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.

Sometimes the Best “Yes” is a “No”, Taxi Cab Medallions, Secondary Market Multifamily

One of the standard documents we have in our SBA application kit is a personal family budget.  We think it is important when someone is buying or starting a business to see what their family expenses are in comparison to the income sources they will have from that business and other sources after they purchase the business. 

Recently, I met with the seller and potential buyer of a business to discuss the possible financing of the sale.  The transaction would also involve some additional expenses in relocating the existing business.  After meeting, I suggested they revise the operating budget for the business to realistic figures.

After that was completed, I told the buyers to then prepare an accurate family budget, not one that unrealistically cuts all expenses to the bone, but one that is representative of actual living expenses they have historically incurred.  I told them the budget needs to be realistic.  Don’t forget about the cost of fixing the car, buying clothes for the kids, or an occasional time to eat out. 

A week later I received a call from the potential buyers.  After they completed their budget, they discovered the business could not provide enough money to support their family.  The business would require that one would work full time and another at least part time in order to be successful.  They thanked me for helping them see the financial reality that was hidden by their excitement and dreams. 

I encourage everyone to complete a personal family budget who is purchasing or starting a business.  Sometimes the best positive answer you can get is to be able to say no to an opportunity.

Beware of Taxi Medallions

A story in Bloomberg today has a headline “Taxi Medallion Prices Are Plummeting, Endangering Loans.”  In a recent study by Capital One of its $690MM in taxi medallions, 81% are in risk of default.  Currently, more than half of these loans are non-performing. 

BankUnited told investors in November that 59% of its tax medallion loans are under collateralized.  Of these nearly 95% of the taxi loans were to New York City borrowers.  The distressed taxi industry is feeling the pressure of ride sharing services like Uber and Lyft.  Uber became the preferable mode of transportation for business travelers in the fourth quarter 2016, taking 52% of ground transportation business according to Certify.  Rental cars accounted for 33% of travel and taxis were below 15%.  Lyft doubled its share from 2 to 4% in the past year. 

On the last business trip I took, I took a taxi and also ordered an Uber.  I found the Uber was cheaper and the driver much more friendly.  She also waited for me when I ran to get food at In-N-Out!

For the lender, if you do not have taxi medallion loans in your portfolio, beware of any new medallion opportunity.  If you are unfortunately to have some of these, prepare for the possibility of some write downs and restructuring. 

Secondary Market Multi-Family Mortgages

Pactola has formed a partnership with one of the largest producers of secondary market mortgages on apartments and multi-family housing.  These are placed in the market with Freddie and Fannie.  Products offer locked rates for 5-10 years or longer. Rates are tied to the underlying US Treasury notes with a spread that varies with different thresholds for LTVs and DSCRs.  

Last week, a qualifying 10 year fixed rate conventional loan could yield 4.50% at an 80% LTV maximum with a minimum DSCR of 1.25x. This product may be able to help you provide some financing for your member or expand your horizon to other projects in your community.  Let us know if we can help.

The Confusing Issue of Free Trade

When I attended college in the early 2000s, the U.S. had just finished a decade of robust growth that had ended in the “dot com bubble” bursting. Alan Greenspan was still the Chairman of the Federal Reserve, and there was a lot of certainty (or maybe hubris) about economic thought at the time. As a student of economics, I was told deflation was never an issue we would have to worry about. That turned out to hugely false with crashing real estate during the recession we witnessed between 2008 and 2009. Another similar belief was that the world would continue to knock down trade barriers, and global free trade was imminent. I wonder what those same professors are thinking now?

The trading of goods and services is a cornerstone of civilization. None of us produce everything we need ourselves, and we need to trade the specialized goods and services we are skilled at producing for the other goods and services we want. Logically, the more of us we have trading, the more things we will have access to. But this leads to a competitive environment as well, where people producing the same things will need compete for business, and the producer with the lower costs can offer a lower competing price.

