Rain, Rain, Come Again

My oldest made the trip home this weekend from his job in north central South Dakota.  Along the way he noted that he was seeing fewer cattle than he normally observed along the way.  He also noted that some fields that a month ago were full of wheat are now being baled into hay.  It is a sign of the times.

The latest US Drought Monitor has all of North Dakota, almost all of South Dakota, and the eastern third of Montana in a drought as of June 20, 2017.  A big portion in east Montana is rated as extreme, as spots in the Dakotas are.  Most of the rest is in the moderate to severe drought area.  The drought is beginning to move wheat prices higher, as the crop yields and quality is expected to suffer. 

Drought is a win-lose situation, if you are in an area not impacted by the drought, you will have a higher price for your commodity.  If you are in the drought area, you don’t have the commodity to take advantage of the higher price.  The other problem with this drought now for the Dakotas is that it comes after we are a few years into this commodity super-cycle of lower prices.  The days of high wheat prices in 2012 and 13 are but a memory now.  So, farmers have been dealing with much lower gross and net revenue streams over the past several years.  Many of you are now dealing with maybe the second year of how to deal with carryover debt that has not been resolved yet.

This will have a negative impact on the lenders in the area as well.  Note that not only the producers of grain and cattle, but also small town businesses are also going to be negatively impacted.   Dr. Kohl of Virginia Tech, believes that these factors will cause up to 30% of operators to liquidate in the next few years.  I think in areas where the weather is not favorable, that number will be even higher. 

Now is the time, and for many of the lenders, you have already been assessing this, to identify additional risk you may be prone to and seek to exit relationships where you can.  Kohl outlined ten credit risks in a recent article and believes that if you have seven of them present and can exit the relationship, you should.  With the drought, that number may be lower.

1.        Trade volatility-movements in the commodities markets can easily cause an operator to sell for a lower than break-even price.  Your producers need to know where their break-even price is at and what protections they are undertaking to protect them from operational losses.

2.       Living expenses-we often come across lenders who want us to underwrite deals with lower living expense factors.  These rose rapidly during the good price times and take longer to come back down.  The ND Ag farm record reports the median family living costs at $72,000 annually.  If the farm operation is too small and the only source of income is from the farm, it is likely not profitable enough to cover family living expenses. 

a.       Here also watch off-farm sources of income.  Before the price peak, spouses would often have jobs off the farm to provide extra income and also cover insurance costs.  When the prices rose to the stratosphere, some quit their day job since the farm was able to take care of their family expenses and more.  Now that pattern has flipped.

3.       Non-farm capital expenses-watch out for the new toys, personal vehicles, high end vacation homes, boats, retirement houses in Florida.

4.       Cash flow margins and taxes-poor cash flow margins and poor tax planning may result in too much taxable income.  Also watch managing from tax records without factoring in accrual adjustments. 

5.       Debt concentration-if you have too many loans to small operators with too much debt or too many loans to operators in poor producing areas, these both cause problems.

6.       Collateral complacency-the lender who thinks they are so well secured that they can lend without covenants or proper controls may face losses that devalue their collateral position.  Always focus on cash flow and look at collateral value with suspicion. 

7.       Regulator overreaction-regulators have acted moderately so far.  They have provided warnings but have not brought down the hammer yet.  When that does change, there has been a tendency in the past to overreact and force the lender to push out too many loans quickly with will result in excessive legal costs and more losses.  Take time now to cull out the portfolio in a sound manner.  Also make a practice to not go into collection on a credit where you have not warned the borrower at some point in writing if they do not perform, that you will request to be paid off.

8.       Alpha pups and dogs-Alpha pups expand just for the sake of expanding without considering the need for profits and capital.  Alpha dogs expand wisely and strategically to cover these bases.  Are you dealing with a borrower who has either of these tendencies?

9.       Fraud-watch out for this as the time gets worse.  Grain checks do not show up at the lender’s door or farm critters may disappear.  Equipment may also be an issue.  Farmers may trade in your collateral for something else without telling you. 

10.   Next generation-changing the farm operations and ownership from one generation to another can be a challenge.  If the farm is too small to successfully produce sufficient net revenue for the family or if the young farmer is too leveraged, it will set up the farm to fail. 

Kohl said that if you have 7 or more of the above present, you need to exit the relationship.  This may be too lenient.  If you see 3-4 of these characteristics, it is time to begin planning to move the relationship or to at least begin using strong controls to manage the farmer.  The presence of any one of them warrants a discussion with the borrower. 

The last significant ag downturn we had lasted for 7 years.  We are sitting in year 3 or maybe 4 in the present challenging times.  I don’t see the issue of the low prices ending soon.  Couple this with some poor weather and you have a formula for disaster for marginal producers.  Only the ones large enough and who have enough price and operational expense controls will survive. 

When the producer is hurt, the next one hurt is the lender.  Now is the time for a more aggressive stance to managing your farm credits.

Do You Have a Culture of Continual Improvement?

There are a couple of things I know that are true about change.  First, for us to improve in life, it requires change.  Second, what is very good today may not cut the mustard tomorrow.  Third, if you do not improve, someone else will leave you in the dust.

We see these characteristics in finance all the time.  Think about all the different changes to the delivery of financial services that have hit over the past decade—internet banking, using an app to bank on your phone, online mortgage and loan products, texting payment, crowdfunding—just to name a few.  Now would any of these items ever come up if credit union and banking folks decided in the year 2000 that what we have now is all OK and there is nothing ever more in the future that is needed to improve the communication of delivery channels between the client and finance professionals.

We must hoist the sacred cow upon the alter of improvement and start the bar-be-que if we are to ever grow as a company.  For this to work best in an organization, it requires a culture of continual improvement.  This concept is so important to some companies that you can find it as one of their core values.  But even if it is not identified as a core value, you still need a heart seeking attitude of how we can do better.  How can you grow?  If you don’t it is like my Aunt Lil used to say, “Once you have fully ripened, the next step is that you start to rot!  So, stay green and learning in life!”

This desired culture requires that you take time to inspect everything that you do to see what can be done better.  Many times, it is easy to do what we call the “spilt milk” analysis on something that went wrong.  In my last banking job, we took time periodically to do this with loans that went bad.  Sometimes, we could identify things that we failed to do at underwriting that would have mitigated some of the loss.  It is easier to look at a failure and analyze what could be done better.

We don’t often think about inspecting the times we succeed.  Often that time is spent on celebrating.  But with every win, there are key actions that should be repeated for the next success.  There are also those areas where further improvement can be made.  Recently, Bill Belichick, coach of the New England Patriots, was asked what other things he would want to accomplish in his coaching career before he retires, as he is already one of the most successful coaches in professional football history. 

“Well I just want to have a good practice tomorrow.”  was his reply.  This shows a commitment to continual improvement.   It also shows a method to break down what needs to be done in small steps.  It is easy to make today better than yesterday.  It is nearly impossible to make this year better than last.  But if you work on making each day better, you will accomplish the latter goal. 

Continual improvement creates momentum in the organization.  Momentum for items that are new or improving, can be one of the best friends of a leader.  A leader who is trying to swim upstream against a tide of negative momentum in the company, often fights losing battles.  I found this out years ago when doing martial arts.  If you can use the momentum of your attacker, it is much easier to get him to fall.

So, once your organization has decided that you will be committed to continual improvement, your next step is to brand that.  You may not want to just call it “a commitment to continual improvement.”  Maybe terms like “make it better”, “finding new solutions”, “grow outside your confines of yesterday”, or “do more today than yesterday” express continual improvement in a catchy way that the team can latch onto.  This language is important as you can drop it in your conversations with others in your company.

After branding it, the next step is for the leader to model continual improvement.  A leader must show that he/she is getting better personally to motivate the team to do the same.  The question here is if everyone in your area is doing the same things you are doing to get better, are you improving or are you just keeping busy each day.  If you want continual improvement as part of your culture, you must show it intentionally each day. 

