Download Demutualization Risks and Credit Unions

Demutualisation Risks and Credit Unions
Kevin Davis
Commonwealth Bank Chair of Finance
University of Melbourne
and
Chairperson, Melbourne University Credit Union
Demutualisation – A common theme
 Irish Nationwide Building Society (INBS)
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April 2003 AGM stoush
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a litany of cases illustrating how woefully inadequate
accountability remains in the financial services
industry
“new legislation is expected later this year that will
facilitate building societies in giving up their mutual
status, enabling them to be taken over immediately.
Currently, a society that ends its mutual status must
remain independent for five years thereafter.” The
POST.IE Tues, April 29, 2003
“Riches even beyond those he [the CEO] currently
enjoys await. However, the interests of members who
own institutions like Irish Nationwide appear to rate a
dismal and distant second.”
Demutualisation – A common theme
 Standard Life (UK Insurer)
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 “Standard Life gets tough with carpetbaggers”
 The Guardian March 28, 2002
Increase number of member signatures required to call a
special general meeting from 50 to 1000.
The number of members required to nominate a director
will also rise sharply to 250 from the previous level of just
two.
Standard Life says the increase will "provide a balance
between democracy - calling a meeting for good reasons and the potential for a small group of members to cause
the company to incur significant costs". A demutualisation
bid two years ago, only narrowly defeated, resulted in
costs for the insurer of nearly £11m.
Demutualisation – A common theme
 National Mutual (UK Pensions Firm)
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 The Guardian, Saturday March 17, 2001
105-year-old pensions company
 one of the last bastions of mutuality in the insurance
world
set to ditch its member-owned status after announcing it
is putting itself up for sale.
250,000 policyholders, 150,000 of whom hold with-profits
policies
only this latter group would receive windfalls
observers have claimed payouts could average £3,000plus.
National Mutual … is talking to potential buyers as part of
a review of its mutual status.
Demutualisation – A common theme
 IOOF Friendly Society (Australia)
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October 17, 2001announcement of demutualisation plan
“a logical progression for the financial services group and
its members. A demutualisation will allow for the reserves
to be distributed to members in the form of shares and
also provide access to capital to support our growth
plans.”
“although the existing mutual structure of IOOF had
served the group well, IOOF is now beginning a new phase
of its corporate lifecycle.”
70,000 members.
Fixed entitlement of 140 shares plus additional variable
allocation of shares according to a formula based on the
type, number, size and duration of policies held.
likely market price of a share would be between $2.70 and
$3.15.
Demutualisation – A common theme
 Principal Mutual Holding Company (US
Insurance Company)
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“Demutualization will help us leverage our strength and
leadership in a rapidly changing financial services
industry. Demutualization provides us with the capital
structure needed to pursue growth through strategic
acquisitions, to develop new products and services and to
invest in technology. We believe that pursuing these
strategic opportunities will strengthen our leadership
position, provide additional security for customers and be
in the best interests of our policyholders.”
eligible policyholders allocated at least 100 shares
IPO (2001) took place at USD 18.50 per share
Demutualisation and Credit Unions
A coming theme?

Australia
 Sunstate – 1997
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City Coast – Australian National Merger 2003
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demutualisation via merger with First Provincial
Building Society
Attempted intrusion by Illawarra Mutual
Building Society
Canada
 Surrey Metro – 1999
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Had non - voting traded shares
Members rejected sale to Canada Trust
Demutualisation and Credit Unions
A coming theme?
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USA
 At least 24 Credit Unions have converted to or
merged with a mutual savings bank
IGA Federal Credit Union
 1998 converted to mutual savings bank.
 1999 converted to stock company
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stock only offered to credit union members for $8
per share
2001 merged with First Penn Bank
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PSB Bancorp acquired Jade Financial Corp (holding
company of IGA). IGA stock sold for $13.55 per
share.
“Converted CU Members Recover Capital From Bank
Takeover” CU Journal Daily for 11/07/00
Is Demutualisation a New Phenomenon?
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No
 US mutual S&L’s since mid 1970s
 US Life Insurance Companies 1910 onwards
 UK Building Societies late 1980s
 Australian Building Societies 1980s
 Australian Life Insurance Companies 1990s
Mutualisation has also occurred
 Some US Life Insurers between 1914- 1960
Is Demutualisation a Growing Phenomenon?