When this competition amongst producers happens within our own country, we tend to view it as healthy capitalism. The bad producers might be driven out of business and the better producers survive. But we tend to take a different view of this when we are faced with producers outside the borders of our country. Is it fair if producers from other countries drive ours out of business? Is it fair if our producers drive theirs out of business?  

This concept gets more complicated with the rise of transnational companies. Our producers might find it cheaper to manufacture in a different country and then import the products back to our country. This is great for our consumers, but not necessarily for the labor force. And then it gets more complicated, where maybe only certain parts or resources are imported, but then the entire product is assembled here. Would that technically make the finished good an import, in part?

Then there is the issue of national security. Is it prudent to rely on other countries for certain products that we deem essential? This has been one of the drivers in having an agriculture policy, so that we are assured a domestic supply of food. Some argue energy is also important to national security, but there has never been a real energy policy for the United States. No matter, these national security interests can clearly affect how international trade works too.

Proponents of free international trade argue it keeps products cheap and it keeps all industries competitive over the long run. They can point to Argentina who recently undertook protectionist trade policies, and it led to people having less choices and paying higher costs for domestically produced goods. Argentinians have also complained the goods are now inferior, because the local producers have less competition so they don’t have to worry about producing high quality goods.

Opponents argue free trade costs domestic jobs and devastate industry. A popular example is how a number of Asian countries prevented the importation of American electronics and cars in the 80s and 90s, so that they could protect their own electronics and automotive industries and give them time to develop. The result is now several of these companies are powerhouses globally, because they benefited from protectionist policies early on.  

There is really no way to fully predict how changing international trade agreements will affect the economy. Neither free trade nor protectionist policies yield a win-win solution. However, the only certainty one can predict is there will be a lot of uncertainty, if a country tries to switch from free trade to anti-trade policies or vice versa. 

Genius or Idiot?

The setting is in Port Huron, Michigan in 1854.  A school teacher, G.B. Engle, grew frustrated with one of his students and called a little seven-year old boy “addled”.  For those of you who do not want to consult a dictionary now, this word means mentally ill.  The young boy stormed home and told his mother, a young lady named Nancy, who returned to school the next day with her son in search of an apology. 

For a boy who enjoyed playing outside and exploring the world all day, sitting in a one-room school house was pure torture.  What made matters worse was that Engle and his wife made their students memorize their lessons and repeat them out loud.  When a child forgot part of a lesson, punishment ensued, often a whipping. 

The young boy did not get along with his teacher.  His mind was filled with questions and not with the memorized lessons.  Fear did not motivate him to learn.  The boy also suffered with dyslexia, which was not diagnosed or treated at this time.  So mother and son, marched to the school to get their apology.

“My son is not backward!” declared the Nancy, adding, “and I believe I ought to know. I taught children once myself!” Despite her efforts, neither the teacher nor his wife, would change their opinion of young boy. But the lady was equally strong in her opinion. Finally, she realized what she had to do. 

“All right, the Nancy said, “I am herby taking my son out of your school.” The young boy could hardly believe his ears! “I’ll instruct him at home myself,” he heard her say.

The young boy looked up at his mother, this wonderful woman who believed in him. He promised himself that he would make his mother proud of him.  The boy grew up, by learning at home and with little formal schooling as we commonly think of today.  Much of his education came from R.G. Parker’s School of Natural Philosophy, and the Cooper Union for the Advancement of Science and Art.

The boy also had developed hearing problems at an early age.  This may have come from a bout with scarlet fever and reoccurring ear infections.  His hearing may have been damaged when his chemical laboratory he had in a boxcar caught fire.  

The boy sold candy, newspapers, and vegetables on the train from Port Huron to Detroit.  When he was not supplementing his income, he was studying qualitative analysis and chemistry.  He began a streak of entrepreneurship when he obtained an exclusive right to sell newspapers and began publishing his own. 