The next step toward making continual improvement a part of your culture is to teach it.  Teaching a concept always helps you master that concept or skill.  We see that on our end when we teach lender classes.  This does not necessarily mean that each leader must get up and give sermons on continual improvement, but it needs to be sprinkled in normal conversations and may include an occasional sermon.

Andy Stanley gives five different questions that need to be answered when you teach a behavioral concept that you want in your organization.  You need to wrap your culture characteristic around each of these questions on a continual basis. 

·         What it is?

·         Why is the characteristic important?

·         What will it require of us?

·         What does it feel like once we have that?

·         What is at stake if we have it and if we do not?

After continual improvement is taught, the next step is to institutionalize it.  Now this is different for different companies.  It may include items like allowing your new employees to evaluate the company once or twice in their first year of work.  Another idea is to do a review of every major event once an event is complete.  We eliminated the traditional employee review process for a quarterly check-up that has many ways a team member can judge what is working and what it needs to be changed.

The final step is to recognize or reward continual improvement.  People will repeat those items they are rewarded for.  So, this can be publicly rewarding things that team members do to improve.  This encourages further innovation and initiative.  These items can be small or they can be large. 

You can probably guess now that this process is one that requires it to all be repeated, over and over again, in a company if they are committed to getting better each day.  Sometimes, a good place to start is to see what are you doing that is old and tired with your staff or clients.  Sometimes seeing that will help put ideas in your mind of where to begin the path of continual improvement.



In other news, do you know who has silently become a giant bank that you do not think of as a bank?  Amazon!  Amazon reported that Amazon Lending Service has surpassed $3 billion in loans to small businesses since it started in 2011.  In the last 12 months alone, Amazon has loaned over $1 billion to businesses.  This helps the business expand and hikes up sales for third party merchants, which provides another Amazon revenue stream. 

Amazon Marketplace VP Peeyush Nahar stated, “We created Amazon Lending to make it simple for up-and-coming small businesses to efficiently get a business loan, because we know that an infusion of capital at the right moment can put a small business on the path to even greater success.”

The rate of repeat business is high as over 50% of the 20,000 small businesses that use Amazon Lending, end up taking additional loans.

So the lesson here is if you only think your main competitors for lending will always be banks, you are wrong.


Similarities and Differences in Consumer and Commercial Sales

Credit Unions tend to do quite well with serving their membership.  This service involves expanding the share of wallet of the member, whereby more of the financial services used by a member is supplied by the credit union.  Many CUs have a strong sales cultures that raise the awareness of their membership for the various consumer services they offer.  Some even go as far as measuring and rewarding successful efforts on the sales front, in a healthy sales culture.  We saw last year the results from an unhealthy sales culture with Wells Fargo!

But can a consumer sales culture be transformed to a commercial one?   Before leaders implement this change, it is good that similarities and differences between the two marketplaces are explored. 

A big similarity is that both areas require a command of the products by the loan officer.  In consumer, you must understand the different loan types, pricing matrix, and parameters that you will do loans in.   Commercial requires the ability to assess, manage, and get paid for the risk in the credit.  The discovery period for commercial risk is much longer than consumer risk and often involves assessment of several additional factors.  In the end, members on both sides enjoy working with people they view as competent and knowledgeable. 

One big difference is the sales conversion cycle is much different in consumer and commercial.  The consumer cycle is often shorter and is transaction oriented.  The member comes into the credit union needing to finance a new car or to open a checking account after they have moved to a new city.  Typically, this occurs after the individual has already researched and made their decision on what they need and which institution they want to use.  The transaction becomes the springboard into building a relationship and the initial cycle is short.

In commercial, the sales cycle is quite varied and can be very long at times.  Relationship building begins well before the loan is closed and often may take years to develop.  Often, showing that you are competent and can deliver for the business over a period of time, is what is needed for the business borrower to open up to you when a request with the primary institution has been delayed or denied.  The “no” answer in many cases is really “not now” or “not in the way you presented it to me”.

A commercial loan creates a bonding relationship between the company and lender, whereas many consumer activities are more transactional in nature.  Once the MBL is closed, ongoing check-ups are required to monitor the health of the business and assess if there are any changes to the risk profile for the borrower.  Most consumer transactions do not require frequent check-ups on the borrower if the payments are made timely. 

One key to success on both sides is having various folks that send business to you.  We call those centers of influence or referral sources.  On the consumer side this could be car dealers or residential realtors.  Commercial centers are often commercial or land realtors, economic development entities, attorneys, and accountants.  Developing relationships with these folks can help to drive commercial business your way.  It also requires getting out of the office.  I believe that much of the consumer side is reactionary to a member coming in, while the commercial side has success based on going out. 

Advertising is also different between the two lines of business.  Consumer advertising is often dominated by a special rate or program.  Commercial marketing is creating more top of mind market awareness in the community.  Rate cannot be decided upon until the financing request and risk inherent is known.  Also, starting out the MBL conversation with rate, places the lender at a huge disadvantage in the negotiation.  It also makes you gain business by often being the low-cost leader.  That is not a position that most smaller and many larger institutions want to get into. 

Both sides will require lenders who are great listeners, highly skilled in their field, and creative in order to long term success.  My hope is whatever area, consumer or commercial, you will win on the field that you play on.

Estoppels and SNDAs, Which to Use for Lending?

At times when financing real estate with commercial tenants, lenders will use legal forms called Estoppels or Subordination, Non-Disturbance, and Attornment forms.  Now I have never seen these for a residential rental and I have not seen them for smaller commercial deals or small leases. 

The most common document for a lease administrator is the estoppel.  This document is usually sent by the property owner or management company to a tenant, whenever the owner is refinancing or may be selling the property.  Either way, the estoppel is to find the executing party to specific statements of fact.  These may include certain details about the lease terms, rental rates, maturity, and status of any breaches of the lease contract from the landlord or the tenant. 

The purpose of the estoppel is to benefit third parties, like lenders, who may not understand the details of the landlord-tenant relationship.  Courts have held that a landlord can’t use the estoppel against a tenant.  An example her may be if the tenant has “agreed” that the landlord has not overcharged for common area maintenance charges.  But care must be given by the tenant when asked to execute the estoppel.

A more detailed form is the SNDA.  Actually, this is three agreements in one.  The first is subordination.  This permits the lender whose lien is junior to the lease (usually because the lease was recorded before the mortgage was recorded), to be recognized as superior to the lien of the lease.  Once the lender’s lien is superior, in the event of foreclosure, the lender can eliminate all junior liens.  Most lenders will insist their loan is in a first lien position.  Most property owners recognize their property is more valuable and attractive to a lender if the lease is subordinate to subsequent mortgages.  Most landlords will have leases that frequently include provisions that declare the lease is subordinate to the mortgage.

The next part of the SNDA is the non-disturbance section.  This section protects the tenant and allows the lease to stay in force if the tenant is not in default.  A tenant who has a long-term lease or who has spent a large sum of money for their custom tenant improvements, has a big vested interest in having this section in place.  This section may need to be added to the lease, as many of them may not include an adequate provision here.  For the lender, the SNDA means that if the tenant is not in default, the lease remains in place, even after foreclosure.

The final section is attornment.  This section protects the lender and it binds the tenant to fulfilling the lease terms, even after the lender forecloses on the property.  This is necessary in some states where lease agreements are extinguished during foreclosure.  This creates a bond between the tenant and the third-party mortgage holder. 

Many of the SNDA agreements also have a survivorship clause where the agreement will continue if the lender on the property changes due to refinance, lender merger, or loan sale to a third party. 

It is also worth noting another document here that is executed with the mortgage or deed of trust, and may be included inside that document.  This is an assignment of rents.  It allows the lender to step between the landlord and tenant to collect rents in the event the property owner fails to make payments in a timely manner, yet continues to receive rent payments from the tenants. 

It is important for the commercial lender to have knowledge of these forms--estoppels, SNDAs, and assignment of rents—when working with commercial tenants on a property you are financing. 

