April 5, 1999
The Board of Trustees
Nesquehoning Savings Bank
301 West Catawissa Street P.O. Box 95
Nesquehoning, Pennsylvania 18240-0095
Dear Board Members:
The notice of intent to convert from mutual to stock form filed on behalf of
Nesquehoning Savings Bank, Nesquehoning, Pennsylvania ("Nesquehoning" or
"Bank"), and subsequent amendments thereto, have been reviewed by the Board of
Directors ("Board") of the Federal Deposit Insurance Corporation
("FDIC") pursuant to 12 C.F.R. Part 303, Subpart I. Included in the review were
the Bank's basis for its proposed merger/conversion, the manner in which the Bank's value
was determined, the distribution of value, the reasonableness of insider remuneration,
conformance to applicable laws and regulations, and general safety and soundness issues.
Based on the information and representations presented, the FDIC objects to the
proposed conversion because it presents, in the Board's judgment, a breach of fiduciary
The proposed transaction is a combination of a conversion of Nesquehoning to stock form
and merger of Nesquehoning with First Star Savings Bank, Bethlehem, Pennsylvania
("First Star"). Nesquehoning proposes to convert from a Pennsylvania-chartered
mutual savings bank to a Pennsylvania-chartered stock savings bank, with a simultaneous
merger with and into First Star. The parent holding company of First Star, First Star
Bancorp, Inc. ("Bancorp"), will offer shares of common stock to qualifying
depositors of Nesquehoning, and potentially others, in accordance with the Merger
Conversion Agreement between First Star and Nesquehoning. First Star will offer these
shares of Bancorp common stock on a first priority basis to Nesquehoning depositors as of
July 3 1, 1997, at A 10 percent discount to the price paid. by any other purchasers in the
offering. The number of shares to be issued will depend on the final valuation of
Nesquehoning to be provided at the conclusion of the offering and the discounted market
price of Bancorp stock at that time. Subsequent to the original proposal, First Star has
also committed to provide additional distributions of Nesquehoning's value, including an
interest bonus payment to Nesquehoning depositors, a
contribution to local charitable organizations, a reduced-rate small business loan program
for Nesquehoning and surrounding communities, a reduced-rate construction loan for elderly
housing in Nesquehoning, and a Federal grant for elderly housing in Weatherly.
Additionally, First Star offered intangible benefits consisting of a new branch in
Nesquehoning and expanded financial products and services. These subsequent commitments
are included in the amended merger agreement, drafted in February 1999, which has not been
signed by either First Star's or Nesquehoning's board of trustees.
Historically, merger/conversion transactions raise a number of regulatory concerns,
including proper determination of the value of the converting institution, distribution of
value to rightful recipients, and conflicts of interest stemming from insider benefits.
The preamble to the FDIC's regulations governing mutual-to-stock conversions states that
" [i]n exercising its fiduciary responsibilities, the board of directors/trustees of
a mutual State Savings Bank must assure that: (1) The value of the converting institution
is fairly determined; and (2) That value is distributed to the proper constituents of the
bank... In no instance will an acquiring institution be considered a rightful
recipient." (59 Fed. Reg. 61233, 61241 (November 30, 1994)) Nesquehoning's board of
trustees has not fully met these conditions. Under 12 C.F.R. § 303.163(e), in the event
that the FDIC determines that a breach of fiduciary duty exists regarding a proposed
conversion transaction, it is authorized to issue a letter of objection to the mutual
institution's plan of conversion.
In addition to Federal law, the FDIC Board has considered applicable state law.
Pennsylvania corporate law recognizes a duty of care that requires corporate boards to
perform their duties "with such care, including reasonable inquiry, skill and
diligence, as a person of ordinary prudence would use under similar circumstances."
15 Pa. Cons. Stat. Ann. § 1712 (1998). Regarding directors' duty of care, relevant
Delaware court precedent has provided that directors would be expected to inform
themselves as to the existence and availability of alternatives to the course of conduct
under consideration. The more significant the proposed corporate action, the greater would
be the requirement that directors investigate and consider alternatives. See, e.g., Smith
v. Van Gorkom, 488 A.2d 858 (Del. 1985).
The information provided to the FDIC with respect to the deliberations of the
Nesquehoning board indicates that there was no substantive investigation and consideration
of alternatives (other than a standard conversion) to the proposed merger with First Star.
Among other things, such investigation and consideration should include a financial
comparison of First Star's bid to other alternatives. Although Nesquehoning's board
initiated a process of "shopping" the institution, the board did not exercise
reasonable diligence to obtain a bid from financial. institutions other than First Star
because it did not adequately pursue initial expressions of interest from other
Efforts by a mutual institution's management to "shop" the institution would
establish a market based value, which its board could take into consideration, in the
proper exercise of its fiduciary duty.
In addition, the information provided to the FDIC does not indicate that the
Nesquehoning board determined the value of the First Star bid. Notably, regarding the
discount on Bancorp common stock, Nesquehoning's board of trustees did not exercise
reasonable diligence to determine the value of the stock discount on the "market
price" of Bancorp stock as provided by the merger agreement. The FDIC has determined
that there exists substantial uncertainty regarding the fair market price of Bancorp stock
(in light of the volatility of the trading price of Bancorp stock during the past twelve
months). Furthermore, the FDIC is concerned with respect to whether the discount on
Bancorp stock would result in the distribution of value to the rightful recipients.
The amended merger agreement submitted to the FDIC provides for, at most, distribution
of 47 percent of the institution's net worth to its constituents. This distribution of
value calculation includes the discount on Bancorp stock, despite the FDIC's concerns
regarding whether the discount would result in a distribution of value. Therefore, the
First Star bid provides a significant distribution of Nesquehoning's value to the
acquirer, which is not considered a constituent of the institution. While the FDIC has
considered intangible commitments in the First Star proposal, these intangibles do not
compensate for the significant shortfall in the distribution of Nesquehoning's net worth
to its constituents.
The FDIC has determined that Nesquehoning's management has breached its fiduciary duty
to its constituency by (i) providing for a low distribution of value to Nesquehoning's
depositors and other primary constituents and (ii) not exercising reasonable diligence in
determining the value of First Star's bid and in considering alternatives (other than a
standard conversion) to the proposed merger with First Star.
Because of the FDIC's objections as detailed above, you are hereby advised that the
mutual-to-stock conversion proposed by Nesquehoning shall not be consummated unless and
until the FDIC rescinds this letter of objection. You are also advised of the right of
Nesquehoning, within 15 days of receipt of this letter, to file with the FDIC a written
petition seeking reconsideration of the Board's objection pursuant to 12 C.F.R. Section
The FDIC's objections to your application are without prejudice - - that is,
Nesquehoning is free to file a new notice of conversion if it wishes to continue to pursue
The FDIC's objection to your application moots First Star's merger application, and the
application will accordingly be returned to First Star.
By direction of the Board of Directors.
Robert E. Feldman