At the age of 19, the boy, now a young man, moved to Louisville, Kentucky to work for Western Union on the Associated Press news wire.  He requested the night shift to give him time for his passions, reading and experimenting.  Eventually, this curiosity cost him his job as one night while working on a lead acid battery, he spilled sulfuric acid on the floor. It ran down to his boss’ desk below.  The next day he was fired. 

He made friends with another telegrapher named Franklin Pope.  Pope allowed the impoverished young man to live in his basement.  It was there that his passion for inventing flourished.  He created several inventions to improve the telegraph, including a stock ticker.  He obtained his first patent with an electric vote recorder in 1869. 

He eventually left the telegraph business and opened up his own laboratory in New Jersey.  Many of his inventions are still those we use today.  His accomplishments total 1,093 US Patents with his name.   He founded 14 different companies. One of them is one of the largest publically traded companies in the world, General Electric.

All this was started because a young mother, Nancy Edison, believed in her youngest son, a boy who suffered from partial deafness and dyslexia, who could not sit still in a school room, and who was labeled with mental problems.  His name was Thomas, Thomas Edison.

Later in life, Edison said, “My mother was the making of me. She was so true, so sure of me: and I felt I had something to live for, someone I must not disappoint.”

How would the world have been different if Nancy had labeled her son a failure just as his teacher did?   Do you have anyone in your family or friends who could accomplish great things in life if they only had you to believe in them, and then get them to believe in themselves? 


Does Strong Dollar = Strong Economy?

What is meant by the phrase “strong dollar”? Is it a dollar that cannot be broken? Is it when the dollar is a mean bully to the rest of the currencies? I think people intuitively associate a “strong dollar” or a “strong currency” with economic strength. But, it is really an objective term, not a subjective term.

A “strong dollar” is when a dollar can respectively buy more of another country’s currency, and therefore goods, with respect to some historical context. Complicated? Think of it this way: A few years ago, it cost around $1.30 to purchase 1 euro (€ 1). As time progressed to the present day, it has taken less and less dollars to purchase a euro. Today you can buy € 1 for $1.07. That means, the dollar has strengthened significantly against the euro.

What caused the dollar to strengthen in value? One possibility is demand for goods and services produced in the European Union declined, so people needed less euros to purchase those. Or, demand to purchase goods and services produced in the United States increased, and so more dollars were demanded. Just because demand for our exports increase, doesn’t mean our overall economy is doing better. Our GDP does increase when we export; however, exports are a relatively small part of our economy. In 2015, our exports totaled $1.51 trillion, while our total GDP was $17.91 trillion. Never mind that the US imported $2.31 million in 2015.

So, if the dollar is strong, it means we can purchase more foreign goods and services. That is good, right? It is, if you are heavily dependent on purchasing imports. We see that the United States purchases significantly more imports than exports, so it helps considerably when the dollar is strong. Our main imports are computers, electronics, crude oil, and cars. We buy all of these more easily when the dollar is strong.

What happens when the dollar is weak? Then it becomes easier for other people to buy exports from us. Our main exports are refined oil (especially gasoline), cars, aircrafts, electronics and industrial equipment. When the dollar is weak, it means other countries will buy more of these things from us. This is why China has long desired a weak currency, because it makes it easier for other countries to buy their exports.

Locally, we export things like beef, corn and soybeans. This means agricultural producers benefit more from a weak dollar than a strong dollar. Another local export, crude oil, is uniquely affected by currency changes too. Most oil throughout the world is priced in dollars. So when the dollar becomes weaker, but the demand for oil hasn’t changed, oil actually becomes more expensive. When the dollar becomes stronger, then it buys more oil, and the price of oil falls. This means, a weak dollar helps support higher prices on oil, which in turn creates more demand for oil.

Now you see, a “strong dollar” doesn’t necessarily mean good things for the economy and a “weak dollar” doesn’t necessarily mean bad things for the economy either. A strong or weak currency is really more of an unbiased idea that alone doesn’t mean anything good or bad in isolation. We need to consider the context of the greater economy, and who the winners and losers are with imports, exports and commodities.

