OCC BULLETIN 2014-35
Subject: Mutual Federal Savings Associations
Date: July 22, 2014
To: Chief Executive Officers of Federal Savings Associations, Department and Division Heads, All Examining Personnel, and Other Interested Parties
Description: Characteristics and Supervisory Considerations
This bulletin describes the unique characteristics of mutual federal savings associations (mutuals) and the considerations the Office of the Comptroller of the Currency (OCC) factors into its risk-based supervision process.
The OCC developed this guidance to highlight the key distinctions between federal savings associations (FSA) organized in the mutual form of ownership and shareholder-owned or stock institutions. The guidance
In 2011, the OCC established the Mutual Savings Association Advisory Committee (MSAAC) to advise the OCC on ways to help ensure mutuals' continued health and viability. The MSAAC recommended that the OCC issue guidance to highlight unique characteristics and enhance understanding of mutuals. For example, the rescissions of Regulatory Bulletin 27b, "Compensation," (June 13, 2001) and CEO Memo 153, "Examinations of Mutual Savings Associations" (November 1, 2001), issued by the former Office of Thrift Supervision, created uncertainty for mutuals, particularly with regard to executive compensation. This bulletin addresses those concerns by focusing on considerations across the CAMELS components as they pertain to mutuals.
Other than regulatory provisions regarding chartering, bylaws, combination transactions, and member communications, mutuals are governed by the same statutory requirements, rules, and regulations as shareholder-owned or stock FSAs. While safety and soundness principles for mutuals are generally the same for stock FSAs and national banks (collectively, stock banks), there are operational differences that should be factored into the risk assessment.
Rights of Mutual Members
Mutuals do not have stockholders. All holders of a mutual's savings, demand, and other authorized accounts are members of the mutual. The mutual charter grants members certain rights, giving members some control over the mutual's affairs.1 Members' ability to exercise control over a mutual is not the same as the rights of stockholders of stock banks, although there are similarities. Mutual members have the right to
In practice, members delegate voting rights through the granting of proxies typically given to the board of directors (trustees) or a committee appointed by a majority of the board.
Operations of Mutuals
Most mutuals operate as traditional, community-based associations, focused primarily on home mortgage lending and retail deposits. Compared with stock banks, mutuals tend to have higher capital levels and earnings that are somewhat lower but more stable. Approximately 90 percent of mutuals have assets of less than $500 million. Regarding asset composition, on average mutuals have a significantly higher concentration of residential mortgages than do stock FSAs, and a comparable level of commercial real estate and junior lien residential mortgages. Compared with stock FSAs, mutuals make fewer consumer, commercial, and industrial loans.
Of the existing mutuals, about 88 percent are more than 75 years old and 42 percent are more than 100 years old. Because mutual management is not under the same pressure to maximize earnings as stock management, mutuals often have more conservative strategic goals and objectives. Mutual management tends to take a longer-term perspective on operations, service to the community, and meeting customer needs.
The following sections highlight important structural and operational considerations in assessing risks at mutuals for each of the CAMELS components.
Mutuals are subject to the same regulatory capital requirements as stock banks. The OCC has the same authority for setting individual minimum capital requirements for mutuals as for stock banks. A difference, however, is that mutuals have very limited means to increase regulatory capital quickly. Therefore, capital planning is critical for mutuals.
Mutuals build capital almost exclusively through retained earnings. Mutuals may also include as capital certain instruments, such as nonwithdrawable accounts or pledged deposits and mutual capital certificates, if the instruments meet the qualifying criteria for regulatory capital. These instruments, however, are rarely used. A mutual may also convert to stock form to raise capital.
Asset quality is an area that receives significant review for both mutuals and stock banks. As noted in the operations discussion above, in the aggregate, mutual loan portfolios are predominately concentrated in residential mortgage loans. While some mutuals originate a moderate level of loans secured by commercial real estate, mutuals tend to be less concentrated in commercial, industrial, and consumer loans than stock FSAs. The higher level of one- to four-family first-lien residential loans is a common distinction between mutuals and stock FSAs. Also, mutuals tend to hold the loans they make on their books. Mutuals typically hold higher levels of capital to mitigate any additional credit risk arising from this exposure.
Management is a key component for mutuals, as it is for banks of any charter type. It is important to note that mutuals, like stock banks, must have clearly defined business strategies and well-articulated long-term goals. Mutual boards of directors are required to exercise their fiduciary duties and provide appropriate oversight over management. Strategic, capital, and succession planning are particularly important for mutuals.
