# Employee Stock Loan



## Bupp (Nov 13, 2009)

My employer will lend me money to buy company stock (big 5 bank).

- fixed rate loan at prime 
- stock dividend pays more than prime

Is it a good idea to take out the loan? Seems like a no brainer to me...

PROS:

- The principle paid down each month on the loan acts as forced savings
- The interest paid on the loan is more than covered by the dividend income
- Interest on the loan is tax deductible

CONS: 

Ties up some cash flow each month
Stock price could go down
dividend may not increase

Is this the slam dunk opportunity I think it is? What am I missing?


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## humble_pie (Jun 7, 2009)

have they not spelled out the full terms of the loan. Essentially it's a margin account but there are no other assets to generate supporting margin, which makes the deal even riskier.

what you're not mentioning is that the bank will undoubtedly call back the stock to protect their loan if markets turn really wonky. There's a percentage drop that the bank will tolerate. After that you could lose some or all of the stock in a margin call.

part of the risk that you might not have quite understood is that, even if the stock tumbles badly, you will still owe the bank the full amount of the loan.

meanwhile your employer is taking zero risk. Either way, the bank will win on the loan.

btw doesn't this bank have the standard canadian bank offer to employees. Last i heard it was something like for every 2 shares the employee buys, the bank will donate a share for free. The foregoing looks like an interesting offer, if it's available to you. The risk is that the stock will tank, but employee/owner is cushioned by the 33 1/3% share subsidy and doesn't have to fear a margin call.

all these recent posts in this forum about buying with leverage are telling me that the financial system is much more awash with cash to lend than one might have been thinking, even here in canada. Contrast that to one year ago. As the doom-criers would have it, the next bubble may already be forming ...


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## Dr_V (Oct 27, 2009)

humble_pie said:


> all these recent posts in this forum about buying with leverage are telling me that the financial system is much more awash with cash to lend than one might have been thinking, even here in canada.


Either that, or people are just getting more desperate to get good returns. It's a worrisome trend, if you ask me....


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## leslie (May 25, 2009)

It appears the 'humble' knows first hand about how these are structured and his warnings seem appropriate. I would approach the question from a different angle. * "Would you borrow $$ from your broker to buy those same shares on margin otherwise??"* I will bet: NO. So what makes you think this is such a great deal?

I am guessing you don't have any other broker account of your own. So owning shares of your employer will further concentrate your economic risk in that one entity. 

Consider the interest rate. Is it so great? I am borrowing from my broker at 1.5%. And I believe that Revenue Canada will allow an even lower rate before it becomes a taxable benefit. What happens when the bank-rate starts rising. Prime will rise, your costs will rise, and the bank's profitability will fall, leading to a possible fall in value of their stocks.


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## msimms (Apr 17, 2009)

I guess if you have the assets to support the loan in case they call it... fixed rate at prime. pretty low, let inflation eat away at the principle of the loan (pay the minimum back) and pay the interest with the dividends, however opportunity cost would be the asset sitting on standby waiting to cover you in case the bank calls the loan. you wouldn't be sweating that asset to it's potential. 
I dunno, i wouldn't do it unless they gave you the bank shares at a 15% discount right off the bat or so, just to give you a margin of safety in case the stock price goes down. even then I wouldn't treat this as serious transaction, just something to have fun with and be able to afford a loss if the unexpected happens.


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## Bupp (Nov 13, 2009)

The terms of the loan are that no shares can be sold until the entire loan has been paid off in full. There are no margin calls if the shares reduce in value.

If prime increases it does not effect the loan, it is at a fixed rate of 2.25% for the life of the loan.

EDIT:

Because of my tax bracket i will not only be able to claim the interest paid on the loan but i will also get to reduce my other tax payable by $7.71 for every $100 in dividends earned while also paying no tax on the dividends. Sweet deal. *http://taxtips.ca/dtc/enhanceddtc/negtaxrate.htm*


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## Bupp (Nov 13, 2009)

humble_pie said:


> part of the risk that you might not have quite understood is that, even if the stock tumbles badly, you will still owe the bank the full amount of the loan.


Agreed this is the largest risk. Do you think there is much of a chance that in 15 years the banks will have lower stock valuation than they do today?

The thing that to me is the most tempting is that currently the dividends would cover 8/12 monthly loan payments each year and it is conceivable that within the next 10 years dividends will have increased enough to pay fully 12/12 monthly payments on the loan.


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## humble_pie (Jun 7, 2009)

are you saying this bank is willing to make a 15-year loan @ guaranteed fixed rate of 2.25% regardless of the value of the collateral ... hmmmmn ... would they also lend money for ice-free year-round deep-water port development in tuktoyaktuk due to global warming ... maybe condo developments on banks island ...

only 8 short months ago canadian bank stocks were approximately half their present values. From sea to sea the sound of margin calls hung sweetly o'er the land. In the US, banks toppled to 1/10 their former values or vanished outright. News less than 24 hours ago that the 121st and 122nd US bank in less than a year have just failed. But your canadian bank is willing to lend @ fixed 2.25% to buy its shares regardless of how low said shares may drop in a bad scenario. And what happens if the employee leaves or worse gets fired during the 15-year interval.

perhaps you could kindly divulge the name of said bank. For my part i'll add insider trading reports (big insider liquidations in canadian bank stocks over past 9 months.) Might be a great shorting opportunity.