The Power of Questions to a Leader

Too many times in my life and career, I have been consumed with how important it is to share my knowledge with others instead of learning to ask questions and listen.  This especially was true early in my financial career.  I was taught the skills of being able to condense the sales pitch of your institution into a thirty to sixty second sound bite.  Now this may have been effective in spewing my knowledge to the client, but it did not allow me to learn from the customer, nor build any sort of relationship. 

One of my uncles once told me, “Phil, the Good Lord gave you two ears and only one mouth.  So shut up and listen!”  His advice is so true.  I learned that I needed to have a natural curiosity about things and ask those questions.  Then I need to listen to the answers.  Sometimes, when I meet with someone I will ask a question I know they know the answer to, but I just want to hear them explain. 

Part of the power of questions comes from a humble realization that you can always learn something from someone else.  We rely on others as our teachers through life.  It is only by questions that you can actually unlock those gems of wisdom. 

Thomas J. Watson said, “The ability to ask the right questions is more than half the battle of finding the right answer.”  This is so true.  But it is only true if you are willing to ask the question in the first place.  Perhaps our jobs in credit, help us be more open to asking insightful questions that could be construed by others as intensively private.  Questions like “why have your accounts receivable grown so much?” “why is your top line room revenue down in your hotel?” or “what is your succession plan for your company?” do seem quite personal at times.  But these questions, if asked with genuine concern and the desire to learn, will help us unlock the inner ticking of the company and understand their risk.  So it is with questions that we have an effective way to connect with people. 

Communication comes from the Latin word communis, which means common.  Before we can communicate, we must establish commonality.  The more common ground we can find, the greater the chance for good and deep communication.  Effective communication prompts people to think, “Yes, I agree and understand!”  Too often communication is one way and will result in the listener saying “So what?”  The playwright George Bernard Shaw once said “The greatest problem with communication is the illusion that it has been accomplished.”  When you think your audience understands what you have said, watch out!  You may be on very vulnerable ground for a mutual understanding.

Of any question you can ask, perhaps “why” is the most important.  It helps unlock the true motives of a person’s heart and will require an explanation other than a yes or no.  Larry King, who made his living as a television talk show host, says that “Why” is his favorite question.  He calls “why” as “the greatest question ever asked and it always will be.  And it is certainly the surest way of keeping the conversation lively and interesting.” 

Asking good questions also require prior planning.  When you are preparing for a meeting with someone, think through the questions you want to ask.  You need to communicate that you value the people you are with and that, if it possible, you want to add value to them.  This process will require asking questions and being able to “shut up and listen!”

Understanding the Cash Conversion Cycle and How to Speed it Up

Have you ever encountered a business that is profitable, yet does not have the money it needs to pay its bills?  This is a plague for many small businesses and farms. You see, it takes cash to pay bills.  You cannot take an account receivable and give it to your utility company to satisfy your electric bill.  You also cannot give your bank excess inventory you have in order to make your mortgage payment.

The process of taking cash, turning it into a product, selling the product on account, and then collecting on that account is the cash conversion cycle. How many stops must cash take along the path from initial cash, then adding value of some form, and finally collecting cash at the end? This is important for a business to know since, after all, cash pays the bills. 

So let’s start the trip along the cash conversion cycle. Now every stop on the way may not apply to some businesses. Also, if the company does not have enough money to satisfy all debts at each point of the cycle, then it has a borrowing need to help fund inventory, receivables, or production. 

Stop 1:  Purchasing materials to create a product. This step will not happen with a company that does not make a product or grow a crop.  If the firm carries no inventory then there will be no funds that are spent here. Also, if a company provides a service, such as a computer repair company, and carries no inventory, no money will be spent here. 

The time spent here, from company to company, will also vary. A potato chip plant may have potatoes delivered and dumped into a bin at the start of a day, and bags of potato chips are shipped just hours later. A company that makes durable goods, such as aircraft, will take more time in this stage of the cycle. 

