As expected, the 1984 Tax Reform Act has already inspired a ground swell of interest in employee stock ownership plans (ESOPs). What wasn't so predictable was the impact that Section 542 of the act would have on the banking community.
Under the new law, lenders are now exempt from paying tax on half the interest payments they receive on an ESOP loan, thus making it more profitable for them to approve ESOP loans below prime than traditional commercial loans at prime.
The question is, how far below prime have banks had to go? And how many banks are responding to the law's lending incentive? The answers on both counts are encouraging.
According to a survey by the Employee Stock Ownership Plan Asociation, in Washington, D.C., loans are now being made at an average of 82.5% of prime. Widespread knowledge of the exemption has made borrowers more aggressive and banks more competitive.
"If we quoted the traditional rate, the borrowers wouldn't take the loan -- they'd go elsewhere," says John Gerlits, a vice-president of American National Bank in Chicago. "We're making it known that we're interested in this type of financing." The financing, he adds, is a good marketing tool for banks in a position to take advantage of tax-exempt income. (One cautionary note: A bank that already has its profits sheltered in other deals, such as industrial revenue bonds or municipal securities, may be unable to use the tax break on an ESOP loan. A potential borrower should shop around for another bank if its existing lender is in such a position.)
Bridgeport Brass Co., a 223-employee metalworking company in Seymour, Conn., recently found itself in a position to go shopping. The managers of the former subsidiary of National Distillers and Chemical Corp. are now seeking financing from several banks after deciding to buy the division from its parent throgh an ESOP last April. "Of the six banks we went to, they all came through below prime," says Carl Drescher, the plant manager, who will be president of the independent company. Were it not for the tax law, the banks told him, the rates would have been higher than prime. "We probably could have raised the money to buy the plant," he says, "but it would have been much more expensive."