Graduation Thoughts

May is the time of year that we see many completing degrees or finishing high school.  My oldest son, Zach, just completed his bachelor’s degree.  One of our team members, Trevor, finished his MBA. 

One thing that is typical of graduation are graduation speeches.  Typical themes in these oratories are often like these: “the world is waiting for your talents”, “you are entitled to great things”, or “what you have completed today is your first step to lifelong success”.  Often, these speeches are filled with clichés and ideas that just are not true with real life.  So, in the effort of being realistic, I offer some of the following.

The world is not waiting for your talents and does not care who you are.  Once you begin a new job, you always begin as the new guy.  Your boss and co-workers already have a set way of doing things and often the new folks on the team will take more time and energy and may be viewed as a distraction by some in getting their work complete.  You must go out there and prove yourself.  Even if you are the number one draft pick on a professional sports team, you still have to prove yourself. 

You are not entitled to anything.  This is the unfortunate carry over of how we have coddled children throughout their lives.  We do whatever we can to insulate them from hardship and disappointment.  We now have snowflakes who think they have a right not to be disappointed, offended, or hurt.  About the only thing I can guaranteed that you will have are problems and obstacles.  It is how you approach those that will refine your character.

You will experience failure and success, not only success.  I have always learned more from my losses than I have from my wins.  Take to heart Winston Churchill’s thoughts, “Success is going from failure to failure with great optimism.” 

Learn persistence to stick through the tough times.  Quitters will never make it to the finish line.  Often the true people who finish the race may not be the smartest or most talented.  They are the ones who want to finish it, more than the others around them.  They decide to push forward, no matter how bad they may want to quit and lie down.

You have only started to learn what you need to know.  Completing a degree is wonderful, but you have barely started to learn what you need to succeed in life.  Commit to life-long learning.  Realize that your best education will happen outside of the classroom.  Treat every day as a new entrance into the school of life and learn all that you can.

Never forget to be full of gratitude.  Take time each day and set aside special time at the end of the week to thank those who have given to you of their time, talent, and treasure.  Never allow yourself to become so important that you lose sight of being thankful.  It helps you to stay grounded.

Find out who you are and your purpose, then live it out.  We all struggle with these questions.  You need to discover the answers and then orient your life to fulfilling your missions.

Never lose sight of the power of one individual.  A single person can have incredible power to make a difference in the world, once they out their mind to it and devote their energies to the cause.  Don’t just settle for what can be done in the group.  Work to excel in whatever roles you have personally and those in the group.  So, go make a real difference. 

The Time Factor

The scarcest resource we all have is time.  We are all allotted a specific time here on earth.  How we spend that time and the relationships we invest in, will determine our legacy after we are gone. 

The time factor plays an important role in business decisions.  It is often overlooked when deciding whether to invest in a new piece of equipment, capital asset, or even developing your team.  There is a tendency for the leader to just look at the dollars and cents on the surface and fail to grasp the true underlying costs and benefits. 

Can you imagine what our world would be like today if people decided to not purchase an automobile since the initial cost of a horse is cheaper?  What about how many cars would be in the world today if the investment was not made to building the assembly line for manufacturing?  I would guess it would have been cheaper to not spend the money on the assembly line.  But, imagine the limitations in production if cars were built in a big building with no organization.  Maybe workers have cars in different sections of the plant and put the car together at their own pace and each in a different way.  The lack of streamlining the production method would slow output to a snail’s pace.

So, the question is what areas of your business have you not invested in to increase efficiency and are still stuck in the pre-assembly line days?  Now if you do not have the financial resources to make the investment, that is one factor.  But if you do, you need to consider the time factor when deciding. 

The first impact of time is how much time will the new item save in staff time.  This is sometimes overlooked when a company is faced with a decision involving a capital outlay.  A little over a year ago, we began to look at what was a large capital investment for Pactola.  This was hiring a software engineering company to write a program for us that is used to securely save our loan file data.  The cost was expensive.  But when we looked realistically at the time savings from the investment, we estimated this would pay for itself inside of 14-16 months of saved staff time.  When we looked at the capital outlay in that fashion, how could we not make the investment?  Considering the time factor should be a portion in your decision process.

The next factor on time is to figure out how can time savings be better spent.  So, is your organization better keeping things as they are now or are you better to make the investment and utilize this time in other areas?  For us the answer was easy, time saved can now be spent interfacing with credit unions and other deals we need to underwrite.  In economics, this is known as opportunity cost.  The basis is that every time you engage in some activity, you are sacrificing time that could be spent in another activity. 

Our highest and best use of time is to serve you to make you successful in commercial and agricultural lending markets.  So, reasonable capital investments that will keep us on tract toward our overall mission, are warranted.  This is also driving us to make the next improvements to the PacPortal.  This summer we should have our secure file sharing platform upgraded to provide notification to users of significant file changes when we send it.  The upgrade will also provide some significant time savings on our end and make the upload process much quicker.  This time savings will help us fulfill our mission. 

Tackling the time factor may involve the slaughter of a sacred cow in your organization.  Now sacred cows make great steak but slaughtering just for slaughtering can create its own waste of time.  Before the sacred cow is killed and the feast ensues, you must ask if this action moves the organization forward.  If the answer is yes, then sharpen the knives!

Staff time and opportunity costs should be considered when looking at a capital investment as well as the obvious cost of the asset, cost of installing the asset, ongoing maintenance costs, and education specifically tied to the equipment.  When all those factors are considered, the high cost of the asset may be more affordable than you realize.



Are You Up or Getting Up?

In one of my banking jobs in Missouri, I worked with a Business Development Officer named Roger.  Roger was one of those people that you wanted to hang around.  He was always positive and every time you left a joint call with Roger, you felt like you had grown an inch in your own character development.  Everyone liked being around Roger, since he always made those around him, better. 

Roger was also very positive.  He once told me, “Phil, I am never down.  I am either up, or getting up.”  It is in that statement that one of the most profound truths in life reside. 

The first thought that came to my mind is the scene in the movie Chariots of Fire, where Eric Liddell is in a foot race and is knocked down by another runner as they go around a turn.  The movie slows down as it shows Eric rolling to his feet and then running as fast as he can.  Soon, he reaches the last runner and then passes him.  One by one, each runner is passed by Eric until he passes the last one and wins the race.  By the way, if you have never seen this movie, why haven’t you?

There is a temptation to look at those who are successful and think they have had it easy, that all the breaks have gone their way.  We use terms like “lucky” to describe them.  This view is incorrect.  Successful people have the same challenges, struggles, and problems as the rest of us have.  They have been knocked to the canvas, or stuck out more times than they can count.  We should not consider them immune to the struggles that all of us experience.

The difference is the winners refuse to wallow in self-pity on the canvas when they are knocked down.  They just simply get back up.  And when they are knocked down, they get back up again.  It reminds me of a saying by Winston Churchill, “Success is going from failure to failure with great enthusiasm.” 

Every one of us gets knocked down.  It is not a matter of if you get slammed to the ground, since we all will be there.  The question is what are you going to do once you have a severe blow.  Will you just lay there?  Or will you say, “This defeat does not define me.  I am to get back up.  I am to enter into the arena again.”  It is those people that are successful. 

Calvin Coolidge once stated, “Nothing in this world can take the place of persistence. Talent will not: nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not: the world is full of educated derelicts. Persistence and determination alone are omnipotent.”  Persistence is getting back up after you are knocked down.  Then it is getting back up again when you fall. 

Remember, both successful and unsuccessful people will be knocked down, have obstacles, and fail at times.  We all have these and we all will.  It continues as long as we are alive.  The question is, do we get back up?  So I encourage you to be like my friend Roger.  You can be either up, or getting back up!

A Clear Vision for the Path Ahead

When we lived in Colorado, we often made trips back to see family in Missouri.  On one of those trips in November, we started out with a wonderful 70-degree day in Pueblo.  We traveled up to Colorado Springs and stopped for gas.  As I was filling up, I noticed a massive wall cloud coming quickly from the west and a sharp cold biting wind hitting my face.  My wife received a call from a friend for us to watch the weather as a storm was approaching quickly.