When cash is spent on material and labor to produce the product, it is not available for other operating expenses. Some tips to manage this stop are:

  • Watch material and inventory levels and do not purchase more than what is needed. Doing so is a use of cash and can hamper profits.  I once saw a hardware store that would borrow money to purchase product for resale. When they sold that product, they would not pay off the bank loan, they used it to purchase more items to sell. 
  • Note the average time frame that it takes inventory to turn over with other companies in your same industry. The hardware store I mentioned only turned their inventory over once a year, when the industry average was much quicker.  As such, they to continue to borrow money to operate, which left them with an unsustainable level of debt. 
  • Suppliers can provide a source of cash if they provide you with generous terms.  I once studied a restaurant that had no debt on their building, fixtures, or operating line from their bank.  They sold over $3 million annually and supplied all their cash needs by paying for food on 45 day terms with their supplier. 

Stop 2:  Taking the product you produced to market.  This step happens once a company has completed creating the item and is taking it to market to sell.  Different industries have different time frames for this step in the cycle.  Also, sometimes, a firm may intentionally stay at stop two.  An example here is if a farmer harvests crop and waits to sell the product as he is expecting to get a better price in the future.  That may work, but there is also a carrying cost to holding onto an item instead of selling it. 
It is important here to not over produce your sales demand, as this will cost you money. Also, learn to be disciplined in your selling approach.  Always trying to grasp the brass ring of the highest possible price for your product often comes with a cost of capital. You may not be making as much profit in the long run as you think.

Stop 3:  Collecting money on an account receivable. This step does not apply to some firms. If you are a retailer and sell no items on account, this step does not apply.  But if you sell a product or complete a service and then create an invoice for the buyer, this step applies to you. 

It is important to see how your company stacks up against the industry. If it takes you much longer to collect your receivables, you will use more cash than similar companies. It is possible to run a profitable business but to be in need of cash. Many times this is because of a lack of collecting your accounts on a timely manner. 

Here some methods may be to offer a slight discount if an invoice is paid within 10 days.  You also may consider the extra cost on your business to collecting accounts slowly.  This may need to be built into your price.  If accounts cannot be collected quickly enough to satisfy cash needs, then the company may need to borrow on an account receivable loan or turn to factoring to receive cash quicker.

Managing the cash conversion cycle and minimizing the natural stops can make a huge difference in the cash needs a business has to have to operate.  Simple steps like paying suppliers slightly slower, managing inventory levels, and speeding up the collection process could minimize or eliminate the need for an operating line for the company.

Why Aren't Business Loans Priced Like Regular Mortgages?

The United States has a unique mortgage product that has helped tens of millions of Americans become homeowners. That is the 30-year fixed rate mortgage. From a banking perspective, that is a really impressive deal. A loan for 30 full years, and the interest rate never changes? Wow!

In reality, how does a bank or a credit union make a loan like that work? Consider that in banking, you fund loans with deposits. Do credit unions have deposits that will be left in place for 30 years? In all likelihood, probably not. That means if interest rates increased, the credit union would have to pay more for deposits to keep money at the institution, but it would be unable to increase the interest rate on the 30-year mortgage. It seems like making a loan with a fixed interest rate for 30 years could be risky business. What if over a 30-year period, the deposits became more expensive than the mortgage?!

The truth of the matter is, a 30-year loan is not really funded by deposits in the long run. What happens is the credit union makes the 30-year loan, and then it turns around, sells the loan to someone else, and the credit union then gets all its money back. Viola! The deposits are no longer tied up in a 30-year loan, and they now have more cash to make other loans with.

Who is buying these 30-year fixed rate loans? Investors, typically insurance companies and retirement funds. They need a predictable long-term stream of income, and what is more predictable than someone paying their mortgage every month? So what really determines the interest rate on a 30-year loan is what these investors want their return to be. This is usually a much lower interest rate than the rates a credit union would typically charge on a loan. But at the end of the day, it is not the credit union who will own the loan, so the credit union doesn’t have to worry about balancing this interest rate risk.

