Lead Me with a Story

I grew up in an age of flannel-graph, puppets, and full color Sunday school art.  I knew stores of Noah and the flood, David killing Goliath, and Daniels in the lions’ den at a young age.  I could recount Samson’s strength, Moses leading the children of Israel, or Paul’s missionary journeys before I was proficient in math. 

Later, when our kids were young, every night was a request to read a story.  Sometimes it was from the Bible.  Other times it was Chester the Horse, or the classic, Peanut Butter Rhino.  My kids’ eyes used to light up as we flipped through the pages of the various tales.  I imagine that any parent experiences the same with their children.

This week, I was on the road visiting some commercial staff at a credit union.  The CEO, who has led his CU to an incredible growth, popped in the office and began to recount several stories on the golf course with prospects who are now members at the credit union.  The tales that he spun stayed with me for hours as I traveled down the road to my next stop.  I began to wonder why things were this way.  Why of all the things about the visit, the stories were the ones which stood out in my mind?

We are created as a narrative creature.  One thing that sets us apart from other animals is our part as keepers of stories.  If you note, most times you get together with a close friend that you have not seen in a bit, most of the time is taken with updates of life in the form of stories.  We cannot explain who we are without telling stories. 

The most important truths come alive with stories.  One of the older guys I have taught agricultural lending classes with is an incredible story teller.  I have found that explaining a facet of commercial lending, sinks in further with the hearer if I can dig up a story from the past.  I will have people recall the concept through a story than if I were to just cite various facts and figures.

Good leadership requires good storytelling.  Faithful leadership requires proper keeping and narrating stories that will help identify and execute the mission of the people he leads.  The strong leader will also know how her story fits into the larger story.  Many consultants focus on the importance of organizational mission, values, and vision, but these very important concepts mean very little unless there is a story of why we are doing what we are doing in the first place.  You start with the story and the rest follows. 

I am a history buff and have a minor in US history in college.  The reason I found this so interesting was a professor I had who was an excellent story-teller.  I could sit in his class for hours as he spun yarns about various events, people, and trends in history.  In fact, one of the biggest factors in selecting my major of economics, was because I had an Econ 101 teacher who was a great story teller and would could make the concepts of economics come alive. 

When I think of strong presidential leadership, the ones who could start with a story and end with action are often the ones who have made the most difference in our nation’s history.  Our most effective national leaders were masters in helping citizens identify with stories and lead others to do the same.  They then used this to rally the nation to a cause with the story being central.  I think of the fireside radio chats of Franklin Roosevelt, or the great Ronald Reagan standing in West Berlin asking for the walls to be torn down. 

Leadership that matters grows out of the leader’s own belief that the story is true, that it matters, and that it must grow and continue. The credible leader is based upon the leader’s identification of his or her story within the organization’s story.   Leadership that is disconnected from the story will often have no one following or worse yet, led to nowhere. 

In World War II, Winston Churchill rallied the British people when they were at their greatest crisis.  He told them of their history, how they were part of a centuries’ old civilization, of duty and sacrifice, how liberty was worth fighting for and how the right moral cause the British had in their struggle.  At the same time, in Germany, a very different story emerged.  Hitler told of great conquest, racial superiority, and elimination of any ideas that did not advance the German interest as he saw it.  Churchill’s story was true, Hitler’s was a lie, and the future of history was based upon which story prevailed. 

For those of you who lead, consider your story, and the story of your organization.  Do you know and understand your story and that of your group?  How well are you keeping the story?  How well are you telling this and living the story?  Success and positive leadership growth in your position and in life itself is based upon how well you are immersed and articulate the story. 

Retail Changes

It used to be that retail was based upon what people are buying.  People may go to Best Buy for electronics, Safeway for groceries, or Shoe Carnival for shoes.  Today what people are buying is now matched with how people are buying as determining the success of a store. 

Melina Cordero, the head of global retail research at CBRE captures this when she said, “Twenty years ago, when you wanted to buy something, you had to go to the store—it wasn’t a choice, it was an obligation.  But today, the store is no longer an obligation; it’s a choice.  We can choose to buy online as well as in the stores.  In addition, we have more choices than ever about where and from whom we buy.” 

