When it was reported recently that Springfield-based insurer MassMutual was being sued by policyholders claiming the company had wrongly withheld as much as $5 million in profits, bankers’ ears perked up – especially mutual bankers.

That’s not to say that mutual insurance companies and mutual banks are the same, but the concept of mutuality is, and if MassMutual’s policyholders are angry and aggressive enough to take action against the company, perhaps mutual bank members will be emboldened to raise their hands on some of the excess capital currently being sat upon by mutual banks.

The laws governing mutual insurance companies and mutual banks are different, but the principles behind them are very similar. But unlike MassMutual, mutual bank members don’t have voting rights, and they do not make management decisions the way a stock bank’s board of directors might.

And Massachusetts banks have not been subject to the kind of suit being brought against MassMutual, but it is not entirely unique.

Dos & Don’ts

In 2001, a small group of depositors at Gorham Savings Bank in Gorham, Maine, sued the bank, arguing that it was overcapitalized and should therefore issue annual dividends for a few years.

Also, the type of situation that could give rise to these problems has a recent history in Massachusetts. Early this summer, Chicopee-based Polish National Credit Union and Valley Stone Credit Union of Wilbraham merged. At the time, much larger Polish National had a capital ratio of about 14.5 percent. Valley Stone’s was about 20 percent.

The only worry was about dilution of Polish National’s capital. So, the two credit unions decided that by issuing a special dividend of about $5.5 million to Valley Stone’s members, Polish National would avoid capital dilution and everyone would be happy.

For banking attorney Kevin Handly of law firm Pierce Atwood in Boston, a merger is the scenario in which concerns over how much capital an institution is holding becomes a concern.

By law, mutual banks may merge without distributing excess capital to members. However, in many mergers of mutuals, one bank has more deposits, but is weak on the capital side while the other has less in deposits but a strong capital ratio.

This is a recipe for capital dilution during a merger, and members may be tempted to say, “You’ve accumulated far more capital than you need. It should be distributed to us,” Handly told Banker & Tradesman.

MassMutual’s deposit holders think the company is sitting on $5 million in withheld profits, according to reports.
At the end of the first quarter, banks in Massachusetts had Tier 1 capital of about 10 percent on average, according to the Federal Deposit Insurance Corp.

In recent years, banks have been happy to horde capital as operational, technology and especially regulatory costs have risen. For mutual banks, raising capital without going public was made more difficult by the Dodd-Frank Act. The act stipulates that mutual banks larger than $500 million in assets cannot use trust-preferred stock to raise capital.

‘Confrontational, Agitated’

It’s all enough to turn usually mild-mannered bankers into little balls of pure stress.
They’ve got commitments to the communities they serve, they say. They know that if they go public, the chances of surviving unmolested past five years are slim indeed.
Mutual holding companies can issue non-voting preferred stock to the Treasury, and it will count as capital.

“But if it’s okay for Treasury, why can’t a private investor invest in a mutual holding company?” Handly asked.

“In order to have a thriving and healthy mutual bank sector, you need a way to entry and the ability to raise capital without going public,” Handly said.
With the MassMutual case as their guide, mutual bank depositors may now make it even more difficult to retain that capital once it is raised.

“It takes an aggressive lawyer, and a confrontational, agitated policyholder to create that kind of lawsuit,” Handly said. “[And] there are policyholders and members of mutual banks that are.”

They may not be looking to take any action just yet, though, said Peter Alden, president and CEO of Worcester-based Bay State Savings Bank.

“With the proposed changes to capital requirements, it’s hard to know what’s adequate,” Alden told Banker & Tradesman. “Most banks try to be in that range that’s well capitalized, but in excess of that, if you’re not deploying the funds, you’re not showing that you’re making any money.”

Alden also pointed to a key difference between the insurance and banking industries. In insurance, it may be more difficult to predict how capital will be deployed.

“How do you know if you’ve got enough reserves?” Alden said. “How do you know how many claims are going to be filed?”