Decisions on Bank Applications
Mutual to Stock Conversions
Nesquehoning Savings Bank
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 duty.
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 institutions.
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 303.11(f).
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 a conversion.
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