he said. "They may win the battle and lose the war."
There's no shortage of convincing arguments on both sides of the debate, but almost every proponent has a conflict.
One investor accused savings bank executives and directors of "wanting to have their cake and eat it, too." Another investor accused the OTS of "wanting to have its cake and eat it, too." And an investment banker accused the investors of "wanting to have their cake and eat it, too."
Their preference for the same cliche is as humorous as it is true. But the tremendous wealth that mutual conversions have produced is evidence that there is plenty of cake to go around.