How people are buying is forcing companies to look at brick-and-mortar storefronts.  Traditional stores are now creating a web presence to increase their reach or may be partnering with companies like Amazon or Etsy to get their product more exposure.  Online strategy must be considered when a retailer wants to increase business.  I have found that ordering items online and not having to go to the store, go through lines and haul all back home is a pain at times. 

On the other hand, strictly on-line retailers are finding value in strategically placed storefronts.  Some online stores like Casper, Untuckit, and Warby Parker are now opening physical locations.  Online shopping gives customers convenience, a vast selection, painless purchasing, and home delivery.  In-store shoppers can feel and interact with products.  They can take the product home right away and not have to worry about the time involved in shipping.  They also can develop the relationship with the retailer in terms of good service and advice.  

JLL notes that e-commerce retailers have plans for 850 physical locations in the next five years.  What many of these companies are finding is the customers prefer an omnichannel approach to buying.  Sometimes they want to purchase all online.  Sometimes apps are used to make a purchase.  Other times orders with convenient car pick ups are done.  Maybe the buyer wants to go in and experience the physical shopping experience where they can see and feel the product, develop a relationship with the sales people, and gain superior service after the sale.  A successful retailer today will be actively pursuing multiple channels in the sales experience. 

Cost is a factor driving the online retailer to consider the physical.  Marketing with Facebook and Google ads can only take you so far.  The spending may get higher than $10 per click just to push traffic to your website.  Then there is no promise that people will buy.  Now imagine an online retailer opening a physical location at the Mall of America, or any other place that will attract people from around the world to physically interact with their brand. 

This physical opening of a store by an online retailer produces “The Halo Effect” as dubbed by the International Council of Shopping Centers.  A physical store increases the overall traffic to a retailer’s website by 37%.  Emerging brands have a higher increase at 45%. 

I contributed to this when I was stranded in Minneapolis during a blizzard back home and needed to get clothes.  I stopped at an Untuckit store.  Now I have seen the commercials but never considered buying off their website.  The attentive staff helped me find my correct “Untuckit size” and I sent pictures of the various choices to my wife to pick.  I purchased a shirt and will consider buying something from the company online now that I have an experience with the product. 

For the retail real estate owner, these new trends present some challenges to the traditional methods of retail.  Landlords may move to shorter and more flexible leases to attract tenants that will drive traffic to their location.  Build out costs can be tricky as an online retailer may not have the capital to complete the work.  Measuring sales from a location is a challenge since the online retailer is offering an experience and may end up completing the sales transaction online later.  This may move rent overages from a hard and fast sales/sf to maybe a combination of sales + traffic/sf.  The mix in a shopping center is a challenge.  Do you just go for the solid credit tenant or focus on the cool new guys who may drive traffic but are not as financially sound? 

The lender may find a center that can cater to multiple channels of buying more attractive to others than those who only offer the traditional store experience.  This may become a factor to note when assessing the financial creditworthiness of the real estate or the retailer. 

Why Capitalism is Compassionate and Focused on Others

There is a title that immediately some of the readers will disagree with.  Some scream how unfair it is that some have more than others.  We see that with polls that show how 40+% of young American adults prefer a socialist economic system.  They have been taught to believe that a system of redistributed wealth is more compassionate than the evils of capitalism. 

These comments remind me of how often we encounter people who will cry out against something, only to be eventually have the same hidden issue in their own life but ten-fold times worse.  Often the protests are a diversion from their own failures.  My folks would say this is like “the pot calling the kettle black”.

A popular definition of capitalism is that it is rife with selfishness and greed.  No one shares anything.  They say it is a trickle-down economy, but it does not trickle.  Nobody gives away anything and capitalism is mean-spirited and uncaring.  It is easy to take the common voices at face value, but we must ask ourselves, is capitalism inherently selfish?

Andy Puzder, the CEO for Carl’s Jr and Hardees Restaurants for more than 16 years and a brilliant lawyer wrote a book in 2011 titled Job Creation:  How it Really Works and How the Government Doesn’t Understand It.  His latest book in April 2018 is titled The Capitalist Comeback.  He had a piece on Fox News a couple of weeks ago where he stated, “Our booming economy can still overcome progressive misinformation, propaganda, and myth.”

Puzder has a thought-provoking summary of the true focus of capitalism when he says, “In a capitalistic economy, the only way you can improve your life is by satisfying the needs of others.  That is by providing products and services that other people want at a price they can afford.”  When you think about it, this is true.  The only way you can succeed is if you change the focus from yourself to an outward focus on others.  You are forced to discover what the needs and wants are of others and then try to meet those with skills, talents, and items you have at an affordable price. 

