Two Massachusetts banks hope to preserve their mutual status for years to come by merging their holding companies now, in an example of how M&A tends to be a different story for mutual institutions.
Newburyport Five Cents Bancorp and Pentucket Bank Holdings recently received board approval to merge into a single holding company. The combined organization, with $2.5 billion in assets, will likely get a new name, Newburyport CEO Lloyd Hamm told a local news outlet. Meanwhile, $1.5 billion Newburyport Five Cents Savings Bank and $947 million Pentucket Bank will maintain their separate brands.
“We definitely want to emphasize it’s not a merger of the banks, and we will likely select a new name for the co-branded holding company,” Hamm told The Daily News in Newburyport. The new organization also plans to change its bylaws in order to make it more difficult for a future leadership team to take the company public. “This is ensuring mutuality for decades to come,” Hamm said.
All employees of the two banks will keep their jobs, and executives intend to invest more in technology, training and talent, and increase charitable giving under the combined holding company. No branch closures are planned as part of the deal.
According to data from S&P Global Market Intelligence, there have been just three combinations of mutual banks in the past five years, including the deal between Newburyport Bank and Pentucket Bank, which was announced in December 2022.
The dearth of mutual bank M&A essentially comes down to numbers: The U.S. had just 449 mutual institutions at the end of 2021, according to the Federal Deposit Insurance Corp., out of 4,839 total banks. In some respects, mutual banks may more closely resemble credit unions than public or privately held banks, though credit unions have been more actively acquiring FDIC-insured institutions, accounting for 56 deals over the past five years. Mutual banks have no shareholders and are effectively owned by their depositors. Any profits they generate are returned to their depositors in some fashion, for example, in the form of lower rates on mortgages. Last year, the FDIC approved the first de novo mutual bank to launch in over 50 years, Walden Mutual in Concord, New Hampshire.
Because mutual banks don’t have shareholders, they don’t need to always focus on the next, most profitable move, says Stan Ragalevsky, who has worked extensively with mutual banks as a partner with K&L Gates in Boston.
“If you’ve been sitting on the board of a small [mutual] bank, you realize there’s a lot of changes going on in banking, but you also think ‘We’re making money. We may not be making 80 basis points, but we’re making 45 basis points,’” Ragalevsky says. “They feel comfortable that they’re doing the right thing.”
Some of those sentiments showed up in Bank Director’s 2023 Bank M&A Survey: 77% of mutual bank executives and directors participating in the survey say they’re open to M&A but focus primarily on organic growth. Just 12% want to be active acquirers, compared to 23% of all respondents.
Furthermore, all of the 20 mutual participants say their bank’s board and management would not be interested in selling within the next five years, compared to 52% overall. When asked why they were unlikely to sell, many refer back to their institution’s mutual status and a wish to maintain an independent banking option in their communities.
Compared with deals involving publicly held banks, mutual bank deals also tend to be driven by the board more than the management, Ragalevsky adds. While board members may be motivated to some degree by personal self interest — retaining a board seat, for example — “there’s also a sense of commitment to the community,” he says.
Additionally, many prospective mutual bank sellers may be constrained by a lack of like-minded buyers. This very reason is partly why $1.4 billion Cooperative Bank of Cape Cod, based in Hyannis, Massachusetts, is unlikely to sell anytime soon, says CEO and Chair Lisa Oliver.
“We don’t sell, because there’s nobody to buy [us]. We’re owned by our depositors in a non-stock kind of way. If anything, it would be a merger for lack of succession planning, if that were really critical,” Oliver says. “But there are plenty of potential candidates that can be hired to become CEOs of a small bank.”
Some also argue that mutuals’ independent streak is, to some degree, woven into their history. Many mutual banks, particularly in the Northeast, trace their roots back over 100 years, when they were initially founded to provide banking services for poor and working class families.
“The mutual bank movement has been one of the greatest, most successful social and business experiments,” Ragalevsky says. “Mutual banks were formed to improve people’s lives — they weren’t formed to make money. They were formed to improve people’s lives, and they’ve done that.”
Privately held banks, including Subchapter S banks as well as mutuals, are no different than publicly traded banks in their efforts to provide meaningful compensation plans for their key officers. Privately held banks must compete with public banks when attracting and retaining key officers and producers.
Publicly held banks typically offer restricted stock or incentive stock options to key employees. This is much more difficult for privately held banks due to a lack of available shares or illiquidity of the stock. Therefore, privately owned banks competing for talent often require more creativity.