When a loan is underwritten to a standard which the investors are willing to buy it, we call it a “conforming” loan. A huge mistake credit unions might make is trying to price all their real estate loans like conforming loans, when they are not all conforming. A non-conforming loan is one that will not be purchased by investors, so why should they be priced low like investors are buying them?

Non-conforming loans should be priced based off the underlying deposits, not based on what secondary market investors want. The act of trying to match the price and term of deposits with the price and term of loans is called “asset-liability management” which is abbreviated as ALM. All non-conforming loans should be priced according to ALM principles, and not rates found in the secondary market.

We should consider that all business loans too, even those for commercial real estate, are non-conforming loans. There is a secondary market for commercial real estate loans, but those investors do their own underwriting and do not purchase loans from banks or credit unions. In light of these facts, that means a credit union should also price their commercial real estate loans according to ALM policies.

In other words, we should ask ourselves what is the cost of a five-year deposit, and then add a percentage on top of that to get our 5-year fixed loan rate. Even if someone is financing rental houses, they should be priced according to ALM and not what secondary market investors pay for home mortgages. This is, of course, because the business loan to finance rental houses can’t be sold, or won’t be purchased by those investors in the secondary market.

Your Business Lending CUSO in 2017

By the time you read this, you will be wrapping up the first week of 2017. Congratulations, only 51 more weeks to go!

With the start of the new year, I thought it might be helpful to remind everyone about who and what Pactola is. We are a one-stop-shop CUSO for everything related to business lending. CUAD actually owns 10% of Pactola and helped start the CUSO, so that all credit unions in the Dakotas would have access to local professionals who could help them with business lending. All together, we have eight senior equity owners and eighteen junior equity owners. Our ownership now includes credit unions from North Dakota, South Dakota, Nebraska, Montana, Minnesota and Ohio.

What does Pactola do in the business lending sphere? We have three main business lines. The principle reason we were established was to serve as a central servicer for participation loans. In other words, credit unions come to us because they need help participating out a loan, or because they want to buy a loan participation. We are in the middle, providing a standardized set of analysis, file management, documentation and reporting. If you need help selling or buying a loan participation, call us.

Our second largest business line is “consulting” or “in-house” services. Credit unions may want help with writing a business loan policy or participation policy. Or, they want help with underwriting, 3rd party reviews, file audits, documentation, etc. So if a credit union needs general assistance with a business loan they aren’t participating, we are here to help with that too. That includes special knowledge regarding government programs like the Small Business Administration (SBA), the USDA programs, or even things like Historic Tax Credits.

Our last business line is education. We see that credit unions want to learn more about business lending, and want to better understand the underwriting that goes into our loans, whether it is a participation or in-house loan. It used to be most of our sessions were held in the fall, but now we are spreading them out throughout the year in case people want to attend more than one. The schedule for this year is as follows:

·         MBL Boot Camp (Intro to Business Lending) : March 20-21 in Sioux Falls, SD
·         Commercial Real Estate Lending : May 22-23 in Minneapolis, MN
·         Commercial & Industrial / Small Business Lending : August 7-8 in Omaha, NE
·         Ag Lending Forum : September 25-26 in Miles City, MT

We should also mention that we’ll be helping our credit union partners at several CUAD and CUNA events throughout the year. Feel free to introduce yourself to us at any of these if you feel you could use some help. Here is a list of events we are sure to attend:

·         MonDak Roundtable : Jan 10-11
·         CUAD Hike the Hill in SD: Jan 25
·         CUNA Business Roundtable: Feb. 7-9
·         CUAD ND Legislative Reception : Feb. 21
·         CUNA GAC: Feb. 26 – March 2
·         CUAD Summit: April 10-12

If you hope to do more with business lending in 2017, please reach out to us. We love hearing from our old partners and new contacts alike. We care most about you succeeding, because that is the only way we can succeed.