I think this analysis is right on the money.  Capitalism also empowers the little man, the consumer as businesses vie for their attention.  This competition allows for many variations in quality and price, resulting in the best service or product at a price that people will pay.  “In a form of economic democracy, consumers vote with each dollar they spend, determining which businesses succeed and which will fail.  Henry Ford built cars for commoners, not for the nobility.  Steve Jobs created the iPhones for all of us, not government elites.  This is because the success of each business is determined by how well that business meets the needs of the masses—consumers.” 

Consider the production side.  Capitalism allows people to use their own time, talents, and treasure to develop skills and products as they see fit for the market.  There is no one centralized bureaucracy telling people what career they must pursue, what product they must produce, and where this must be completed.  People are free to develop these skills and products based upon their own free will and creativity.  They are not pigeon-holed into certain career at a specified location as a worker in a total command-and-control economy may be. 

Puzder paints an accurate picture of socialism that is different from what some in popular culture think today.  Socialism is the exact opposite of capitalism in its focus.  Instead of focusing on others and the market, in socialism you focus on yourself and your own needs. 

You succeed in socialism by getting more for yourself than others get from the limited amount of goods and services provided by the government.  People standing in a breadline in a socialist country are focused on getting enough to meet their need.  If you are lucky, you may be able to rise above the worker class and become part of the bureaucratic elite in a socialist society.  This drive is focused solely on self.  There is a same drive to succeed in capitalism, but there must be consideration given to the market and to others. 

This focus on others has provided the highest standard of living that has ever been known to man.  The capitalist model stands in strong contrast when one considers things we take for granted here compared to those which are not available in purely socialist countries.  North Korea does not have electricity available throughout the country.  In Cuba, most of the vehicles and appliances are like ones available in the U.S. sixty years ago.  In Venezuela, one of the richest countries in resources, food is very scarce.

Even though capitalism is outward focused, it is not equal in outcome, which nothing in life is.  But it offers the best focus on being better outside of ourselves.  I am reminded of a quote from Winston Churchill.  “The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries.”  When all around you is misery, it becomes very easy to focus inwardly.



Leadership Requires Convictional Intelligence

Talking about brain smarts is often a way to incite some conflict.  My wife and I once took intelligence tests and she outranked me on the scale.  At times she brings up those test results if we are in some discussions with each other.  Intelligence is controversial since it is inseparable from other kinds of issues.  In the middle of the twentieth century, educators, business, and political leaders thought that a person’s IQ was the key to unlocking the secrets of who would succeed and who would not.  I once was denied a job because my college entrance score was lower than what the interviewer had as a threshold.  I don’t think the interviewer appreciated me pointing out the abject absurdity of asking that question to a person who had taken the exam two decades earlier. 

Calvin Coolidge in his great quote on persistence notes that that genius is inferior to persistence as unrewarded genius is a proverb.  Education is inferior to persistence as the world is filled with educated derelicts.  Intelligence as mere intellectual ability is not a good projector of where someone will get in life or even about their ability to lead.  I once heard a college president say, “Be nice to your ‘A’ students as some may come back and teach at your institution.  Be nice to your ‘C’ students as some of them will come back and spend millions of dollars to erect a building on campus!”

Intelligence starts with the mental capacity to receive, process, and use knowledge.  But other forms of intelligence are just as necessary.  Howard Gardner, a Harvard psychologist, popularized the idea of multiple intelligences.  We may think of them as abilities.  Some of these may be musical intelligence, spatial intelligence, logical intelligence, or linguistic intelligence.  If all which was required for leadership success was a high IQ, then only those with the biggest brain would be the business tycoons, political leaders, and thought leaders of our society.  But, as we know, this is not always this way. 

In the past year, I read about emotional intelligence (EQ).  Daniel Goleman of Rutgers University studied 200 corporations and their leaders.  His findings showed that intellect was a driver of outstanding performance.  Skills such as big-picture thinking, and long-term vision were important.  But when the ratio of technical skills, IQ and EQ were measured as the ingredients of outstanding performance, EQ proved twice as important as all the others.  This was true for all jobs at all levels. 