While some privately held banks offer stock options, restricted stock or restricted stock units (RSUs), these types of plans are uncommon. Rather, privately held banks that want to provide rights of ownership to executives often use synthetic equity such as Phantom Stock Plans (PSPs) and Stock Appreciation Rights (SAR) plans. While these plans have an earnings impact to the bank, they do not have a per-share dilution as no actual shares are issued.
Competition for top talent is strong. Assuming the bank offers a competitive salary and an annual incentive plan, the challenge is the ability to offer a long-term incentive/retirement plan. The following types of plans are often used to attract and retain key executives and include:
Supplemental executive retirement plans (SERP) can be designed to address an executive’s shortfall that would result if the executive only had social security and the bank’s qualified plan to provide retirement income. Generally, under the terms of a SERP, an institution will promise to pay a future retirement benefit to an executive separate from any company-sponsored qualified retirement plan. The benefit is typically expressed as a fixed annual dollar amount or as a percentage of final compensation.
Deferred compensation plans (DCP) allow the bank to make contributions to the executive’s account using a fixed dollar amount, fixed percentage of the executive’s compensation, or a variable amount using a performance-based methodology. The DCP can also allow the executive to defer his or her current compensation.
Split dollar plans allow the bank and the insured executive to share the benefits of a specific BOLI (Bank-Owned Life Insurance) policy or policies upon the death of the insured. The agreement may state that the benefit terminates at separation from service or it may allow the executive to retain the life insurance benefit after retirement if certain vesting requirements are met.
Survivor-income plans/death benefit-only plans specify that the bank will pay a benefit to the executive’s survivors (beneficiaries) upon his or her death. The benefit may be paid in a lump sum or in annual payments over a specified time period. Typically, the bank will purchase BOLI to provide death proceeds to the bank as a hedge against the obligation the bank has to the beneficiaries. The benefits are paid directly from the general assets of the bank.
Picking the right plan design is only part of the process. Striking the proper balance between making the plan attractive to executives but not excessively expensive to the company are also significant factors when designing the benefit plan. Nonqualified plans can be customized to each executive, avoiding a cookie cutter approach by allowing flexibility in the amount of the benefit, vesting schedule, non-compete provisions, timing of payments and duration of payments. For example, assume you provide a substantial retirement benefit to a 40-year-old executive, but provide no vesting until age 65. The executive will likely not see it as a valuable benefit since most 40-year-olds think they will retire long before age 65. Likewise, if the executive is fully vested at age 55, the executive may not be motivated to stay past that age.
The plan must also provide a fair benefit upon death, disability and change in control. The payment terms can be customized to fit the needs of the executive while remaining in compliance with IRC Section 409A of the tax code. A properly designed nonqualified plan can enhance the bank’s bottom line by attracting and retaining top talent, but doing so in a way that is cost-efficient to the bank.
With over 30 years of history, BOLI has proven to be an effective tool to help offset and recover benefit expenses. While many public banks purchase BOLI to recover the cost of general benefit liabilities only, many privately held banks purchase BOLI for the same reason, but also include recovering the cost of nonqualified plans. BOLI is a tax-advantaged asset whereby every $1 of premium equates to $1 of cash surrender value (CSV) on the bank’s balance sheet. The CSV is expected to grow every month and earnings are booked as non-interest income on a tax preferred basis. From a cash flow perspective, BOLI is a long-term accrual asset that will return cash flow to the bank upon the death of the respective insured(s). BOLI is an investment asset that currently generates a return in the range of 2.50 percent to 3.50 percent after all expenses are deducted, which translates into a tax equivalent yield of 4.03 percent to 5.65 percent (assuming a 38 percent tax bracket).
Summary Privately held banks must compete with all types of organizations for talent. Their future is dependent on their level of success in attracting and retaining key executives. The use of nonqualified plans, when properly chosen and correctly designed, can make a major impact on enhancing long-term shareholder value.
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Mutual savings banks have had a tough time the last several decades. Their ranks have been reduced by roughly one-third during the last 10 years, mostly due to stock conversions or failures. What got started as a philanthropic endeavor in the early part of the 19th century and grew to considerable prominence in the banking industry, mutual savings banks now are fewer in number, have multiple challenges and are little understood. But they also have advantages that continue to draw proponents to this day.
Mutuals do not have stock holders. Instead, the owners of the mutual are its depositors. Because of limitations of the mutual charter, mutuals can do little to raise capital, aside from generating earnings or converting from a mutual into a stock corporation. This can put them in a precarious situation, but it also means they tend to be better capitalized, more conservative and with better asset quality than other banks and thrifts because they are extra careful to protect capital. Just like stock-based thrifts, mutual thrifts have loan portfolios with heavy concentrations in residential one-to-four family mortgages. Federally charted mutual banks are regulated by the Office of the Comptroller of the Currency (OCC) and mutual holding companies are regulated by the Federal Reserve Board, after the Dodd-Frank Act disbanded their previous regulator, the Office of Thrift Supervision, in 2011. Mutuals that are state chartered have the OCC as their secondary regulator.
