Credit availability seems to be improving in the commercial markets.  One common (and obvious) test for new commercial lending is “how will the borrower fare in the tough times, or a stress test?”  Generally, loans to employee stock ownership plans (called an”ESOP”) do well.  So, loans to ESOPs will have access to credit. Starting about 9 months ago, I started to see a resurgence in commercial lending. One sign of the good times for lenders took me last week into the ring (not a WBA sanctioned event) with Lori Oliphant.  We discussed the topic of ESOP loans.  My opening combination ended with the stress test question:

  •  how do loans to ESOP companies fare when the company comes under stress?

The stress test concept is not new – it was just nudged out from the ring-side seats in the “old” economy. Lori’s answer was simple: the nature of the borrower, amd the typical collateral structure and credit enhancement, combine to make loans to ESOP companies a capable contender, even when tested with the stress of tough times. Here is her scorecard:  

  • the transaction is generally structured to have the plan sponsor lend money to the ESOP, in exchange for a promissory note
  • the bank lends money to the plan sponsor, in exchange for a promissory note
  • the loan from the plan sponsor to the ESOP is secured by the shares purchased by the ESOP (with the proceeds of that loan)
  • the bank loan cannot be directly secured by the shares purchased by the ESOP, so  . . .
  • bank secures its note with other collateral from the plan sponsor (and sometimes from the selling shareholders)
  • other “soft” factors supporting the loan: employee ownership culture fostered by the plan, and the tax-deductible nature of the contributions to the ESOP that are used to allow the ESOP to repay the plan sponsor (or selling shareholder) loan

Generally, ESOP loans go the distance. If you have comments, please post them below.