According to recent filings with the Securities and Exchange Commission, at least one bank has found an opportunity to improve its capital position through changes to its employee stock ownership plan (ESOP). A similar opportunity may be available to other banks to do the same thing under the right circumstances.

The bank in question maintained both a leveraged ESOP and a 401(k) plan for its eligible employees. While a majority of the shares of bank stock in its leveraged ESOP were allocated to participants’ accounts, the ESOP still had indebtedness for shares that were not yet allocated to participants’ accounts. In this respect, the existing ESOP loan was reflected on the right side of the bank’s balance sheet as both a liability and a contra-equity amount (“Unearned Compensation”) in accordance with generally accepted accounting principles (GAAP).

As part of a benefit plan restructuring and in order to generate capital, the bank terminated the ESOP and merged the accounts of ESOP participants into the bank’s 401(k) plan, with the unallocated shares of the ESOP being redeemed by the bank in exchange for cancellation of the ESOP’s debt to the bank.

While the termination of the ESOP had no material impact on the bank’s earnings, the Unearned Compensation contra-account amount was reduced to zero, thereby improving the bank’s capital position by the amount of the reduction ($3.1 million), which represents the amount of the unpaid ESOP loan.

For banks that maintain ESOPs with outstanding leverage, including many mutual thrifts that converted to stock organizations using a leveraged ESOP as a part of such conversion, this may present an opportunity to improve their capital position. Before doing so, however, careful analysis of all implications of terminating a leveraged ESOP should be undertaken to ensure that the best interests of the bank and its shareholders are served, and that there are no inadvertent violations of the fiduciary provisions of the Employee Retirement Income Security Act of 1974.