The next stretch of road we traveled on from Colorado Springs to Limon was US 24.  Now this is a stretch of road winding through the eastern Colorado plains that has one lane in each direction.  There also are not a lot of towns the road goes through and the trip usually took a little over an hour.  We left the gas station and I noticed that the temperature had already dropped below 50. 

Within 20 minutes the temperature had plummeted to the upper 20s and the cloud was overtaking us.  The wind whipped up and tossed our SUV back and forth on the winding road.  In another 5 minutes a blizzard started.  Snow flew so thick in front of us that we were forced to crawl along at under 20 miles an hour.  Sometimes, you could see the taillights of the car in front of you, and most time you could not.  We were part of a group of six cars that snaked slowly through the blizzard in white out conditions. 

There is a verse in Proverbs that says “where there is no vision, the people perish.” If you have ever been driven in conditions where you cannot see, you can understand how this verse can be true.  I did find out where the term white out came from.  Three hours later, when we finally passed out of the storm into clear skies, white was the only color in my knuckles as they clutched onto the steering wheel.

Sometimes organizations can lose their vision.  This could come from a lack of clarity of purpose.  It could be the result of a failure of the group setting dreams and goals.  It may come from being lost in the everyday tasks and forgetting the bigger picture of where we are going.  To combat this, many companies have created vision statements. 

A vision statement starts with a dream.  When we arrive at our destination, what will it be like?  What will we be like?  What experience will our stakeholders be able to talk about?  What will others say about us? 

That dream needs to be turned into goals.  And not just regular goals, but great goals.  I believe every one of us has built in them the desire to be great and to be part of something great.  For a credit union, it may be to reach a certain asset size, expand their territory into a certain geographic footprint, or achieve membership numbers of a certain percentage within your community.  It may be as simple as just being viewed as the best financial resource that your membership has.  In their eyes, you will be great!

The vision needs to be communicated and embraced by everyone in the organization if great things are to be achieved. This characteristic is found in every individual or group that excels and achieves great things, even at times when there are unsurmountable circumstances arrayed against them.  We witnessed this earlier this year when the New England Patriots scored the last 31 points in the Superbowl to defeat Atlanta.  At one time with 8:31 left in the third quarter, the Patriots trailed 28-3 and were given a 0.5% chance of winning the game.  I think the difference was a clear vision that every team member bought into and a commitment for everyone to do their job to fulfill that vision. 

Recently, in our strategic planning retreat, we formed the beginning framework of a vision.  Now like all visions, this one will change over time and there may be some adjustments as we move forward.  Our vision is as follows:      

                “Pactola is a leading resource in the industry serving financial institutions throughout the United States by assisting them with commercial and agricultural lending.  Our work helps our stakeholders meet their goals by:

·         enlarging their impact in their communities;

·         elevating their vision to the possibilities around them;

·         exploring options, they believed impossible in the past; and,

·         expanding their reach.

We have expressed this vision in various ways over the past few years.  We want to make credit unions able to compete head to head with large regional banks and WIN clients.  We want to be known by 80% of the credit unions in the United States who do business loans.  We want to be the best MBL CUSO that is constantly sought after for our expertise.  We want to make you better.

If you have not joined us, now is a great time to.  If you are part of our group, we stand ready to help you in 2017 to make this your best year yet in making a real difference in your business and farming community.



Why is Your Credit Union Here?

I thought of this question this Sunday afternoon.  Our church is going through a sermon series designed for the listener to answer two large questions of, “Who am I?” and “Why am I here?”  Answering these questions are fundamental to finding direction in one’s life.

But what about an organization, specifically, what about your credit union?  Who are you?  Why do you exist?  When this question is asked, we often begin to hear of stories about how the credit union was founded, decades ago.  That story tells how you were started and not who are you and why you exist.  Many of you are in institutions which look vastly different today than they did at the beginning.  The field of membership may be different, the size of the institution, the leadership and team.  For many, who you were when the CU was birthed, does not have any implication as to who you are today. 

Organizations that achieve success, like people who achieve success, have an answer of who they are and why they are here.   Many times, this begins with a mission, vision, and values statements.  Many organizations have them; the best ones live the statements.  They are defined by them. 

Now if your CU has a mission, vision, and values, that is a good start.  But can you go to any employee and have them tell you what these are?  Often, these ideas are put down on paper and buried in an employee handbook or in a lunchroom on a wall.  But the staff does not really, really own these words as a guiding force for their daily actions.  Many of these may just be words thought up by the marketing or HR departments and not those of the team as a whole.

To be transparent, at Pactola, we operated the same as many other institutions where there was no ownership of our mission, vision, and values.  We had these drafted in our employee handbook, but they were drafted by myself and there was no common vision among the team and board as to what we should be.  No one, not even the author of these ideas, could recite them if asked to.

Now this did not mean that we wandered aimlessly from day to day.  We had a code of action, vision, and ideas that ruled our work.  We just never set down these ideas on paper.  I think our situation is similar to many other organizations.  Perhaps it is the same as yours. 

So, a couple of weekends ago, we held our first retreat with the board and our staff together.  Some of the tasks we completed was to form our mission, vision, and values as a group.  This is now something that we can own together.  Now these ideas are subject to some adjustments as we want every word to be impactful. 

Our Mission is to facilitate your success in the commercial and agricultural lending markets.  When you think of business lending in your community, you will think of established banks of local, regional, and national size.  These banks may have established departments and seasoned lenders.  They may have a customer base that is something you wish you would have.  Well, our mission in helping your success is to help make you compete with the commercial banks in your area.  This competition is not always on the cheapest rate or the highest leverage.  Our goal is that you will become a trusted financial advisor in the areas of commercial and agricultural lending in your communities. 

This means that you will be spoken of around the table at the local coffee shop when the farmers gather.  When the economic development authorities in your town have a new project, they will begin to include the credit union in the mix.  We are here to help you shine.  Just think of us as the guys in the background who are hooking up the power to your floodlight. 

I will write more of our vision and values later.  But the important point here is that in your life individually, as well as in your credit union (or whatever other organization you are a part of) knowing why you are here is essential.  It is the first step to aligning your team for success. 

Start at Home When Searching for MBLs

There is a question that is asked of every credit union after they have realized the importance of business lending to their membership.  Business lending is one of the best ways to serve your membership and your communities.  It truly makes a difference with establishing relationships that create employment, increase wealth, and fulfill the dreams of owners.  In many ways, it helps the credit union take its rightful seat at the table of economic progress in the community, when new companies are discussed with local economic growth officials.

Once that decision is made on what you want your credit union to look like in relation to your area that you serve, the question comes up.  It also is asked in shops that have seasoned commercial or agricultural credit departments at times as well.  The question is, “Where do we find our next commercial relationship?”

You will note that I said, “where do WE find…”  This begins with the recognition that commercial is much different than the consumer and mortgage lending credit unions do so well.  It is common to utilize mass marketing, rate specials, Realtor days, or auto shows to generate quick, transactional loans.  But commercial lending is much different.  Mass advertising of anything other than to raise awareness that we offer this service, often has the result of bringing in the rate shopper or the relationship that has already been turned down with several other banks before it lands on your door. 

Commercial prospecting is that in and of itself.  It requires work to seek and develop good business relationships.  At times, it will seem as though you need the patience of Job!  One of my largest clients was a construction company that I called on for five years before we landed substantial business.  Quitting along the way, which was very tempting, would have not yielded the desired results.  Persistence in relationship developing is a good topic for another blog.

So, asking, “where do WE find…” is the first step in realizing that the journey into business lending is much different that the transactional nature of consumer. 

Since business lending is based upon relationships, the starting point must be with your own membership base!  Undoubtedly, you will have small business owners, landlords, and entrepreneurs as members to your credit union.  This often can be the low hanging fruit as these people already know and like you.  You also know them and may understand more about what companies may be a good credit fit for your institution.  You understand the character of the owners. 