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Probably Yes
 Life Insurance, Building Societies/S&L’s, Friendly
Societies, Stock Exchanges, Credit Information
Bureaus
But
 The stock of mutuals is declining, unless new
mutuals created
Has the mutual concept become irrelevant or noncompetitive as a form of organisation of financial firms? If
so is that due to
 An inherent self destructive life cycle
 Inadequate adherence to mutual principles
 Changes in the economic environment
 Legislative biases against mutuals
Expropriation or Efficient Mutation?
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Why the demutualisation trend?
 Is it a case of some self interested
individuals profiting at the expense of
others? - Expropriation
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If so, who is doing what to whom?
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Is it a case where all stakeholders are better
off? – Efficient Mutation
Are mergers between mutuals any different in
principle (or effect) to demutualisation?
 Changing entitlements of members
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Control rights
Rights to accumulated wealth
Mutuals versus Stock Companies
Sources of (Dis)advantage
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Stakeholder conflicts
 Owner – customer
 Borrower – lender
Governance and control
Stakeholder social relationships and information
Goal setting and Objectives
Unwritten (implicit) contracts between
stakeholders – mutual self help, intergenerational
Market discipline and efficiency
Taxes
Cooperation between non-competing mutuals
Has the Mutual Advantage Disappeared?
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Prevalence of Government Depositor Protection
 Mutuals were potentially safer
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No separate group of owners
Managerial risk aversion
Capital Accumulation
 Inherently incompatible with mutual status
 Incentives for expropriation
Has the Mutual Advantage Disappeared?
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Growth, Mergers, and Weakening Common Bond
 Member involvement and Governance
 Loss of informational advantages
 Determining agreed communal objectives
Competition
 Declining member loyalty
 Less flexibility in setting goals
 Repressive regulation may limit ability to
offer “one-stop-shop” range of financial
products desired by members.
 Between “cooperating” mutuals
Mutual v Stock Performance
Academic Studies
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Demutualisation (US Insurance and Thrifts)
 All major stakeholders appear to benefit
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Stock price gains on listing day for subscribers are
substantial (20+%)
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Investors view change as beneficial, or
Reflects privatisation of communal wealth
Converted US (New England) thrifts failed in mid 80s
at higher rate than mutuals
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Also true of “mutualisations”
Despite higher capital ratios
Mutual v Stock Thrifts efficiency (US, Australia)
 2 of 3 studies suggest mutuals more efficient
 But many studies suggest economies of scale
Does Demutualisation Improve Performance?
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Casual Empiricism
 Australian Building Societies
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Australian Life Offices
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Many have since disappeared (acquired)
Disappeared, Poor performance
UK Building Societies
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4 of 10 have merged or been acquired
Net interest margins of mutual building
societies smaller, better products, financial
inclusion
• (BSA – “The Case for Building Societies”)
Common Conversion Arguments
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Need for Capital
 Growth constrained
Increased Accountability
 Increased shareholder effectiveness
Clearer Goals
 Profits (v balancing diverse member concerns)
Market Discipline
 Share price signals
Aligning Stakeholder Incentives
 Managerial stock ownership and remuneration
Escaping Legislative Constraints
Academic Studies and Conversion Reasons
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Insiders do well from demutualisation
 Share allocations, profit gains
 Takeover regulation may also facilitate managerial
entrenchment
 Mutual holding companies may facilitate external
capital and insider control
Current members and carpetbaggers do well from
demutualisation
Likelihood of conversion increases with
 size, importance of non-financial business, net worth
 Strength of demand and competition
Conversion accompanied by increased risk taking
Demutualisation Risks – I I I
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Internal
 Greedy management and members
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Willing to give up benefits of mutual form for
conversion of communal wealth to private wealth
Losers are future members and society
Interlopers
 Carpetbaggers
Irrelevance
 If the mutual is indistinguishable from others (goals,
services, financials), who will support its continuance
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There may be no mutual advantage or
Mutuals behave like the others
Demutualisation Risks – the fundamentals
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Capital Accumulation
 Communal v Private Wealth conflicts
 Are there alternative structures (compatible with
mutuality goals)?
Size and Mergers
 Participation rate declines as bond widens
 Accounting performance appears to decline
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Despite cost economies
Managerial “rents” increase
Larger accumulated capital encourages carpetbagger
interest and insider incentives to demutualise
Governance and One member one vote
 has little rationale when membership involvement /
affinity is low
 facilitates insider entrenchment
Conclusion
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Mergers, Increasing Size and Industry
Concentration
 May reflect cost efficiencies
or
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Managerial ambitions
but
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Reduce benefits of mutual structure
Increase likelihood of demutualisation
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Even if mutual form is socially beneficial.