A bank's earnings determine its ability to absorb losses, ensure capital adequacy, and generate a reasonable return. Earnings are essential to any bank's viability but are especially important for mutuals, which build capital primarily through the accumulation of earnings. Examiners evaluate mutuals' earnings for stability, trends, quality, and level. The mutual's operations are also evaluated, and additional factors, such as capital level, credit risk, and interest rate risk, are considered.
When determining the earnings rating for a mutual, examiners consider the adequacy of earnings relative to the bank's risk profile, capital level, and strategic plan. Lower earnings, by themselves, are not indicative of a poorly run mutual. If a well-run mutual with conservative growth plans and a high capital base has low earnings, such earnings, if stable and consistent, may be adequate and are rated accordingly.
Mutuals generally have lower earnings, net interest income, noninterest income, net interest margin, and return on equity relative to stock FSAs. However, mutuals have more stable levels of profitability. Mutuals, like stock banks, must generate sufficient earnings to meet expenses, pay interest on deposits, and satisfy regulatory capital requirements. Whenever possible, examiners compare mutuals with other mutuals to provide a more meaningful review of the various financial ratios to identify problem trends and outliers. There is a Peer Group Average Report available among the Uniform Bank Performance Reports (UBPR) at www.ffiec.gov. This report provides averages for mutual-only peer groups in four asset ranges.
When it is not possible to compare a mutual with other mutuals, which can be the case with large mutuals that have few peers of the same asset size, it is appropriate to compare a mutual's net income to a stock bank's net income after dividends. Net income after dividends is the earnings reinvested for both types of charters (see table 1).
Table 1: Comparing After-Dividend Income for Stock Banks and Mutuals
Similarly, adjustments to net income based on the effective tax rate are needed to compare mutuals to subchapter S corporations. In a subchapter S corporation, the tax burden is passed on to individual shareholders, but mutuals cannot elect subchapter S status because they are not owned by shareholders. Dollar values reported on the call report are not adjusted for this difference in tax treatment, but there is a ratio on the UBPR for return on average assets that is adjusted for subchapter S corporations.
The "Liquidity" booklet of the Comptroller's Handbook outlines the OCC's expectations in managing liquidity risk. The booklet emphasizes the importance of cash flow projections, diversified funding sources, stress testing, a cushion of liquid assets, and a formal, well-developed contingency funding plan as primary tools for measuring and managing liquidity risk. The OCC expects national banks and FSAs (collectively, banks) to manage liquidity risk using processes and systems that are commensurate with the bank's complexity, risk profile, and scope of operations. Within the contingency plan, management should identify the stress events that could threaten the bank's ability to fund both short-term and long-term operating and strategic needs. These events include those situations that have a significant negative impact on liquidity, earnings, or capital because of the bank's balance sheet composition, business activities, management, or organizational structure. A defining aspect of mutuals is that they typically rely much less on wholesale funding than stock FSAs.
Sensitivity to Market Risk
Management of interest rate risk is important to mutuals. The median percentage for long-term assets to total assets and residential real estate to total assets is higher for mutuals. As a result, mutuals may possess higher on-balance-sheet interest rate risk (apart from hedging activities and other offsets to reduce risk). Mutuals, on average, hold higher levels of capital as a cushion to help offset this sensitivity exposure. In addition, mutuals have a higher percentage of Federal Home Loan Bank advances that are long term (i.e., greater than one year). Mutuals should have processes in place to quantify the sensitivity of earnings and capital to adverse changes in interest rates.
Please contact Donna Deale, Deputy Comptroller for Thrift Supervision, Midsize and Community Banks, at (202) 649-5420.
Jennifer C. Kelly
1 OCC regulations provide a form of mutual charter and possible charter amendments, as well as bylaw requirements for mutuals. The charter, bylaws, and other regulatory requirements establish the rights of mutual members. These rules also establish the general corporate governance requirements for mutuals, including the conduct of member meetings, the composition of the board of directors, the board members' responsibilities, and how to amend the charter or bylaws.
2 In a phantom stock plan, a company grants participating employees or directors "phantom shares" of stock. The company does not issue actual shares to the plan participants. The plan specifies (among other things) a means by which the value of the phantom shares is determined and a vesting schedule. Subsequently, participants are eligible to receive a payment (normally cash) in exchange for their phantom stock.