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Mutual bank conversions ebb, but still offer big upside
August 7, 2013 / 3:32 PM / 4 years ago

Mutual bank conversions ebb, but still offer big upside

BOSTON (Reuters) - Parking your money at a mutual bank before it goes public is the best way to pull off a heist with no threat of jail time.

For years, mom-and-pop depositors have made a lot of easy money when their local mutual bank converted to a stock-owned bank. That’s because they typically get their shares at a steep discount to the bank’s book value.

The number of mutual banks ripe for conversion is less than in recent years, when banks converted at a rate of about 17 a year, according to some experts.

“It’s going to become an increasingly rare event,” said Kenneth Ehrlich, a Boston lawyer who co-chairs the banking and financial services group at Nutter McClennen & Fish.

But investors still can find profitable deals in the banks that will convert, in almost 20 others that are already in the midst of multi-step conversions, and in some 17 others that offer the prospect of post-conversion buyout deals.

There are about 500 mutual banks in the United States, with most of them located in the Northeast. They’re a holdover from a bygone era when wealthy industrialists set up banks for their workers. Mutual banks don’t have direct owners, but are structured more like membership organizations in which depositors have an interest in an institution’s net worth.

Since 2010, there have been about 50 mutual bank conversions nationwide. Not every mutual will convert - some managers are philosophically opposed to conversion because it doesn’t fit their organizing member-style concept.

Mutual-to-stock conversions can be attractive because depositors get first crack at any stock offering, usually for a price at 50 percent to 60 percent of book value (assets minus liabilities), according to Trent Feldman, president of Feldman Financial Advisors Inc, a consultant on a number of deals.

To get in on the ground floor of a conversion is simple. For as little as $50 on deposit, you can subscribe to a mutual bank’s stock offering. An investor with a single deposit account may buy up to $150,000 worth of stock, depending on demand.

Your best bet is to find a local mutual bank that has not changed its bylaws to make a conversion more difficult. Hedge funds have been known to spread their money across a number of mutuals ripe for conversion. However, banks can refuse deposits from out of towners, reserving the profit potential of any conversion for their local customers.

The ground floor approach isn’t the only way to make hay, though. Some mutuals convert in steps. They’ll sell a minority stake to the public and then later do a so-called second step offering.

Second-step offerings can be attractive, as they typically offer shares below book value, too. Banks may offer the shares to depositors through a subscription offering. Any remaining shares can be offered to the public.

“You can still do well,” said Frank Schiraldi, a managing director at investment bank Sandler O‘Neill + Partners. Investments in mutuals before their second-step conversions have outperformed the Nasdaq Bank Index, on average, by 72 percent over a 5-year period, he said.

There are nearly 20 mutuals that have yet to announce a second-step offering, including Boston’s Meridian Interstate Bancorp Inc, New Jersey’s Kearny Financial Corp and Lake Shore Bancorp Inc in Dunkirk, New York.

In a research note, Sandler O‘Neill analysts suggested last fall that investors who are willing to invest in small bank stocks, which aren’t as liquid as big bank shares, could assemble their own portfolios of mutual banks that have done only one-step conversions.

Shares of partially converted mutuals can be purchased on the open market like any other stock. Investors should hunt for shares trading below book value and target banks with good growth and clean loan portfolios.

What’s more, a fully converted mutual bank can sell itself to a larger acquiring bank once it has gone three years past its conversion. That gives investors/depositors another chance to reap more gains from any merger-and-acquisition premium.

Peoples Federal Bancshares Inc, a small Boston bank with $575 million in assets, converted to a stock bank in July 2010 at two-thirds of its book value. Depositors got their shares for $10 each and without paying a commission to a brokerage.

The bank’s stock is up 86 percent since the offering, easily beating the 66 percent rise on the S&P 500 Index during that period. Peoples Federal is a fresh potential takeover target because its moratorium expired July 7.

Takeovers aren’t a pipe dream either. About one-third of all converted mutual banks wind up in the arms of a larger bank, according to Sandler O‘Neill + Partners.

The average time before an M&A deal is announced is almost two years after the 3-year post-conversion moratorium expires. But it can happen a lot faster. People’s United Financial Inc struck a deal to acquire Boston-area Danvers Bancorp in January 2011, just 10 days after the three-year anniversary, offering 160 percent of book value.

Sandler O‘Neill and SNL Financial recently identified 17 converted banks that will reach their three-year anniversary by the end of this year. One, Simplicity Bancorp, whose stock is trading at less than 90 percent of book value, marks its three-year conversion anniversary in November. The bank is small, with a market capitalization of $124 million.

Editing by Linda Stern; Desking by Bernadette Baum

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