Mutual-to-Stock Conversions by New England Savings Banks: Where Has All the Money Gone?

Article excerpt

In the aftermath of the real state slump and the attendant financial troubles of the New England banks, it is natural to look for causes and contributing factors. One phenomenon that has received its share of the blame is the rush of conversions by thrifts in the mid 1980s from mutual to stock form of ownership.

Conversions were hailed initially as a way to fortify the eroded capital of thrifts and increase their safety and soundness. At the same time, conversions coincided with deregulation and the granting of new lending powers to thrifts. Foremost among these was the authority to make commercial and industrial loans, commercial real estate loans, and construction loans. A number of converted thrifts hastily invested their capital in real estate projects, many of them ill-conceived.

This article compares the behavior of converted thrifts with that of the mutuals. It finds that converted institutions took greater risks, suffered bigger losses, and failed at a higher rate than he mutuals despite being very highly capitalized after conversion. Three conclusions are reached. First, converted thrifts accounted for a substantial share of the increase in real estate financing during the boom of the mid 1980s. Second, ability to take greater risk, rather than efficiency, appears to have been a dominant motive for thrift conversions in New England. And third, even very high capital ratios may not prove sufficient if an institution takes big risks in its loan portfolio.

Part I of this article provides an overview of the mutual to stock conversion process. Part II describes the sample of thrifts under analysis and presents the empirical results. Part III analyzes management incentives. Part IV concludes with the implications for regulatory reforms.

I. The Conversion Process

Mutual thrifts are owned by their depositors. A conversion involves an issuance of stock to the public, which changes ownership from depositors to equity holders. (See Dunham (1985) for a historical overview and a step-by-step description of the conversion process.) Theoretically, depositors own the accumulated retained earnings of the mutual thrifts. To protect their ownership rights during conversion, the depositors are given nontransferable rights of first refusal to buy shares during the stock offering. They can buy stock in proportion to the size of their deposits (as of 90 days before the conversion plan is adopted by the thrift), as long as each depositor's share does not exceed 5 percent of the total offering. Management and directors who have deposits at the thrift can buy.stock along with other depositors, subject to somewhat more stringent limits on their aggregate purchases. If any stock is left unsubscribed it is offered to managers and employees and marketed to the local community. Large stock offerings are sold by underwriters to the general public. The conversion process is completed only when all the shares are sold.

Reason for Conversion

Economic efficiency is often suggested as a reason for conversion (Masulis 1987; Mester 1991). Since the separation of ownership from control is greater in the mutual than in the stock form of organization, managers of mutual thrifts are more likely to pursue their own goals at the expense of depositors. Masulis suggests that managers of mutual thrifts will choose less profitable but lower-risk investment projects over more profitable but riskier investments. If mutual thrifts are subject to greater organizational inefficiency than stock thrifts, then conversion to stock form will improve efficiency, by aligning managerial incentives more closely with those of the stockholders. This will lead converted thrifts to invest in more profitable but riskier projects.

II. Performance of Converted Thrifts in

New England

In New England, the majority of thrift conversions from the mutual to the stock form occurred since 1983. …