There are fewer than 500 mutual banks left today, many of them in New England, and in particular, Massachusetts, which has a total of 46, according to industry consultant RP Financial in Arlington, Virginia. Mutuals have deep historic roots in New England, which explains why the region has such a high concentration. During the early 1800s, philanthropists started mutuals by donating the capital and appointing themselves trustees of the organization to help the working class become savers at a time when commercial banks had little interest in them. Mutuals were extremely popular throughout much of their history. The average mutual had $3.7 million in assets in 1900, compared to $700,000 for the average commercial bank at that time, according to the Federal Deposit Insurance Corp. (FDIC). Today, about 90 percent of mutual banks have assets of less than $500 million.
Many mutuals failed in the 1980s as interest rates rose, and they struggled to compete for depositors while contending with a lot of fixed-rate assets on their balance sheets. A law meant to strengthen the banking industry, the Financial Institutions Reform, Recovery and Enforcement Act of 1989, eliminated certain forms of regulatory capital that had benefited mutuals. As a result, even more mutuals disappeared in the 1990s.
Regulators have struggled with what to do with a mutual bank that needs capital and doesn’t have the earnings growth to get stronger.
Capital and Regulatory Issues Mutuals have the same regulatory capital requirements as banks and other thrifts. To raise capital, they can use unique forms such as pledge deposits, but these are not FDIC-insured and depositors can’t make a withdrawal without regulatory approval, so this form of capital is rarely used.
Mutuals can also raise capital through stock conversions, but that essentially converts a mutual into a stock company. Some mutuals have converted in stages, with a first step conversion selling less than half the subsidiary bank’s stock to the public and retaining the rest in the mutual holding company. The second step can fully convert the mutual holding company down the road. This lets the mutual raise capital in stages while maintaining majority control. Investors Bancorp., the holding company for New Jersey-based Investors Bank, did so this year, raising $2.2 billion in a second-step stock offering. Hudson City Bancorp, one of the largest mutuals, did so in 2005 and raised $3.93 billion.
Because of the lack of stock, mutuals tend to be highly capitalized and are not so interested in risky investments or risky growth. The average mutual in the $250-million to $750-million asset range had a Tier 1 leverage ratio of 11 percent as of December, 2013, compared to 9.8 percent for other institutions in that size range, according to an analysis by RP Financial.
As a result of capital constraints, the OCC considers capital planning “critical” for mutuals, as described in an OCC bulletin from July 2014. To do so, the board needs to stress profitability and moderate the company’s growth so it doesn’t outgrow its capital base, says Ron Riggins, president and managing director of RP Financial. From a risk management perspective, mutuals need to position the balance sheet with lower risk than competitors might typically take on. For instance, mutuals tend not to do much in the way of consumer or commercial lending, which can be higher risk, and they purchase more government-issued securities than their non-mutual competitors.
Because of the lower risk profile, mutuals tend to have slightly better asset quality than other types of banks and thrifts. The average non-performing asset ratio for mutuals in the $250 million to $750 million assets range was 1.4 percent, compared to 1.5 percent for all non-mutuals.
The conservative nature of mutuals and the higher cost of regulation given their small size tends to make them less profitable than other institutions. The average return on average assets was .5 percent for mutuals above $250 million in assets and .9 percent for similar sized non-mutuals and commercial banks as of December 2013.
The OCC has spent the last couple of years trying to better understand the traits of mutuals and how to regulate them effectively. Mutuals have been lobbying to be compared only with other mutuals, which has been proposed by Comptroller Tom Curry. Exceptions occur when there are no similar mutuals for comparison, as when the mutual is very large. In such instances, examiners will make adjustments. For example, when comparing net income between a stock bank and a mutual, the OCC will subtract dividends of stock banks to make a better comparison with the net income of mutuals.
“I think the OCC has worked really hard to understand our cultures better,’’ says Paul Mackin, the president and chief executive officer of $1.5-billion asset Think Mutual Bank in Rochester, Minn. Mackin is on the OCC’s advisory committee for mutuals. “Most [mutuals] would say the examination process today has advanced because of that work and the work they continue to do.”
Early on during the transition from the OTS, mutuals had to learn that exams would be tougher and the OCC had a different way of looking at risk, which was much more forward focused, he says.
Riggins says there was little change for mutuals that were state chartered, but for those with federal charters, the OCC had a different view of the adequacy of loan loss provisions and the sufficiency of capital to manage risk than the OTS did.