Goleman identified skills of self-awareness, self-regulation, motivation, empathy, and social skills as important keys of leadership.  If a leader lacks elements of EQ, it really does not matter how smart he is.  Einstein was a genius, but he was not much of a leader.  Many of the world’s most mentally gifted people lack empathy and emotional skills to lead well. 

Another type of intelligence necessary for success is that of morals or ethics.  We often see examples in business or government where a moral failure may have produced a business success but led people to an outcome that was wrong.  We saw this with the push at Wells Fargo to build market share of its customers.  For years we knew of Wells as a place that trained people well but burnt through them with a heavy-handed management style that incited front line people to open accounts just to make sales goals.  Some did this jus to keep their jobs.  Some to make a bonus.  Some of these accounts were not real causing Wells to reap millions of dollars of profit, and a tarnished image at the same time.  Albert Mohler states that “financial intelligence will wreck itself without moral intelligence and the guidance of ethical reasoning.”

Mohler makes the case in his book, The Conviction to Lead, for a further type of intelligence necessary for leadership.  This is convictional intelligence.  A leader without any sort of base intelligence will not be able to communicate ideas effectively.  If a leader has a low EQ, they can’t connect with the people they are trying to lead.  A leader with misplaced ethics will lead people into a moral catastrophe.  But leaders who lack convictional intelligence will fail to lead people faithfully. 

Convictional intelligence begins with a basis in truth, and a strong moral compass.  For me, it begins with my faith.  The knowledge of truth should form habits that impact your thinking and rethinking as information is processed in the world around you.  Habits are part of all our lives.  Think about this morning when you awoke, cleaned up, got dressed and started your day.  You may not remember brushing your teeth or putting on your socks, but you did.  Some mornings you may not remember much about the drive into the office, yet you made it.  Why is this?  Your intelligence was at work in every one of these actions, but you are operating out of habit, reflex, and intuition.  These are three factors that point toward convictional intelligence. 

Habits of the mind tell much about us.  If you ignore the assistance of people around you, it points toward ingratitude.  If you devote yourself to constantly studying, it points to a habit or discipline of constantly improving. 

Reflexes are the second factor of convictional intelligence.  Much of this comes from attitudes.  Chuck Swindoll stated, “Life is 10% of my actions and 90% of my reactions.”  If you doubt that, think about how much of your workday is consumed with answering questions, responding to emails, and putting out fires.  Somedays, my entire time is one continuous set of reactions strung together.  Now reactions with proper grounding are very beneficial to leading others, while flying off the handle can stop progress in its tracks. 

The last part is intuition.  Steve Jobs was described as a master of intuition by people at Apple.  They tell how he would hold an iPhone prototype in his hands and run his fingers over each crevice and angle on the surface.  Then he would order modifications until it would feel right to his touch.  We call this trusting your gut.  I have asked our analysts once they have reviewed a credit and interacted with the borrower, “what does your gut tell you?”  A trained gut is often more beneficial than the sharpest mind. 

Convictional intelligence uses these things to lead.  It is also sprinkled with humility.  A good convictional leader realizes that he is always learning.  Churchill once said, “success was going from failure to failure with great enthusiasm.”  Another reason for humility is the knowledge that as a leader, someday and often multiple times, you will be called to give an account for your leadership.

High-Debt Borrowers Signal Warning and Can You Bank at the Post Office?

During my travels last week, I picked up a Wall Street Journal and found two articles interesting in the May 14th edition.  The first is by Bob Eisen and is titled “More High-Debt Borrowers Backed by Fannie, Freddie”.  It starts, “The gatekeepers of the American mortgage market are increasingly backing loans to borrowers who have heave debt loads, highlighting questions about mortgage risk as policy makers debate ways to change the system.”

In 2018, nearly 30% of all mortgages that Fannie Mae and Freddie Mac packaged into mortgage backed bonds, went to home buyers whose total debt payments exceeded 43% of their incomes according to Inside Mortgage Finance.  This share has doubled since 2015.  In my banking career when I was doing home loans, the threshold was at 36%.  I remember vividly when the limit rose to 38% and the debate within our shop, as to if this was leveraging customers too highly. 

But these hard and fast debt/income ratio goes out the window with the new computerized algorithms used to underwrite loans today.  But even so, 43% is extremely high and how does this happen? 

