Approximately 9% of all ESOPs are in banks, the highest percentage for an NAICS (North American Industry Classification System, the standard for classifying industries in the U.S., Canada, and Mexico) subcategory. The popularity of ESOPs for banks is based on a number of benefits, including attracting and retaining employees, capital structure, and creating a market for thinly held shares. This book is a guide for those interested in implementing an ESOP at a bank. It begins with an overview of how ESOPs work, including a discussion of banks as ESOP lenders. The next chapter focuses on specific issues for banks as ESOP sponsors, including a look at how ESOPs affect capital structure and accounting issues, holding company issues, regulatory requirements, and common ESOP applications. Chapter 3 explores how ESOP valuations are done for closely held banks. Finally, chapter 4 provides three case studies of banks that have implemented ESOPs.
Table of Contents
Introduction: The Popularity of Bank ESOPs
1. Banks as ESOP Sponsors: An Overview of How ESOPs Work
2. Special Issues for Banks as ESOP Sponsors
3. Valuation for Bank ESOPs
4. Case Studies of Bank ESOPs
About the Authors
About the NCEO
From Chapter 2, "Special Issues for Banks as ESOP Sponsors"
When considering the purchase of bank or bank holding company stock by an ESOP, attention must be given to the possible application bank regulatory provisions, such as Regulation W of the Federal Reserve (“Reg. W”) and the change-of-control provisions of the 1956 Bank Holding Company Act (BHCA) in addition to the provisions of the Code applicable to such plans.
In most instances, a bank holding company will serve as the sponsor of the ESOP, with the bank subsidiary also serving as an adopting employer, thereby covering the employees of the bank. To fund the plan, the bank would “upstream” funds in the form of a dividend or make direct contributions to the ESOP based upon the compensation of its employees. These contributions would be used to purchase stock in the bank holding company.
In some cases, however, the bank may itself be the sponsor of the ESOP for state tax reasons or the absence of a bank holding company.
In general, Reg. W governs transactions between member banks and their affiliates, such as a purchase of assets from an affiliate, extension of credit to an affiliate, investment in securities offered by an affiliate, issuance of a guarantee on behalf of an affiliate, and certain other transactions that expose a member bank to its affiliate’s credit or investment risk. For purposes of applying the provisions of Reg. W, an ESOP may be considered to be an “affiliate” relative to the acquisition of stock of a bank. However, Reg. W would not apply to a bank holding company that carries out these transactions with the ESOP as its affiliate.
For purposes of applying the change-of-control rules, even a minority interest ESOP may need to demonstrate that it is not in control of the bank as defined in the BHCA, or the ESOP may be deemed to be a bank holding company itself.
From Chapter 4, "Case Studies of Bank ESOPs"
As one of the few 100% employee-owned banks in the nation, Phelps County Bank (PCB) is a true ESOP success story. PCB is based in Rolla, Missouri, along historic Route 66, with four locations and more than 500 million dollars in assets. The bank describes itself as a community bank owned by the employees through an ESOP.
Phelps County Bank was chartered in 1963. Don Castleman was an original stockholder and a member of the board of directors. In 1971, Castleman acquired a controlling interest in the bank, and in 1978 he agreed to sell his stock to a holding company, encouraging the other investors to do the same. Phelps County Bancshares, Inc. was established as the holding company and controlled approximately 80% of the bank’s outstanding stock. By 1997, the holding company owned 97% of the outstanding stock.
Emma Lou Brent was named the executive vice president in 1976, and in 1982 she was promoted to chief executive officer. During this time, Brent worked closely with Castleman in the development of the holding company and expanded PCB into neighboring markets with the purchase in 1983 of another small community bank in St. James, Missouri. Brent was instrumental in presenting the idea of a profit-sharing plan to Castleman. After much research and deliberation, she decided to propose an ESOP as a way of transferring ownership of PCB to its employees. Castleman agreed to the plan, and PCB’s journey into the world of ESOPs began. Over the next 13 years, Phelps County Bancshares purchased all of Castleman’s remaining stock to become a 100% employee-owned bank in 1993.
In its initial stages, the ESOP operated as mostly a financial benefit for employees, but Brent, the new CEO, believed it could be a lot more. She wanted employee ownership to be the cornerstone of the company’s culture. Working with the NCEO, she and a team of employees created a model for communicating the ESOP and getting employees involved in sharing ideas to improve performance that many other ESOP companies would follow.
That involved two key parts: a communication committee made up of nonmanagement employees to help explain how the ESOP works, and “The ESOP Challenge” to generate ideas. Employee-owners looked for ways to solve the issues that cost the bank time, money, or loss of business. It was the responsibility of that employee-owner to research solutions and present those to the bank’s executive team. Multiple improvements were implemented from that challenge, with cash prizes going to the year’s best ideas.
Twenty-nine years later, PCB has more than 100 participants in its ESOP. The bank has paid out the original ESOP participants from the early 1990s, handsomely rewarding those retirees for their years of work and faith in the ESOP model. A significant percentage of the bank’s current employee-owners have less than five years of service. To incentivize this younger workforce and recruit talent, PCB increased its ESOP contribution rates, often investing 20% or more.
Unlike a standard 401(k), the employees aren’t asked to match even $1 of that annual contribution. Employee-owners are entitled to an in-service distribution once they have completed five eligible years of service and are offered the option to diversify their assets once they have completed 10 years of participation in the plan and reached the age of 45 or older.