While many banks have established Employee Stock Ownership Plans (“ESOPs”), few banks have thought about ESOP banking as a separate niche. This might be a mistake as lending to ESOP not only can reduce credit risk compared to lending directly to a company, but a bank can showcase their lending expertise enough to win valuable cash management and deposit business often. In this article, we discuss the profitability of ESOP banking and why banks should consider making this their specialty. Also, we invite you to a free webinar (bottom of this article) where we will give you a step-by-step education on how ESOPs work, a set of marketing tools and a guide on how to get started.
ESOPs In a Nutshell
An ESOP is an Employee Stock Ownership Plan that qualifies as a defined-contribution employee benefit plan (ERISA) set up to invest largely in the stock of the employer. If done correctly, ESOPs provide employees with an ownership interest in their company while creating additional liquidity for shareholders not to mention a layer of protection against a hostile takeover.
In addition to the benefits of employee ownership, given the number of owners that are aging Boomers, ESOP and ESOP financing has never been more popular. The structure lends nicely to estate planning. Banks are an ideal position to provide debt to help an ESOP finance all or a portion of the Company’s equity. For example, aging owners that want to exit their company will find an ESOP a near perfect tax-efficient vehicle to sell all or a portion of the company to its employees or the next generation of family owners. Below is an example of the pre and post-acquisition structure of such a situation.
ESOP as a Standalone Credit Indicator
If you take no other action as a result of reading this, know that the mere presence of an ESOP is an indicator of superior credit performance. It is one of the questions we ask upon an initial meeting with a new customer or prospect. Having an ESOP tends to create a “culture of ownership” which often results in better retention, greater revenue per employee, larger revenue growth and a higher return on assets. From the National Center of Employee Ownership, we have the statistics in the graphic below:
For banks, an ESOP can also serve as a tax and credit advantaged tool to provide financing for the expansion of a business unit. Because of the tax leverage, an ESOP creates better collateral value and thus have a more advantageous risk profile compared to non-ESOP companies.
While many ESOPs employ no leverage, approximately 44% of the roughly 7,000 ESOPs in our country do utilize debt to finance the equity. Of all the ESOPs, about 65% of them require loans of $10mm or less putting most ESOPs squarely in the sweet spot of the average community bank. Average loan tenors are around five years, but the ability to make a 10-year, fixed-rate loan is often the key to winning the business.
We modeled an average ESOP relationship that a community bank would encounter (below) and it comes out to about a 15% risk-adjusted return on equity, a probability of default of 1.40% and an expected loss of 14 basis points. Due to the structure and protection that the ESOP affords, the stressed, or recessionary case, is an approximate 11.8% return on equity. The superior performance in a downturn makes this lending niche an excellent addition to a balance sheet that might have a heavy concentration in commercial real estate or cyclical lines of business.
Because this takes specialty knowledge, few banks have taken the time to develop an ESOP focus. Those banks that have, such as JP Morgan, PNC, Associated Bank, First American Bank and others, have found the niche an excellent way to get into high-value companies. These banks focus on both existing companies with ESOPs plus work with companies to establish new ESOPs.
Join Our Free Upcoming Webinar – May 3rd, 2018 at 2 pm ET
This is just the tip of the proverbial iceberg. If you would like to learn more about the fundamentals of ESOPs, please join us and the preeminent law firm for ESOPs, Hunton Andrews Kurth, as we go through the mechanics and details of ESOP banking. This webinar is targeted at all commercial lenders, business development officers and senior managers that are looking to set themselves apart and specialize in a niche where few bankers play. If you are looking to drive loan growth or add another capability to your resume, you can’t miss this one-time webinar.
Attendees of the webinar will not only receive training but will also receive our ESOP banking guide that includes webinar notes, marketing ideas, proven marketing templates and a list of leads for your bank’s home state. This webinar and ebook are designed to provide you with the turnkey tools to turn this idea into action in less than 30-days.
To register for the webinar, go here: https://attendee.gotowebinar.com/register/898394848234402563
Sign up today and get the same tools and training that we are developing here at CenterState to be more valuable to our customers.
Submitted by Chris Nichols on April 05, 2018