Regulatory Misconceptions in Pricing Thrift Conversions: A Closer Look at the Appraisal Process

A series of news articles in the summer and fall of 1993 reported excessive managerial compensation and stock option packages at some large state-approved thrift mutual-to-stock conversions. Congress reacted to these reports and the House Banking Committee introduced legislation late in 1993 requiring state-chartered thrifts to comply with federal regulations in conversions. At the heart of the public policy debate in 1994 was whether windfall profits existed in conversions, and at the time of conversion from mutual to stock organizational form, who would be the rightful beneficiary of the accumulated build-up in proceeds. Under current OTS regulations, conversion from a mutual-to-stock organizational form is done under the sale-of stock approach, by selling stock to managers and depositors. Stock not purchased by these groups are offered for public sale. Issue proceeds are retained within the thrift as capital which is added to the accumulated equity of the mutual thrift to create a new capital base for the converted entity. Regulations require that the stock be priced based on an independent appraisal of the pro forma value of the converting thrift. Regulatory guidelines for the appraisals include specific valuation equations which appraisers must use to identify the offering price of the conversion. The appraisal industry estimates that during the 1970s approximately 1600 institutions were appraised in excess of $16 billion. Hence, these appraisal equations have had a significant effect in pricing these conversions. The validity of the appraisal equations has never been discussed either in the academic literature or in Congressional hearings. This paper evaluates the assumptions imbedded in these equations and demonstrates how regulators overlooked the inapplicability of these assumptions in thousands of conversions. The author raises serious questions about the integrity of the appraisal process in these conversions. The paper starts with a brief description of (This abstract was borrowed from another version of this item.)