The End Of A Surefire Stock Play?

Everything seemed to be going smoothly as First Federal Savings & Loan Assn. of Rockford, Ill., geared up to go public early last October. All the stock it planned to issue had been allocated to its employees and depositors, who are legally entitled to first dibs, and public trading was to start the next day. But on the day before the offering, federal authorities alleged that would-be outside investors, hoping to get in on what promised to be a great investment, had offered depositors as much as $1,500 in cash to transfer their stock-purchase rights. The deal went through, but the Feds confiscated the roughly 10% of the shares the outsiders had acquired. FirstRock, which cooperated in the investigation, did not return phone calls.

The thwarted investors had good reason to be tempted. For the past 18 months, so-called mutual thrift conversions--public stock offerings by thrifts previously structured as mutual companies--have been among the best investment deals around. Typically priced at bargain opening prices, company shares have risen as much as 50% in their first few days of trading.

The good times, though, may be drawing to a close. A spate of large thrift conversions is in the offing, and the flood of new supply will hit the market at a time when thrift stocks' initial offering prices are rising. "This is a fool's game," says Richard M. Schapiro, a managing director at Salomon Brothers Inc. "Eventually, the cycle will complete itself, and people are going to get stung pretty hard."

STRANGE DEAL. Thrift conversions certainly have gained allure. Investment gurus such as Peter Lynch have lauded conversions as shrewd investments, and a herd of professional investors has been combing the country for thrifts that could soon convert to public ownership.

The pros' reasoning is simple: The rules on conversions almost dictate below-market prices for new thrift stocks because most of the shares are first offered to depositors, who have rights to the companies' equity in the event of liquidation. "It is the weirdest transaction in the world," says Benjamin B. Crabtree, an analyst at Dain Bosworth Inc. "You sell something to someone who already owns it." Naturally, depositors and thrift executives want the offering price to be as low as possible.

The result? Thrifts have come to market with shares priced at less than 60% of book value. Since shares of thrifts that have already gone public have been trading at price-to-book ratios closer to 100%, speculators have been bidding up newly issued shares quickly. That has attracted aggressive investors who try to open deposit accounts at thrifts considered to be likely candidates for conversion--and who, in the extreme case of FirstRock, allegedly try to buy depositors' nontransferable stock rights.

ERODING EDGE. As is usually the case, market forces are starting to squeeze out the surefire bonanza. More thrifts, including some big ones, are rushing to cash in. Green Point Savings Bank, based in Flushing, N.Y., is due to go public before yearend, a deal one of its underwriters, Adams Cohen Securities Inc., predicts will raise $800 million. That's more than triple the size of the next-largest deal of the past 18 months. A $250 million to $300 million offering for the Lake Success (N.Y.) Astoria Federal Savings & Loan Assn. and other deals could hit the market about the same time. "We're probably in a horse race" with Green Point, says George L. Engelke Jr., Astoria Federal's president and CEO. He adds, however, that "there are plenty of investors to absorb these offerings."

Meanwhile, the price-to-book ratios of new thrift stocks are gradually approaching those of currently traded stocks, because the offering price for new deals is based on the escalating trading prices of already-public thrifts. That, in turn, is eroding investors' quick gains (chart). Many newly independent thrifts, further, have been lackluster performers, prone to making safe but low-return investments.

Thrift conversions should still make money for investors, particularly if the overall outlook for banks and thrifts continues to improve. But the spectacular, surefire returns that led unscrupulous investors to FirstRock could soon be history.