This may seem a simple and obvious place to start.  You may believe that all your members know that you are work with commercial and agricultural lending.  But I continue to be amazed at how many long-time members of credit unions with seasoned MBL departments, fail to realize that their credit union does business lending. 

Start with going through your membership list and identifying the successful farmers, business and property owners that are already working with you on the consumer side.  Perhaps, some may already use you for business deposits.  Now it is time to deepen that relationship with introducing them to your business department.  It is also important, now, to not let the size or complexity of the deal intimidate you.  Now is the time to listen and learn what the member’s need is.  We also are a resource to help you.

With all other things being equal, people enjoy doing business with their friends.  You may have already established deeper friendships than some of these businesses have with their local banks.  It is time to deepen that friendship.  It is also time to seek out new friends with successful business owners in your community that to not yet use your credit union. 

We stand by to help and support you.  Our mission is to facilitate your success in the commercial and agricultural lending markets.

Pulling in the Same Direction

When I was a lad, one of the summer jobs I picked up was working on a hay crew.  Now this was in the days before the large round bales and huge block bales that you see today.  Bales of hay were a smaller block size and could typically weigh between 60 – 80 pounds, depending upon the grass that was cut and how much moisture was in there. 

A hay crew would consist of someone who drove the tractor that pulled the wagon, a stacker or two who stacked the bales on the wagon, and several throwers who would walk alongside and chuck the bales up to the stackers.  In my day, you may get 5-10 cents for each bale.  We would stack the wagon as high as we could without tipping over the bales, then haul the hay to a barn to store the bales in.  It was not the most pleasant job in the hot and humid Missouri summer. 

The job required teamwork.  If the driver was going too fast, it was too hard for the rest of the team to catch up.  If he jerked the wagon a bit, the bales could fall.  If the stackers did not stack bales fast enough, the structure would likely fall.  If the throwers did not follow the right pace, it would take longer to get the job completed.

One very frustrating summer day, my cousin, Jim, was driving the tractor for our hay crew.  This job took a lot more time than it needed to in the 100 degree and 95% humidity of that fine Missouri summer day.  Jim jerked the tractor a lot, causing the stackers to fall and tipped over the bale structure.  He also ran one side of the tractor in a ditch that was a few feet deep.  This also did not do any favors for the crew.  After completing a job in six hours that should have taken half of that time, Jim pulled the wagon into my Uncle Bob’s barnyard for us to unload. 

Our task was to first move bales that had dried on the side of the barn, up to the second floor of the loft, then replace those bales with the ones we had just pulled from the field.  Bob had a large beam that protruded out from an opening in the loft.  Bales could be attached at the bottom and pulled from the bottom through a pulley contraption to go up to the loft where other people could unload them.  That way we did not have to hold bales over our heads when we walked up a ladder.

Uncle Bob’s pulley contraption was tough to use.  We grunted and pulled; then pulled and grunted some more, but we never could get the bales to zip up to the top as we had seen our uncles and fathers do.  We must have worked for an hour on this when Uncle Bob came in from another barn where he had been shearing sheep.  After about ten minutes of watching us and chuckling, he finally said, “Boys, you are not pulling in the same direction.  If you flip this lever (and he showed us the lever), this system will work together so when both of you pull on the bottom the bales will zip up to the top!”

So, the problem had been the operators!  Once the levers were in the right place, it was easy for two of us on the ground to yank on the ropes and make the bales soar to the second story.  We finished moving those bales in record time.

I thought of that story this weekend during a business retreat.  During that time, it became evident that in some ways, our group was not pulling in the same direction.  It kind of reminds me of people rowing in different directions in a boat.  You tend to exert a lot of effort and just go in circles. 

So, alignment is important in any group, family, or organization.  We need to align our mission, values, and vision to how our day to day work is executed.  We need departments pulling in the same directions in our organization toward a common goal.  We need to make sure we are all following the plan in our families or chaos may ensue.  Otherwise, we will exert a lot of effort, and have a lot of activity, but not accomplish great things as we are pulling against each other. 

Another way to think of this is a picture from the book of Ecclesiastes that states “a three-fold cord is not easily broken.”  Now if each strand of that cord is placed separately from the others, the individual strings can be severed.  But cutting the rope is harder if all cords are in alignment and intertwined with each other.

The lesson here is to ask yourself where in the organization, the business, or the family is there a lack of alignment?  How can we get back to pulling together instead of against each other?

2017 Legislative Outlook for Commercial Real Estate

President Donald Trump took some of the country by surprise with his victory in November.  The Republicans also continued their control in the House and Senate, as well as more dominance by elected officials throughout the country.  Since Obama’s first election in 2008, Democrats have lost over 1,000 elected seats throughout the country. 

In the next four or eight years, we will have to see what the Trump presidency means for commercial real estate.  But we can already see some factors that will influence the direction of real estate from a legislative and executive prospective already. 

The first of these is to rollback unnecessary burdensome regulations that have been established in the past.  Trump comes into office with the background of a businessman and not a politician.  So, he has experienced firsthand the challenges to business and real estate that are posed by rules which ultimately only benefit those who make and enforce them as compared to the good of the public.  This has already shown in some of his executive orders aimed at easing the burden of Obamacare, one new regulation that must be replaced by repealing two order, directing every federal agency to set up task forces to identify and eliminate red tape, review of EPA regulations, and streamlining the approval process for development projects.  Trump has held meetings with business leaders to learn of their challenges and appears to be willing to find ways to get government out of the way of business. 

On the fifteenth day of his presidency, Donald Trump signed an executive order to direct the Treasury secretary to review the 2010 Dodd-Frank financial regulatory law.  The House Financials Services Committee Chairman, Jeb Hensarling, has introduced legislation to eliminate parts of Dodd-Frank, including the risk retention rules for CMBS lenders.  Hensarling has expressed his desire to completely repeal the bill, but there has been a lack of support in the Senate and until now, an unwilling President to do so.  Now that Trump is in office, look for changes that would repeal portions of the bill and ease the regulations on community credit unions and banks and CMBS lenders.  These should help provide easier access to credit for borrowers.

On the tax side, Trump has expressed an interest in lowering the income tax rate on corporations.  We currently have the third highest tax rate in the world, behind the United Arab Emirates and Chad.  A substantial drop will create more economic activity and provide upward pressure on real estate.  Obama proposed increasing the top capital gains rate to 28%, while Trump has stated he will keep it at 20% and eliminate the additional 3.8% tax on net investment income.  Also, personal income tax reform that leaves more money in the pockets of Americans will help grow the economy.

Some Republicans in Congress have also proposed allowing an immediate write off in an investment of buildings as opposed to the 27.5 or 39-year deprecation schedule.  On the negative side, there have been proposals in Congress to deny the deduction of interest expense and limitations on the 1031 tax deferred exchanges.  Exchanges and leverage are very important parts of real estate investors decisions.  If any of those items were to occur, it would slow down commercial real estate activity.

President Trump has also proposed a trillion dollars in infrastructure spending. This will directly and indirectly benefit real estate by stimulating the economy.  He has stated that he intends to encourage public-private partnerships and harnessing market forces to help attract new private infrastructure investments through a deficit-neutral system of infrastructure related tax credits.  A strong commitment to improving our infrastructure is necessary to provide adequate resources and transportation avenues for our economy. 

Yet this issue will face some challenges by Republicans in Congress, who remember the large infrastructure program Obama pushed through and how little was spent on the “shovel-ready” projects the former president claimed existed.  Then, the House and Senate don’t always see eye-to-eye on issues, even when they are controlled by the same party.  It is also unlikely that bills may be passed without a significant majority to avoid a filibuster, unless some moderate Democrats in the Senate join the bill. 

The next positive impact on real estate has come from the number of companies that have announced their plans to expand production and office facilities in the United States.  If tax reform occurs, without hurting real estate, and regulatory reform becomes a legislative reality, then we will see more bullish forces impacting our economy and commercial real estate. 

