Partial Conversions

By: Chuck Hughes

The following is an excerpt taken from Chuck Hughes' Sure Thing Profit Secrets

Banks can do a full conversion and sell 100% of the available shares to its depositors, however, there is a second type of conversion known as a ‘partial conversion’. Some mutual banks form what is known as a ‘Mutual Holding Company’ (MHC). Banks with a mutual holding company structure own the majority of shares (greater than 50%) of stock in the subsidiary bank. When a Mutual Holding Company converts stock ownership it sells a minority (less than 50%) of the available shares to its depositors in a partial conversion. Minority shares that are sold to depositors are publicly traded on the NYSE or NASDAQ stock exchanges.

For example, TFS Financial Corporation operates as the holding company for Third Federal Savings Bank. The TFS Financial holding company retains 74% of the outstanding shares of Investors Savings Bank. Third Federal Savings Bank conducted a partial conversion and sold 25% of the outstanding shares to depositors of the Third Federal Savings Bank. The shares are traded on the NASDAQ under the symbol TFSL. I had a savings account at Third Federal Savings Bank and was able to purchase shares in the partial conversion.

The Mutual Holding Company structure has become more and more popular and now accounts for the majority of the conversions.

The Net Worth of the Bank Can Double Overnight

Investors Bancorp is still a Mutual Holding Company. Many MHCs decide at a later date to sell the shares held within the holding company in what is called a ‘second stage offering’. In a second stage offering the majority of the shares held within the MHC are sold to depositors in a ‘second step’ IPO.

When this occurs the existing minority shareholders almost always receive a substantial price appreciation in the price of the minority stock. This price appreciation occurs as a result of the increase in net worth of the bank that can double or even triple on the day of a second stage offering is completed. The net worth increases as the cash received from the sale of the majority shares is added to the bank’s treasury.

MHC second stage offerings are not the same type of offerings that result when a public company authorizes an increase in the number of its outstanding shares and then completes a secondary offering during which additional shares of stock are sold. This results in a dilution of shareholder’s equity. The MHC second stage offerings are accretive to shareholder equity as cash is received for the sale of the majority shares in a second step IPO but the total number of outstanding shares is not increased.

During a MHC second stage offering minority shareholders normally receive two to four shares of the new stock issue for each minority share owned in order to maintain their original percentage of ownership. ‘Second stage’ offerings increase the capital base of the bank which allows the bank to increase its loan portfolio which in turn can increase the earnings potential of the bank.

90% Return with Low Risk

For example, in my son Ryan’s education account, I purchased 500 shares of Bank Mutual Corporation the Mutual Holding Company for Mutual Savings Bank at $23.50 per share for a total investment of $11,750.

Bank Mutual MHC subsequently conducted a second stage offering and sold the majority shares held by the holding company to depositors at the bank. As minority shareholders, we received 3.668 shares of the new Bank Mutual stock for each minority share we owned so now we own 1,834 shares of Bank Mutual. The price of Bank Mutual at that time was 12.20. Our 1,834 shares are now worth $22,374 which translates to a $10,624 profit and 90% return.

The 90% return demonstrates the powerful profit potential of investing in the minority stock of Mutual Holding Company and the proceeds from selling this stock may even cover one year of college expenses for Ryan!

MHC Strategy

It is not possible to predict when a Mutual Holding Company will conduct a second stage offering and sell the remainder of the majority stock held within the holding company.

Once a MHC announces a second stage conversion, there is usually a substantial price increase in the minority stock and it is generally too late to purchase the minority stock before the price increase. Therefore, the best approach for MHC investing is to purchase minority stock in as many Mutual Holding Companies as you can and hold this stock in your trading account.

Purchasing the minority stock of a MHC allows anyone with a stock trading account to participate in the profit potential available from a MHC second stage offering without having a savings account at the MHC bank.

If the MHC does a second stage conversion, owning the minority stock can result in a substantial price increase in the existing minority stock when a second stage conversion is announced. As previously mentioned, this increase in stock price is normally due to the potential of the net worth of the bank doubling or tripling overnight on the day when a second stage offering is completed.

For example, if TFS Financial does a second stage offering, the proceeds from the sale of the 74% of the outstanding shares held within the MHC would dramatically increase the net worth of the bank.

SNL Securities in Charlottesville, VA www.SNL.com maintains a comprehensive data base of mutual savings banks and Mutual Holding Companies. SNL Securities publishes the SNL Conversion Watch and the SNL Thrift Investor Monthly. These publications keep you up to date on mutual savings bank and Mutual Holding Company conversions.

The list of MHC Banks reveals the MHC banks that have minority stock that is traded on US stock exchanges but have not yet completed a second stage offering. Simply purchasing and holding the stocks on this list has resulted in a good return in my trading accounts over time.