As someone who has spent his professional career over several decades working with mutual savings institutions in every state and with every form of governance, I am troubled by what might be described as the prevailing attitude among trade groups, legislators and regulators – and sometimes the industry itself – that the mutual form has passed its evolutionary apogee. 

Much of this can be blamed on the ever-escalating efforts of Congress and the agencies to standardize regulation with the eventual goal of charter homogeneity, i.e. one size fits all. With the dominance of the federal government through preemption and the deposit insurance regulations, the standardization trend has had a similar homogenizing effect on innovation by state-chartered savings institutions. 

Banks holding more than $50 billion each in assets account for more than 68% the assets in the U.S. banking system and 66% of the deposits. This still leaves a significant role for community banks – institutions with less than $50 billion each hold a combined $4.1 trillion in assets – and, in specific regions of the country such as the Midwest and the East, mutual community banks. It is not unreasonable to contend that even with recent innovations in the mutual charter (e.g. mutual holding companies) and the variety of state and federal laws governing how mutuals are formed and operate, there is less innovation in the mutual savings industry than ever before. Many mutuals are disturbed by this situation and believe there is no reason why they should not evolve further to become even more vital providers of banking services. Indeed, a number of prominent mutuals have formed an advocacy group, America’s Mutual Banks, to advocate on their behalf.

There are numerous recent examples of the existential threat to mutuals. For reasons that have nothing to do with the performance of mutuals, the federal ones just lost their regulator, the Office of Thrift Supervision. Only 12 state and federal mutual savings institutions have failed during the crisis, compared with more than 450 stockholder-owned banks – hardly a reason to assign a special risk to the mutual industry. Nonetheless, Congress struck from the final Dodd-Frank bill the provision that would have created a mutual national bank charter (a form that America’s Mutual Banks supports). How is this decision to be interpreted? Are mutuals unworthy of a national bank charter? Is there something inferior in their business capabilities that would not permit them to have a national bank charter but would allow a federal or state stock savings institution to have one by simply converting to a national bank? Other examples include the Collins amendment’s provisions discriminating against mutual institutions; interagency guidance on executive pay that talks about “balancing different forms of compensation” without acknowledging that mutuals have only one form (cash) or even mentioning mutuals; and the difficulty the Treasury department has had including mutuals in the TARP Capital Purchase Program and the Small Business Lending Fund.

Much of the problem stems from the absence of alternative forms of equity investments. America’s Mutual Banks has encouraged the agencies and Congress to revive the agencies’ policy of working with mutual banks to develop new capital instruments.  

Historically, outside capital for mutuals was derived from nonwithdrawable accounts and retained earnings. Under the old building association model, mutual liabilities were few as all accounts were a form of equity – they were “share accounts” with no guaranteed interest but discretionary dividends. With the phase out of the thrift tax exemption in  1952, institutions were forced to obtain deposit powers; otherwise they would have to pay tax on their gross income. In the 1970s, with demand for housing loans rising, the Federal Home Loan Bank Board developed a variety of synthetic capital instruments such as subordinated debt and mutual capital instruments. With the thrift crisis of the late 1980s the Board developed various alternative capital instruments for savings associations for issuance to the Federal Savings and Loan Insurance Corp. in exchange for cash. Congress modified these instruments, which became known as net worth certificates. Troubled mutual savings banks could sell them to the FDIC and include them in what was then the equivalent of Tier 1 capital.

There is no need to engage in a typical Washington theoretical debate about what will suffice for mutuals. Fortunately, alternative capital instruments already exist that will meet the needs of these various constituencies. Curiously, they come from the U.S. and Canadian credit union industries. 

In Canada a credit union is permitted to issue Class B investment shares which are counted toward Tier 1 capital. These shares do not carry voting rights. They are noncumulative, meaning missed dividends do not have to be made up. They are redeemable at the sole discretion of the board, and they cannot be redeemed, nor can dividends be paid, if the institution is out of compliance with the capital, liquidity and operational requirements set by regulators. And Canada guards against overreliance on forms of capital other than retained earnings. Under Canadian rules if Tier 2 capital exceeds Tier 1 capital all Tier 2 capital is disqualified from regulatory inclusion as capital. Otherwise, only the amount of Tier 2 capital equal to Tier 1 capital can be included in meeting regulatory requirements. 

The U.S. precedent for this approach can be found in the laws and regulations pertaining to federal and state chartered savings and loans and corporate credit unions. In those cases investment instruments with nonwithdrawable features are treated as Tier 1 capital

Imagine if mutual savings institutions could issue and include these instruments in Tier 1 capital. First, mutuals that wanted to meet the credit needs of their communities by growing without hurting their capital ratios could do so and remain mutual. They would also have a means to involve their members in more equity-like interests, tying them more closely to the success of the bank. Mutual boards, which are already risk-averse, would take comfort with the ability to serve the bank’s growing constituency without reducing the bank’s capital buffer. Compensation plans could be based in part on the performance of these shares. Small savings institutions in the mutual holding company form could issue these certificates without reducing their consolidated capital, as measured by the Federal Reserve, and without worsening their debt to equity ratios. Mutuals looking at acquisitions that are wary of the disadvantages built into the accounting for mergers among mutuals could use these instruments to offset any noneconomic hit to capital. They could also issue the certificates to fund cash acquisitions of stock companies. Finally, as government programs are structured to infuse capital into the banking system, mutuals would not have to wait at the end of the line.

There is no reason why mutuals cannot meet the heightened capital standards of this century. The approach followed by the great-grandfathers of today’s mutual savings executives served the public well. However, the solutions of the past, at least in their traditional form, are no longer acceptable. The number of mutuals declines each year by reason of merger, conversion to stock form and the absence of an acceptable organizational capital instrument. We at America’s Mutual Banks believe it’s time to reverse this trend – and there’s a tool at the ready.

Douglas Faucette is a partner in the Washington office of Locke Lord Bissell & Liddell LLP. He heads the firm’s banking and transactional group and is counsel to America’s Mutual Banks.