The performance figures presented in this article demonstrate that investing in mutual banks that convert to stock ownership can be very lucrative even if you invest after the Initial Public Offering. Listed below are some of the reasons why this type of investing has been so profitable and has provided such consistent returns:
Mutual savings bank conversion stock is usually priced at lower price-to-earnings and lower price-to-book multiples compared to most other stocks.
'Interesting Phenomenon' of the net worth of the converting bank normally doubling on the IPO date. This increase in net worth allows the bank to increase its loan portfolio and profitability.
Normally converting banks have lots of extra cash available and start paying a dividend within a few months of the conversion.
With this extra cash many converting banks also start stock 'buy back' programs, which reduce the number of shares outstanding.
Converting banks are classified as small cap value stocks.
Many converting savings banks have 100 years or more of profitable operations and possess valuable banking franchises in their marketing area.
The current consolidation in the banking industry favors small banks, which are increasingly being purchased by larger banks wanting a 'footprint' in the local area obtaining approvals and constructing a new bank is very expensive and time consuming. Purchasing an existing franchise of local mutual savings banks is a much more cost effective way for a large bank to expand.
The stock of many newly converted mutual banks is included in small cap stock indexes such as the Russell 2000 Index. Inclusion in a major stock index normally causes a stock's price to increase due to the fact that index funds have to purchase the stock in order to track their target index.
Mutual savings banks have no overseas operations, no foreign exposure and no currency risk.
The investment portfolio of mutual savings banks consists primarily of residential mortgages and U.S. Treasury Obligations. This type of portfolio produces more consistent returns and is relatively a lower risk compared to the average portfolio of a commercial bank. The percentage of non-performing loans is lower with a residential mortgage portfolio than with a typical commercial loan portfolio.
How to Analyze a Bank that is Converting to Stock Ownership
If you elect to participate in a mutual savings bank conversion, it is important to evaluate the financial history of the bank before you decide whether to order stock. Once in a while, I come across a bank with weak financials that intends to convert. Each conversion package you receive in the mail contains a stock order form and Subscription Offering or prospectus. The "pro forma" sections of the prospectus will contain the necessary information you need to evaluate the general financial condition of the bank. Listed below is a checklist of financial data that I use to evaluate a bank's financial strength. I used actual data excerpted from the prospectus of American Financial Holding (AMFH), which is the current name for the American Savings Bank of New Britain. Connecticut. American Savings was founded in 1863 and converted to stock ownership in November of 1999. It had $1.6 billion in assets and $286 million in accumulated earnings or equity.
According to the prospectus, American Financial offered a minimum of 26,732,500 shares and a maximum of 36,167,500 shares in its Subscription Offering. There were 28,771,000 shares actually sold which was close to the minimum number required in order to complete the conversion. Investors who did not have an account at the bank were able to purchase shares in the Community Offering. Individuals could purchase up to $500,000 worth of stock.
Minimum
Maximum
Number of Shares
26,732,500
36,167,500
Gross Offering Proceeds
$267,325,000
$361,675,000
Estimated Underwriting Commissions and Other Offering Expenses
$5,905,000
$7,069,000
Estimated Net Proceeds
$261,420,000
$354,606,000
Estimated Net Proceeds per Share
$9.78
$9.80
Equity-to-Assets Ratio ("E/A")
The E/A is probably the most important measure of a bank's financial strength and survivability. The higher the E/A is the better. The more equity a bank has, the more money it can lend. I normally look for a minimum E/A of 4 to 5% before the conversion. If a bank plans to convert and has an E/A of 4%, it will normally wind up with an E/A of about 8% after the conversion due to the sale of the stock, which increases the equity. An 8% E/A is good and exceeds the average E/A ratio of most regional and money center commercial banks. An E/A ratio of 8% or higher not only provides disaster protection, but also makes for an attractive takeover candidate. This excess equity gives a bank more lending capacity that a larger bank may want to utilize.
You can see from the prospectus above that American Financial had $286,028,000 in equity (accumulated earnings) before its conversion. Based on selling the minimum number of shares (26,732,500) its equity would increase to $520,288,000. It actually sold 28,771,000 shares, which was slightly more than the minimum. After the conversion American Financial would be a very attractive takeover candidate. A larger bank could increase its presence in Connecticut and also increase its lending capacity by acquiring a bank with such a rich E/A ratio. As noted earlier, most mutual banks that are taken over are purchased at a very rich premium to the current price.
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