These comments are on the real estate market as a whole.  Of course, there are forces that are providing strong headwinds to certain sectors.  Retail is facing struggles with the changing buying habits of consumers.  Farmers are facing a new paradigm of what land prices will be with a possible long-term low commodity price cycle. 

Perhaps the biggest factor in the decision to acquire or expand commercial real estate is hope.  If the investor believes that there is hope that the future will be better than what it is today, they will look for real estate opportunities to invest.  Recent surveys are showing that more Americans believe our country is on the right track.  If that continues, look for the future of commercial real estate to be bright.

Size and Industry Retractions

I recently took a cross country trip with my wife and daughter.   While on the trip, I had the opportunity to visit with credit unions in several states.  It was fun to learn about different credit unions and visit their communities.  I am fascinated with what motivates different CUs and how they seek to better serve their communities and/or membership base.

One of the shops I visited is staffed with a business team who wants to find ways to make their credit union grow.  They have done a tremendous job in building a commercial department from scratch, and making it one of the biggest profit and membership drivers for the credit union.  The team has great ideas on how to make a real impact in their community.

But they are held back.  The leadership of the credit union is afraid of large deals so they keep aggregate credit exposures at a rather limited level.  For larger deals, they do have a small participant group they can participate the deal among, but their loan servicer has a very narrow view of projects they will look at. 

Some things are off limits such as construction lending, hotels, non-profit lending, and land development.  Most of the “off-limit” commercial real estate types are such, because a lender had a bad loan at some time in the past in a particular industry.  This limits opportunities that are available in their market. 

Now I know that every credit policy should have industries that are off limits.  Most of these are standard ones which involve illegal or immoral activities.  Some would also be industries that are obsolete.  If you brought me a company that manufactures buggy whips, I would probably turn it down due to the industry. 

Many credit administration folks keep an off-limit industry list.  If you have no familiarity with an industry and have no desire to learn credit skills for that industry, you should stay away.  However, a broad prohibited industry list can hamstring the credit union of good deals and relationships that may be available in their membership audience.  In any industry, there are good companies that are top performers, even in times when the industry is challenged.  A well-run company can manage through tough times in the industry.  But, a company that is poorly managed in a strong industry, will face severe challenges at times when the industry faces struggles.  Banking the consistent peak performers is a strategy that should over the long run, produce a portfolio that returns principal with minimal losses. 

Size also should not scare the lender.  Large loans can be placed into a well-managed participation and the risk divided up among several loan investors.  I am always amazed at how many CUs will avoid good credits with strong companies that are large.  In some cases, the large credit with highly skilled sponsors may be less risk to the loan investor than the small marginal loan. 

So, if you come across a project that is outside your initial comfort zone, let us help you.  We have experience with a large variety of industries and credits and can help manage credits that would normally be too large for your comfort zone or in an industry that in times past may be have been something you avoid.

In other news, we held our Beginning MBL Lending Boot Camp last week and Trevor had 18 students in Sioux Falls.  We have a new Commercial Real Estate class in Minneapolis on May 22 and 23.  We will cover topics like managing construction and development projects, analyzing rental data, structuring real estate cash flow, appraisal review, and global cash flow.  We will have case studies.  Contact us for more information. 

Looking from the Outside In

Greetings this morning from Missouri.  I am in the middle of a trip that is part work and part vacation.  Today I am in the middle of the state in the county I grew up in, visiting family and friends.  We are staying with friends we have known for years.  Now no one in the house drinks coffee. 

They do know how much I enjoy consuming a pot or two in the morning. So, before every visit we make, they always talk to my wife about what types of blends of coffees I enjoy and stock some so it is available when I am here.  They go out of their way to understand how I view the world in a caffeine starved state and make provisions to ensure that does not occur.  They also know that I view coffee as very warm and inviting.  Some would call this thinking about others first or Southern hospitality. 

One way you can think of this is being able to see yourself the way that others see you.  Once you can view yourself in that manner, you are faced with a decision of how to act.  This applies to organizations and companies as well.  The ability to be able to view the group as folks would on the outside is a valuable skill, especially for those companies that have members, customers, or shareholders. 

One of our clients is a hospitality management company.  They constantly strive to understand how others view them.  They have implemented a lot of ways to keep their guest in the forefront of their focus.  One hotel I stayed in earlier this month sent a text message about a half hour after I unpacked asking about the condition of the room and if it was up to the standard I required.  They then sent another text for the premium Wi-fi code.  Throughout my week stay there, they sent several different texts to ask if there was anything else that I needed, offered me a free entrée at their restaurant, and invited me to their evening social.  In short, they went out of their way to make me feel invited.

A stark contrast to this is a technology company I have worked with as a customer.  This company is very internally focused.  When you talk to them, it is as if you are an outside and not part of the inside secretive club that they have.  Problems that are brought up are often sent to the “development team” on the other side of the world.  Most problems are never addressed head on; vague responses are given that make complete sense to the company but are nonsense to the customer.  That is if they even choose to respond to an issue that is brought up.

One solution they offer is to increase the communication between our group and theirs. Yet this fails to solve anything as they will still communicate in internal company code and we sit on the outside.  This company is a classic example of an organization that has never developed the skill of understanding how the customer looks at them.  As such, they will be stymied in their growth potential as clients will soon figure out the tech guys either do not have the ability or do not care to understand how they appear from their customer’s prospective and make changes to their actions. 

Now this does not always apply in a business lending case.  Of course, the borrower wants as much money as possible at the lowest rate and with the most generous repayment terms.  But since that may incur an unacceptable amount of risk to the lender, making accommodations to those borrower requests may not be the best decisions.  The goal of the lender is to have their principal repaid, with a reasonable rate of return for the risk, and with the lowest amount of hassle possible.  Sometimes, the most merciful answer to the borrower is to say “no”.

But even in that response, it is important to understand how you are perceived from the outside.  That is if you want to know how others view you and make decisions on how to respond accordingly.

Thoughts on My DC Travels

Last week, I had the pleasure of attending the annual CUNA GAC meeting in Washington DC.  Amanda Baldwin, one of our credit analysts, also attended with me.  We set up a modest booth on the vendor floor as our purpose there was to meet other CU folks from around the country. 

The trip for us is a busy one and we cannot attend most of the sessions for the conference since we are meeting with folks, even when the sessions are going on.  I believe our meetings will prove to be beneficial as we have over three dozen CUs to follow up on with a number of interested issues like agricultural lending, loan participations, writing loan policy, and back office credit union administration support.  Several things stand out in my mind from the trip.


When you go, be prepared to be exhausted when you get home.  The non-stop events do wear you out. 

Our CUAD leadership for our Dakota CUs is incredible.  Events were well thought out and planned.  Time that was spent with our senators and representative included concrete examples of proposed legislation and regulatory changes we need to see in order to better serve our members.  Big thanks to Amy, Jeff, and Jay. 



Legal Seafood is some of the best seafood in the world and the fellowship that is found around adult beverages and raw oysters at Clyde’s after the Hill visits is incredible.  If you go to DC, you definitely need to go for the famous “De-Brief”.

As we sat in the room with our legislators in the Russell Senate Building, I realized that everything we were talking about—reigning in the power of the CFPB, moving 1-4 family properties out of the MBL cap, the Financial Choice Act, tax reform, regulatory relief—are all items that the initial problem was caused by our government in the first place.  Sometimes you would expect that we have the best and brightest as our rulers, but this is quite questionable when you see the red tape that emits from Washington along with a $20 trillion federal debt.



Washington is a juxtaposition for me.  I have a minor in US History and the area offers an incredible amount of history and wonderful storytelling.  The place also is home to a large number of wonderful restaurants and I do love to eat.  However, the Beltway, seems to be an area that is divorced from the reality of the rest of America.  Often when rules are made in these ivory towers, little thought is given to how they will impact the rest of us in flyover country. 

