The recent wave of mutual-to-stock conversions has many bankers scratching their heads. Why, after all, would a banker trade free capital for expensive equity capital? What banker would go to his or her board with grand visions of “building a franchise” to advocate for a strategy that will likely result in the bank being sold within five years? Fortunately, most mutual bankers have common sense. They can see through the purported reasons for mutual-to-stock conversions, even though these conversions do not seem to present important policy issues for bank regulators.
In 1986, I was executive vice president of Quincy Savings Bank, one of many mutual savings banks to convert from mutual to stock ownership shortly after such conversions were first allowed. There was much naiveté surrounding conversions in those days. The Quincy Savings Bank board had visions of building a powerhouse community bank. But these visions were never – and could never be – realized.
After its conversion, Quincy Savings Bank lasted just eight years before its subsequent acquisition by Citizens Bank in 1995, joining the 88 percent of converted mutual banks that have disappeared after converting to stock. Rights to the millions in capital accumulated by the bank over the 125 years prior to its conversion were ceded to stockholders.
Who profited from this? Insiders: bank officers (including me), directors and a coterie of investment bankers, lawyers and sundry “investment professionals,” singing a siren’s song of how more capital would most certainly assure the bank’s longevity. And who lost? The bank and its bedrock constituencies who did not have a seat in the process: employees, customers and the community at large.
Withstanding Even The Red Sox
One of the fundamental flaws of a mutual-to-stock conversion is that it ignores the purpose for which a mutual bank was founded. Mutual banks were formed, in most cases, well over 100 years ago. They were philanthropic institutions formed to help working families save, purchase homes and build wealth and security. Most mutual banks still serve these purposes, with an increasing focus on small and family-owned businesses that larger commercial banks have determined do not create sufficiently profitable relationships.
For this type of banking, longevity is important, and the mutual form of ownership is built to last. Many mutual banks have survived civil wars, world wars, great depressions and even the 86-year Red Sox World Series championship drought. A converted mutual bank rarely survives for more than 10 years. The good ones sell out within five. It is doubtful that a bank that converts today will survive long enough to celebrate a Cubs World Series championship.
Does anyone on a board of directors that approves a conversion think about this? Once a mutual bank converts to stock, it is destined to become an outpost of a much larger institution – one that cannot possibly have the deep roots in the community that the mutual bank had.
What about the short-term business case for a mutual-to-stock conversion? We have already established that conversion is tantamount to selling the institution and assuring its demise. Even if a converted bank were to survive – meaning its franchise is not attractive enough to garner the interest of a strategic buyer – it faces incredible challenges.
First, capital that was once free must now be paid for. On average, stock banks pay about one-third of their net income out as dividends or stock repurchases. As a result, capital grows more slowly. By contrast, a mutual bank like Eastern Bank can make large cash purchases for stock banks and simply regenerate the capital used with earnings in a year or two.
Second, it is extremely difficult for a converted mutual bank to effectively deploy the large amount of capital raised. It is not easy – and certainly not a good idea – to double the size of your loan portfolio overnight. This can be a systemic issue, too. Life is more difficult for mutual banks that are forced to compete for loans with banks that have just raised capital and feel the need to lend it out quickly with overly aggressive pricing.
The need to pay for capital, and the inability to prudently deploy capital raised, result in converted mutual banks employing their unique “sell low-buy high” strategy with stock repurchases. Often, within a year or two of conversion, these banks buy back stock that they sold for $10 per share at a price well above that. I am aware of no other industry in which a company starts buying back its stock within a year of an initial public offering. With most IPOs, the issuer is looking to sell more shares into the market while pricing is attractive.
And then there are compliance costs and shareholders. Most mutual bankers rightly believe that they already have enough regulation and compliance obligations. Few are anxious to add to that. But mutual banks that convert add to their own regulatory burden, taking on serious compliance obligations under securities laws, including detailed disclosures and periodic filings. For good measure, there is the significant potential liability that comes with compliance missteps. What do you get for this aggravation? The privilege of making money for activist shareholders and institutional investors that purchased your stock for the sole reason of profiting from the bump that comes when you sell the bank. And if you don’t sell the bank when these investors want you to, they will have you reaching for the Advil a few times each day.
Given that mutual-to-stock conversion appears to be such a dubious business proposition, we are left with the question: Why would any board of directors seriously consider it? The benefits and value of such a decision based on employment contracts with takeover provisions, various stock awards and/or options granted are realized to the greatest extent if the bank is sold. So maybe one can make sense of conversions after all …
Charles Simpson is chairman of the board of directors of Holbrook Cooperative Bank.