Mergers and Acquisitions The unique structure of a mutual also leads to challenges in mergers and acquisitions. There is no stock to exchange, unless the mutual institution has at least gone through a first stage conversion. This is an expensive and time consuming proposition. Mackin doesn’t see M&A as much of an obstacle for a well capitalized mutual, which in most cases can afford to pay cash. For mutuals wary of paying cash, an alternative strategy could be a merger of equals. Since no premiums are paid, management of the target can be rewarded with enough compensation to attract a merger partner, Riggins says.
Growth through acquisitions might benefit a mutual in terms of dealing with increased regulatory costs, the increased costs of technology and cybersecurity, as well as the need to compete with growing credit unions and other banks.
Compensation and Working for a Mutual Like other non-stock companies, mutuals can’t pay employees or executives in stock, but Mackin hasn’t found that to be much of an issue for his employees. He finds he can attract employees from the bigger banks because his bank focuses on customer needs instead of investors’ needs. The web site for the mutual declares: “We believe fair prices are more important than increased profits.”
“As an industry, we lost a lot of trust with customers because of what happen in late 2000s,’’ Mackin says. “I think [Think Mutual has] really strong brand appeal because we are owned by our customers. In this day and age, when banks are not as widely trusted as they once were, we have a strong appeal to the marketplace.”
That brand promise is a powerful recruitment and retention tool. Mutuals tend to have less of a focus on short-term profitability than publicly traded banks, and might win over employees who are interested in institutions that can make long-term investments and provide job stability because of reduced earnings pressure. Think Mutual does not offer cash bonuses or a stock incentive plan but does pay higher salaries than banks that do, Mackin says. He believes this is consistent with the mutual’s customer-ownership culture.
“Paying higher salaries means we expect top performance from every employee and our managers have to be very active coaches,’’ he says. “Still, earnings remain important to build longer term capabilities and we do offer profit sharing to all employees when we exceed our net profit goals.” The plan pays out a percentage of their salaries based on the company’s level of excess earnings and is distributed shortly after fiscal year end.
Governance Issues Being owned by depositor-members who don’t own stock also brings up its own governance issues. Members have many rights, for example, the right to vote on board members, inspect corporate records, amend the charter and request special meetings, but in practice many give voting rights by proxy to the board or a special committee of the board. Getting a quorum is always an issue at an annual meeting to re-elect directors, so in some cases as little as one member is needed to make quorum, and there is no requirement to mail out proxies to member homes in advance of the meeting. The bylaws of the mutual will dictate rules and procedures, and will be governed by state law or by the OCC’s rules. Regulators understand that in effect, mutuals have a tough time getting participation from depositors when those depositors may feel like they have no financial stake in the vote.
The special governance structure could lead to weaker governance practices, such as a lack of accountability to depositor-members on the part of the board. Mackin suggests that every mutual should develop its own corporate governance policies for directors, expectations for the board and a rigorous evaluation process. At Think Mutual, directors are individually evaluated every other year. The board then assesses its overall performance during the off-years. The individual assessment calls for each director to complete a self-evaluation and do the same for the other directors. The executive management team also participates in the process. The process is complete once the chairman and vice-chairman of the board have met with each director about their performance and that includes recommending continuing education as needed.
Think Mutual also addresses board tenure with age limits and mandatory resignations. The age limit is 72 years old. Also, directors must submit their resignation letter should a material career change occur, including retirement. This provides the board with a decision point so it can evaluate if the director will have the same capacity to perform their duties, says Mackin.
Conclusion With the loss of mutual banks in this country, it could easily seem as if they were becoming a poorly understood minority in the financial marketplace. “They don’t have the lobbying power they once had,’’ Riggins says.
In an age where credit unions are growing in size and mutual banks are declining in number, who will advocate for their health, and role in society? Who will make sure their voice is heard at the regulatory table, and that they don’t go the way of the passenger pigeon?
Mutuals tend to attract impassioned advocates, and their survival may hinge on the strength of those passionate managers and board members who cleave to the form.
Privately held banks, including Subchapter S banks as well as mutuals, are no different than publicly traded banks in their efforts to provide meaningful compensation plans for their key officers. Privately held banks must compete with public banks when attracting and retaining key officers and producers.
Mutual savings banks have had a tough time the last several decades. Their ranks have been reduced by roughly one-third during the last 10 years, mostly due to stock conversions or failures. What got started as a philanthropic endeavor in the early part of the 19th century and grew to considerable prominence in the banking industry, mutual savings banks now are fewer in number, have multiple challenges and are little understood. But they also have advantages that continue to draw proponents to this day.