In spite of all of this, there is an attitude of hope that I have not seen in the previous trips I have made there.  There is an attitude that things can and will get better and there is a renewed spirit of optimism, not because of DC, but because of the freedom and liberty unleashed upon the American people. 

Now is the time to continue to remember your congress folk.  It is nice to get in front of them with thousands of other like-minded CU folks.  But they need to know that back home they are being supported and watched closely. 


We are also holding our MBL Bootcamp on March 20-21 in Sioux Falls, South Dakota.  This is a great opportunity for those just getting involved with commercial lending, support staff, and those who need training on the basics, to learn from our wonderful team.  We look forward to seeing you there.  Please contact us for more information and also for registration. 


Pactola's Approach to Training in Business Lending

We are starting our 2017 round of training seminars, and I thought it may be helpful to lay out our methodology for anyone interested in attending our sessions this year.

Business lending is a big bucket that catches several types of loans, and it is important to understand that there is a lot of diversity in business loans just like you have in consumer lending. Consumer lending encompasses home loans, car loans and maybe even unsecured credit cards. You know that each of these loans have different underwriting requirements and different risks as well. You will find that business lending will also have considerable diversity. Just to name a few, we may deal with commercial mortgages, lines of credit, and agricultural loans.

So where to begin with everything? Lucky for you, we try to answer that question by making our first session of the year an introductory course on business lending. We refer to it as “boot camp.” The intent is to help you understand what differentiates business lending from consumer lending. Then we will discuss the different types of loans you will find in business lending, and generally, how you will approach underwriting and servicing. The goal is to get you oriented to understanding this unique field of lending so we can then begin to explore more complex topics. Our Boot Camp will be in Sioux Falls on March 20-21.

As a result of Boot Camp, you will learn we try to put most of our business loans into three big buckets: commercial real estate, commercial and industrial (better known as C&I) type loans such as equipment and lines of credit, and lastly, agricultural loans. We then schedule sessions for the rest of the year to explore these individual categories.

We will be holding our commercial real estate seminar in Minneapolis, MN on May 22-23. We discuss how we model the risk of lending for commercial real estate requests, which includes a look into different commercial real estate types, researching real estate markets, and how we investigate construction and development loans.

Our next session will be C&I lending in Omaha, NE on August 7-8. This seminar is also co-titled “small business” lending, because the principles of C&I lending are the same tools you will need for small business requests, like lines of credit and equipment financing. We dive into assessing financial statements and projections, and how to compare similar businesses to each other.

Last, we have our agricultural forum in Miles City, MT on September 25-26. This differs a bit from our commercial real estate and C&I seminars. We have a standing meeting with a core group of credit unions at this event, and each year we try to address some contemporary issues, explore case studies, or do some refresher exercises. New participants are always welcome to come!

My hope is this information helps you better understand how we have arranged our classes, so you can best make use of what we are offering. And as always, you can always contact me or anyone else at Pactola about any questions or for clarification.

Whiners and Winners

It is so easy to focus on the negative obstacles in life.  Some people make these challenges even bigger by digging a hole of deep self-pity.  They complain that they do not have the same education, privilege, money, opportunities, or whatever else that other people get.  Heck, it is easy for any of us to fall into this trap.  

When we do so, it is easy to fail to count the blessings that each of us has right now.  When I was a teenager, we had a pastor visit our church who had Down Syndrome.  The man hobbled up to the pulpit and in broken English would exclaim, “God don’t like no belly-aching, no complaining, no griping.”  Clearly when the congregation saw the condition that he was in, who really had a better reason to complain than any of us ever had, it put us to shame. 

My younger son is in college studying to be a pastor.  He is also interning at a church.  One of the pastors there was born with spina bifida.  He walks with a limp and tires out easy.  When he was young, he could not enjoy sports like the other kids, so he worked on training his mind.  He developed a tremendous memory and is very sound in his logic.  He also is a powerful preacher and very clear in his oratory.  Here is another case of someone who had a lot more reasons to complain than I ever will, but did not. 

Another example I think of is my mom.  She was diagnosed with Multiple Sclerosis when I was a freshman in college.  She lived with that disease that robbed little by little of her ability to control her muscles.  She lived with that disease for thirty years.  Yet she would sing as she went through the day and would smile and laugh a lot.  It could be convicting to be around her at times, especially when you were complaining about your lot in life.  

Complaining takes valuable energy and wastes time.  Have you ever spent more time complaining about work than it actually took to complete the task?  I did once in college with a surprise term paper that was sprung on us that was due in a week.  I spent the first five days griping about how unfair the exercise was only to finish the paper within a day once I started.  It took me more time to gripe than to finish the job!

Whining and quitting takes a lot of energy and time and robs it from productivity.  Whining never overcame the obstacles to create the light bulb, invent the airplane, or explore space.  All happened with continually chipping away at the obstacle until it was eventually overcome. 

Griping make us ungrateful, and focuses on the problem and not solutions.  If you ever want to conquer a complaining spirit, just be thankful.  Even be thankful for the challenges, as you learn more in struggle and failure than you ever will in success and ease. 

So this next part is an extra.  I know some of you tend to hate Mondays.  You may use it as a way to coast in a lower gear instead of really kicking it into high gear on your efforts.  I saw an interesting acrostic for Monday:

Make it happen because you

Only live once, and there is

No time for whining…

Don’t make excuses, just

Ask yourself, do

You want it bad enough?

Maybe that will make your Monday a bit more productive.  In a couple of other things, we will be at the CUNA Government Affairs Conference in Washington DC next week.  Stop by our booth #550 and see us!  Better than that, bring us one of your CU friends from around the country who would find it valuable to meet us.  We want more friends!

We are also hosting our MBL Boot Camp in Sioux Falls, South Dakota on March 20 and 21.  This is a great opportunity for business lenders who are starting out, or those with little experience, or business support staff to pick up some good skills and knowledge from some of our fabulous team members.  We look forward to seeing you there.  Contact us for reservations.


Are We in the Last Innings of the Real Estate Cycle?

On a national basis, the upward momentum for commercial real estate prices and values has slowed recently compared to the rate of increases we saw in the first few years after the credit crisis.  Now there are two things to keep in mind about this statement.  First, commercial real estate (CRE) values are still driven by the market area.  It is the old location, location, location thing.  Those in Williston, North Dakota, have not seen overall CRE increases in the past year with the decline in oil prices that hit the second half of 2015.  Also, we will begin to see ag land prices softening with lower commodity prices today than what was in place in 2013.  So the sector and location you are in will dictate if you are seeing upward growth in values like the national averages.

Second, the only time it is possible to time a peak in the market is in hindsight.  If you are able to forecast a market peak correctly, then you are pretty lucky.  So what we can understand is the influencers in CRE today and make preparations for the next steps of the CRE market.  In order to do this, we must try to figure out which innings of the market we are in today.  I use innings as we have spring training that is right around the corner for those baseball fans.

CRE has been an overall great investor performer and a preferred asset class since the end of the credit crisis.  Values were depressed in many areas, in some cases to the point of abnormality.  Investor confidence in CRE peaked in 2013 and has dropped since then.  In the third quarter 2016, CRE still remains slightly higher in investor confidence than stocks, with cash as a close third.  Confidence in bonds is relatively low as investors believe that higher rates are around the corner.  This drop in confidence indicates that we are entering into the later innings of the CRE uptick. 

A recent poll at the University of Chicago Booth School of Business Real Estate Confidence among real estate professionals asked where the industry is in the current cycle.  The professionals were asked to use a baseball analogy to characterize the inning of the CRE growth cycle we are in.  The result is we were in the bottom of the 8th inning in late 2016 and are entering in the 9th inning in 2017.  This year is expected to be much like 2016, with CRE prices and values on average increasing slowly and cap rate compression slowing down.  The questions are what are signs that we are getting close to the third out in the 9th and what are possible signs we can go into extra innings.