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## MoneyGal (Apr 24, 2009)

oh, snap! Great post, Humble Pie.


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## Oldroe (Sep 18, 2009)

My only question would be whats the max.


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## AdamW (Apr 22, 2009)

*Employee Loans*

I currently work at a large Canadian financial institution. This is the second I've worked for in my career.

The first did offer employee stock loans but the rate was set at prime, not locked in. Payments were low and it was a 10-year amort period.

I've never seen a big bank *lock in* the rate at prime for 10+ years. You might want to check the fine print there.

As a side note these types of investments have worked out well for me in the past, but that's likely because I've never needed to touch the money I put in and the last 10 + years have been fantastic for the banks.


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## Bupp (Nov 13, 2009)

The loan is fixed-rate at 2.25 for up to 15 year amortization. Glad the investment worked out for you in the past. I'm not sure that the next 10 years will be as good for canadian banks as the last 10 were. But I think as long as the dividend payments do not get cut I will come out ahead on this loan?


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## Bupp (Nov 13, 2009)

humble_pie said:


> are you saying this bank is willing to make a 15-year loan @ guaranteed fixed rate of 2.25% regardless of the value of the collateral ... hmmmmn ... would they also lend money for ice-free year-round deep-water port development in tuktoyaktuk due to global warming ... maybe condo developments on banks island ...
> 
> only 8 short months ago canadian bank stocks were approximately half their present values. From sea to sea the sound of margin calls hung sweetly o'er the land. In the US, banks toppled to 1/10 their former values or vanished outright. News less than 24 hours ago that the 121st and 122nd US bank in less than a year have just failed. But your canadian bank is willing to lend @ fixed 2.25% to buy its shares regardless of how low said shares may drop in a bad scenario. And what happens if the employee leaves or worse gets fired during the 15-year interval.
> 
> perhaps you could kindly divulge the name of said bank. For my part i'll add insider trading reports (big insider liquidations in canadian bank stocks over past 9 months.) Might be a great shorting opportunity.


Not sure why you keep talking about getting hit with a margin call. There are no margin requirements on the loan.

Good point on whether I decide to leave/get fired. If that were to happen and the shares were worth less than the loan I would be pretty screwed.


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## msimms (Apr 17, 2009)

Bupp said:


> Agreed this is the largest risk. Do you think there is much of a chance that in 15 years the banks will have lower stock valuation than they do today?


Banks could issue equity and dilute their stock for various reasons, which could definitely drive your stock price down. I mean, with this real-estate craze, prices going too high, people with 35 year mortgages and 3% loans, what will happen if interest rates double, and the bank needs emergency money to cover losses, most likely they'll issue equity in order to keep their balance sheet strong. who knows what could happen.


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## eddieparker (Jun 18, 2009)

Just adding to this thread - apologies if someone else said the same thing in different wording:

Another risk you run is that you're tying up a great amount of capital in an industry you're already invested heavily in - one that supports your income.

If your sector gets hit by hard times, not only will your stocks be depressed, but your job could be at risk as well (and then *you'll* be depressed ).

It pays to diversify. My work sector is all tech, and I know in the dot-com boom, a lot of tech guys got bit buying heavily into their own industry, only to lose their jobs AND have a handful of useless paper.

Forewarned is forearmed.


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## Dana (Nov 17, 2009)

I've worked for two of the big five banks and both offered this scheme to employees. I took advantage of it at one of the banks and it worked out well. No doubt there will be a clause in the loan agreement stipulating that the rate will increase to prime + something in the event you leave your job. 

Prime is so cheap right now, why not?

Just be careful that you do not over expose yourself to this sector. Your income is already dependent on the financial services sector, if you lose your job and the stock has tanked, that would hurt. Hopefully your other investments are diversified away from Canadian Financial Services.


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## Bupp (Nov 13, 2009)

Thank you for the feedback everyone. I decided to go ahead with the investment.

The point about the tech industry made two posts back is definitely my greatest concern. If things go badly and I am laid off then I will have been hit with a double whammy.

The biggest thing in the loans favor to me was that at 2.25% interest less the tax deduction it is likely the interest on the loan will be less than inflation many years so this will be free money.

Hopefully the world doesn't end and the stock doesn't get crushed


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## Bupp (Nov 13, 2009)

It's been 9 months since I took out the loan so I thought I'd throw out an update.

