AMHC Chairman Craig Montanaro, member Don Jennings and counsel Doug Faucette meet with Federal Reserve Board staff in Washington, DC

Today AMHC Chairman Craig Montanaro(CEO of Kearney MHC  Fairfield N.J.) and member Don Jennings ( First Federal Savings , Frankfurt, KY) and myself met with the Federal Reserve Board staff to discuss the implementation of Reg MM. At the meeting were five representatives of the Federal Reserve Board staff four lawyers and one bank supervisory official.

At the outset of the meeting the Fed staff explained that in view of the open comment period on Reg MM our remarks would be treated as public comments. Accordingly, the staff advised us that they could not negotiate a position and the summary of the meeting would appear in the public record of comments.  Chairman Montanaro lead off thanking the staff for the opportunity of meeting with them. He acknowledged that  the meeting was part of the regulatory comment process. He also said that that he hoped the staff would listen to some of our suggestions and incorporate them in its recommendations to the Board of what the final regulation should contain. He pointed out to  the staff that the regulation was proposed in August of 2011 with a formal comment period of the end of October of that year. He explained that with the passing of the March dividend waiver date there had been a sharp increase in  rumors that the Staff would not grant any further  dividend waiver approvals without evidence of depositor. This in turn has caused uncertainty in the market and  accompanying investor nervousness. He urged the staff to bring the process to a close so as to end the uncertainty.

He  said that he understood the staff’s concern  that the governance of the MHC involved a potential conflict of interest and would not debate the point . However, rather than opposing the fundamental premise upon which the regulation lies we were hopeful we could make some suggestions that would allow a MHC to reasonably  implement compliance. A conversation ensued  concerning alternative approaches to overcoming any conflicts. I explained that the regulation was unbalanced in favor of the mutual depositor. I stated that while the mutual depositor has certain incidents of ownership depositor ownership status is inchoate at best and in no way equates with stockholder ownership. Therefore, the balance the regulation struck between these two classes went entirely too far in the direction of the depositor in that in some cases it leaves no practical mechanism to reconcile the interests of the two classes. I cited the provision of the regulation that requires a depositor vote if even one share of stock is held by an insider, associate thereof or a benefit plan .

Chairman Montanaro asked whether the staff would entertain a provision that would  allow an insider to voluntarily restrict the amount of dividends received in a manner that would eliminate the appearance of any conflict in their fiduciary duty to the stockholders and depositors. That is, insiders would waive their right to be paid a dividend that would exceed the ownership percentage of the minority holders so long as they held the shares. For example, if 40% of the outstanding shares are held by minority holders then the insiders would receive only 40% of the dividend declared on each share held. There was further discussion of this concept by the staff and we explored how such a restriction could be created, monitored and enforced. We distinguished this method from the abstention or waiver of  all dividend  rights presently contained in the non-grandfathered part of the regulation.  We acknowledged that presently no dividend could be waived without a depositor vote or completely stripping insiders of ownership. We explained the mechanism for assuring compliance with a dividend limitation on insider stock explaining the legend method for restricting the transfer of insider stock and the SEC insider reporting requirement for tracing stock purchased in the open market.

As an alternative to the individual voluntary acceptance of dividend limits on the amount  paid to insiders, we discussed extending the period during which any depositor approval of a waiver would apply from one year to three. We cited the say on pay process as a precedent and the fact the Board members are elected for three year terms. The staff seemed interested in this method perhaps because it was relatively easy to monitor and still retained depositor discretion on whether a dividend is waived. We explained that we thought there should be at least two alternatives neither of which would be easy to comply with i.e. the voluntary limit would require a  majority if not unanimous consent of insiders or the three year  depositor approval  which would still involve a substantial expense.

Don Jennings explained  how the rule would be even more onerous on his bank. He stated that since his bank is a small bank in a small community most of his investors are from within the community and rely on the dividend. If his MHC could not bear the cost of the depositor vote it would have significant ramifications. He too urged the staff to recommend that the Board move quickly to eliminate regulatory uncertainty.

The conversation resumed concerning interpretations of the interim regulation. I inquired as to whether the depositor approval would be valid for four quarters explaining that a literal reading of the regulation which states that proxies were good for 12 months would not cover all four quarters since the proxies would be obtained before the year began. The staff confirmed that it was their intention that the depositor approval would cover four consecutive quarters. I also asked what governance procedures would be used to count votes . They seemed to agree that whatever procedures applied for normal governance  would apply, for example one vote per $100 on deposit for a federal MHC. They mused over whether borrowers would have a vote.

A general discussion followed about the advantages of a MHC particularly being able to retain many characteristics of a community mutual while still taping the equity market. There was also a recognition that since most mutuals have high capital ratios the MHC is a method to gradually deploy capital while changing the culture of the bank  to become more market oriented.  They seemed to recognize that raising too much capital could be a problem. The staff seemed to acknowledge that without the ability to pay dividends MHCs would likely repurchase stock reducing  the net capital in the industry. Finally the point was made that if the rule was not modified there would likely be a rash of second step conversions followed by the acquisition and elimination of more community banks.