Interest rates are creeping up, which will curb the availability of loans for projects.  It is anticipated the Fed will continue on a course of slowly measured increases.   As rates do increase, we will see marginal financing projects become unaffordable.  Another factor to limit capital will be the new regulations in the CMBS market, with its billions of dollars of loans that will be maturing over the next few years.  Credit unions and banks will see an increased amount of refinance activity, but overall expect the supply of loans to slow with these changes.

Any possible black swan event could also lead to a major market correction and the end of the game.  This could be started from wide-scale terrorist attacks, a financial crash, or some other unforeseen event.  One would think that when such an event occurs, the market will act rationally.  However, with new players who have not experienced the Great Recession in the CRE realm and how irrational folks can get, it may not always have a smooth ride.

So what can take us into extra innings of CRE growth.  One large factor is the investor perception.  If people believe that things are improving in the future, they will be more apt to invest in CRE today.  We have seen an increase in the spirit in our country after the election which has been seen in major announcements of new offices and production facilities.  Another factor is the rise in the stock market.  Clearly, if a sizeable portion of the cash that has sat on the sidelines since the Great Recession begins to flow into the market, we will see extra innings. 

Another factor is fiscal policy reform.  This can come from both tax cuts and regulatory burden relief.  If Trump is successful in cutting corporate and personal taxes and also eliminating 2 regulations for every new one started, we will see the economy grow with the shackles of Washington loosened.  Accomplishing these things seem elementary simple to the average American in the heartland, but do represent a threat to the bureaucrat’s way of life.

Ken Riggs of Situs RERC Advisors sees industrial properties will still have the largest cap rates of any major property type.  We may see some price compression in offices and retail properties prices will slow.  Any property with a long term lease may look good to a lender, but will have more interest rate risk and lower values in a rising rate environment.  If the economy keeps growing, apartments and hospitality may be in the best position to take advantage to hedge out increasing rates. 

So back to our question, what inning of the CRE growth cycle are we in?  Are we in the latter innings?  And if so what factors could send us to extra innings and what means the game is over?  Unfortunately, this is not as clear as the third out in the bottom of the 9th is in a baseball game.  But we can see the influencers and make moves accordingly.


The People Factor in Business

We often focus on cash flow and collateral when analyzing loans.  Surely if the deal will produce adequate cash to satisfy all operational expenses, take care of all payments, and leave leftover money for the owners or for the future, that would be sufficient, right?  If a business has a strong equity position and may even have more of its own money invested into an asset than you do on the loan side, that would be sufficient as well, correct?  Both of these factors are important in assessing the credit, but perhaps the people factor can be the deciding issue of if a business will live or die.

I once financed a horizontal construction business who did amazingly well when the economy was going great in the early 2000s.  They went from one subdivision to another putting in streets, sewer, and water lines.  But then the crash in 2008 hits.  Three subdivisions are developed by them and the owners did not make the full payment.  In some they took property back as payment, but unfortunately, property does not pay the bills.  The company saw most of its equity erode away with the large losses. 

Throughout this entire time, the borrowers never missed a payment.  They held one of the first characteristics you want in a borrower, they did whatever necessary to fulfill their obligations, even when it meant the sacrifice of their comfort. 

The second characteristic is they had the ability to look at their business critically and make hard decisions which required a business mind to make with an absence of sentimentalism.  They assessed and sold off a line of business they were in, even when that line was profitable.  They realized the timing was good to sell and they also were able to get rid of a divided focus and concentrate on their core line of business.  A different result came from a custom countertop manufacturer I had financed.  When the economy turned and business dried up, he continued to promote granite countertops, even when the demand ended.  He refused to go to other countertops that were selling which were of lesser quality and also less expensive, even when those surfaces were selling.  Eventually, he closed down.

Another factor is the ability to be taught.  I met my horizontal contractor for lunch one day and shared with him how his business looked to a lender.  We identified three symptoms in the business financials and traced them back to their three root causes.  In addition to selling off a line of business, they brought in additional capital from the owner’s family, and established strong pricing discipline.  They stopped chasing any business that did not have at least a gross margin at a level they believed was necessary to operate the company.  This led to less business, but what they did do, they made money with. 

If these folks were not willing to learn, they would not have made the necessary changes and been able to survive.  When I visited with the countertop builder identifying some of the same issues, I was met with an explanation of how I did not understand the business and thus could not offer advice.  He would not look at the symptoms of his sick business and work to trace back to the root cause.  Eventually, he closed. 

Businesses that survive are also filled with leadership that can cast a vision and provide hope to others on the team.  Challenging financials, tight liquidity, shrinking margins—all of these can be horrible downers to their staff.  But somehow, these leaders were able to point toward the eventual goal and cast a vision in the mind of the workers.  It was essential during the three-year period that took them to claw out of their poor financial state. 

Character is developed during times of struggle.  We sit at a time with renewed excitement for business prospects since the election.  Also when Trump and Congress are able to achieve real tax cuts, healthcare reform, and regulatory relief, we will see our economy take off in ways we have not seen in years.  A lot of money has been sitting on the sidelines in the past decade, and those funds can really be put to work in the economy. 

But the challenge for a lender is to try to assess the character of your borrower.  A strong economy can hide a multitude of sins.  We have seen that in the Bakken area.  A few years ago, horribly performing businesses could still make a tremendous amount of cash.  When wheat was at $7/bushel, all wheat farmers were making money.  There was no push to become more efficient, putting money aside for a rainy day, or growing at a measured pace.  So when prices tumbled, the impact was greater. 

If your borrowers have a strong character, they will often be able to rise above the troubled waters.  The difference was worlds apart between the countertop manufacturer, which we foreclosed on, and the horizontal construction company.  The last problem I had to work with on the horizontal contractor was what to do with the excess cash that the company was generating.  They went back and made up their missed contributions to profit sharing plans for the employees and paid bonuses. 

Why Land Loans Can be Risky Real Estate Finance

Many people who like to invest in real estate say it is one of the best investments out there. Why is that? Because, they argue, they aren’t making any more of it! The amount of land in the world is fixed, right? I think that is a fact we can all accept. The occasional development of multistory buildings hardly adds to the additional inventory of real estate in the broader world.

Real estate is kind of funny though, because it tends to hold its value better if it has buildings and other improvements. This is because real estate that has been improved can usually be rented, which means an income stream is attached to it. So while the value of the underlying land might increase or decrease because of market conditions, improvements can still always be rented and provide more value over raw land.

To take this one step further, appraisals for commercial real estate are often heavily based on the income stream the rental real estate can generate. The more money you can rent an office building or apartments for, the more money someone else is willing to pay you for it when you sell.

The value of land is generally not determined by how much rental income it generates. Rather, the value is based on what other similar types of land are selling for. In other words, the value of land is more based on what people think it is worth, and not based on more scientific methods that can compare it to the income of other investments.

Because the value of land is determined by what people think it’s worth, it is subject to wide swings in value when the economy changes. When there is a recession and people feel gloomy about the future, they are not willing to pay much for land. The value of land will decline. When there is an economic boom, people get very excited about the future and can’t buy land fast enough. The value of land will increase.

How do lenders protect themselves from this uncertainty in values? First of all, land will require higher down payments than improved real estate. In other words, the buyer must have a high amount of equity invested to protect against the swings in the market. It is not uncommon for lenders to limit land loans to LTVs between 50% to 65%.

And then there will still be concerns about how and where repayment will come from. If that land is generating rent, then the land itself won’t help repay the loan. The borrower will need to use some other existing source of income. Because a land payment can be a real albatross around your neck, many lenders prefer to keep land on a shorter amortization; typically ranging from 3 years to 10 years.

Notice what a huge difference in lending standards this creates. A home residence can have an LTV of 97% and amortized over 30 years. An apartment building can have an LTV of 80% and amortized over 20 to 30 years. But, raw land might have an LTV of 65% and could be amortized over 5 years! When raw land serves no purpose but some future speculative purpose, lenders rightly hedge their bets to protect against the uncertainty.