Interest on the loan so far has been $360. <--This is tax deductible

Dividend payments so far have been $780. <--Dividend tax credit means I pay negligible tax on this amount

The stock price is pretty much unchanged. (+$1.00/share)

I've since been promoted and base salary is +50% higher than when I purchased the shares so the loan is now only 66% of salary.

I have the opportunity to do a second loan at 2.75% fixed for 15 years but am holding off unless the dividend yield increases to above 5.50%.

Unexpected downside to the loan were:

- Not allowed to use dividends to help my cash flow as they must stay within the secured brokerage account
- having to pay to get the security registered. (added 0.5% to my costs for 2010)


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## kcowan (Jul 1, 2010)

Congratulations on your successful investment.


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## Square Root (Jan 30, 2010)

humble_pie said:


> are you saying this bank is willing to make a 15-year loan @ guaranteed fixed rate of 2.25% regardless of the value of the collateral ... hmmmmn ... would they also lend money for ice-free year-round deep-water port development in tuktoyaktuk due to global warming ... maybe condo developments on banks island ...
> 
> only 8 short months ago canadian bank stocks were approximately half their present values. From sea to sea the sound of margin calls hung sweetly o'er the land. In the US, banks toppled to 1/10 their former values or vanished outright. News less than 24 hours ago that the 121st and 122nd US bank in less than a year have just failed. But your canadian bank is willing to lend @ fixed 2.25% to buy its shares regardless of how low said shares may drop in a bad scenario. And what happens if the employee leaves or worse gets fired during the 15-year interval.
> 
> perhaps you could kindly divulge the name of said bank. For my part i'll add insider trading reports (big insider liquidations in canadian bank stocks over past 9 months.) Might be a great shorting opportunity.


Wrong on most counts humble. These loans are designed as perqs for employees only. I took out a series of these loans when I was employed. Over a 50 year period you will be hard pressed to find as good an investment as any of the big five. Last I checked most of them (I think excluding CM-which is close) had double digit total yearly returns since 1960. I'm not selling any of mine and I'm glad to hear to OP has done well. I know people who retired with multi million dollars of employee stock using only this practice. Granted it lacks diversification but as history has shown, the big 5 are well managed enterprises and very profitable. The ROE's on their domestic banking business is over 30%. Sorry but bank bashing is a bit of a sore point with me.


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## Cal (Jun 17, 2009)

One question - Are you taking all of the dividend payments in cash to pay the loan? Or are you using your paycheck/income to pay the loan back and reinvesting the dividends, as some of the banks currently pay an additional 1-3% when you reinvest, making your investment that much more profitable? But you need the cashflow to do that.


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## Bupp (Nov 13, 2009)

Cal said:


> One question - Are you taking all of the dividend payments in cash to pay the loan? Or are you using your paycheck/income to pay the loan back and reinvesting the dividends, as some of the banks currently pay an additional 1-3% when you reinvest, making your investment that much more profitable? But you need the cashflow to do that.


Cal,

I wanted to use the dividends to pay the monthly payments. However, because of how the investment account is secured, nothing can go in or out until the loan is fully paid off.

Therefore I am reinvesting the dividends.

Because of the pay raise cash flow is not an issue, however if I was still in my old role not being able to use the dividends to make the payments would have sucked!


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## alphatrader2000 (Aug 18, 2010)

Bupp said:


> My employer will lend me money to buy company stock (big 5 bank).
> 
> - fixed rate loan at prime
> - stock dividend pays more than prime
> ...


Technically what you are missing is the fact that you are not hedged. Your investment and income are the same. Therefore, if for whatever reason (remember lehman, bearsterns, nortel) the bank goes bust then you loose your job and investment.


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## Square Root (Jan 30, 2010)

alphatrader2000 said:


> Technically what you are missing is the fact that you are not hedged. Your investment and income are the same. Therefore, if for whatever reason (remember lehman, bearsterns, nortel) the bank goes bust then you loose your job and investment.


You are correct of course, but the fact that the banks escaped relatively unscathed and will be subject to new risk reducing capital rules, should mean that a major long lasting bank meltdown is extremely unlikely. The fact that he will not be subject to a margin call and the dividends more than carry the interest makes this a no brainer to me. When. I did this many years ago the interest rate was set at the then current dividend yield. As the bank raised dividends I became cash flow positive (other than principal repays). Made a ton on these shares.


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## Bupp (Nov 13, 2009)

It's been one year since I started this thread so I figured we are due for a follow-up.

-Paid $360 in interest
-Earned $750 in dividends
-Value of shares increased by $4000
-Paid extra $100 in set up cost (unexpected)
-Paid $15 annual fee (unexpected)

What is really great is that come income tax time, I can claim the $360 as a deduction so will reduce my tax bill ~$75. Also because of dividend tax credit I end up not paying any tax on the dividends (actually get a refund of $45).


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## furgy (Apr 20, 2009)

Congrats Bupp , I love it when people make money.

Good move.


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