It appears an obscure half decade old rule made these mortgages with people with high debt loads possible.  This provision started after the Consumer Finance Protection Bureau introduced tighter mortgage lending standards after the financial crisis while at the same time creating temporary measures to avoid slamming the mortgage door shut on some borrowers.  This exception was nicknamed the “qualified mortgage patch” allowing Fannie and Freddie to lend to highly leveraged borrowers.  Fannie said two years ago it would guarantee mortgages with debt/income ratios between 45-50%. 

Let me wrap my mind around this.  In the mortgage crisis, we did see some bad actors.  Appraisers who inflated values.  Mortgage brokers who pushed deals through just to get a paycheck.  Bankers who financed houses to make their bonus and present a large source of income to their shops.  But we cannot forget about one of the largest causes of the problem—the secondary market.  Market makers created methods to purchase more mortgages, package pools of good loans with bad loans and call them all “investment grade” and expanded underwriting standards to make it so any adult with a pulse could get a mortgage or even several.  If the market would purchase the mortgage and no residual risk was posed to the appraiser, mortgage broker, or banker, then why not do it?  The main drivers behind the markets are the government sponsored entities of Fannie and Freddie. 

Some economists bring up a valid point that facilitating house loans to borrowers with a large proportion of debt requirements to their income has a negative impact on the broader housing market.  This can artificially inflate house values.  We saw this in the 1990’s, a decade with real income annually increasing around 3%, while average house values nearly tripled in those ten years.  The article quotes Ed Pinto, co-director of American Enterprise Institute’s Housing Center, “We have a huge shortage of housing.  You can’t address that shortage by driving house prices up through leverage, which is what we’ve been doing.”

Some wonder if we will face some retraction in housing prices when the “mortgage patch” provision ends in 2021 or whenever Fannie and Freddie decide to take underwriting standards to stricter levels as was common in the not too distant past. 

In the same edition of the Journal, in the opinion page is a column titled “Bernie and AOC Are a Credit Risk”.  The article states that two of the “loudest socialists’, Sen. Bernie Sanders and Rep. Alexandra Ocasio-Cortez called for capping interest rates on consumer loans at 15%.  Today’s median rate on credit cards at 21%, is too high given that banks can borrow from the Federal Reserve at 2.5%. 

But is that an accurate argument?  The writer points out that credit cards function as payment networks with functions such as processing countless small dollar transactions, sending monthly bills, offering on-demand customer service.  The cost of daily operation is high, yet in 2010 Congress capped the interchange fees that financial institutions can charge.  The result was many institutions found other ways, such as increased fees on deposit accounts to make up that lost income. 

In Economics 101, we learn that price ceilings on any good or service cause shortages.  Demand increases since the public sees this good as being cheaper, given its utility.  Supply for the good decreases as the producer now has less profit reason to produce (remember economics is:  people respond to incentive).  Shortages of consumer credit would hit with a cap and it would impact those folks who would benefit the most from the higher credit card rate when compared to options of a pawn broker or payday lender. 

But the pair has another suggestion to help address the lack of financial services widely available.  Let Americans get checking accounts or even low-interest loans, from their local branch of the U.S. Postal Service.  Credit Unions see constant market share being eaten away from banks and many non-bank competitors today.  Now we must worry about the federal government. 

The convenience is not at the USPS.  My local post office is open only 5 hours a day on the weekdays and 3 on Saturday.  The experience level of delivering financial service is not there.  How is the USPS supposed to set up an ATM network, deposit accounts, and underwrite loans with no deep experience in any of these areas?  How can they do this where it is anywhere close to break even financially with an entity that lost $3.9 billion last year and has unfunded pension liabilities and retiree health care of $100 billion?  Politicians would push the postal bank to further lower underwriting standards and fees as they fight those who are on the outside of banking services.  This strategy seemed to work great in the mortgage business.  The losses would be incredible and would be forced on the heads of the U.S. taxpayer.

We worry about entities like Apple, Starbucks, Amazon, or Wal-Mart for supplying banking services and how this impacts the landscape of our credit union members and those-who-could-be a member.  Now if the proposal from AOC and Sanders comes true, your new competition comes from a group with unlimited money.  The oversight for the USPS bank is not as concerned with sound financial management as they are pleasing the populace to gain more favor for the leadership whenever elections occur.  That, indeed, could be a challenging competitor for us.

Road Trip with CECL

Tonight, I write from Mid-Missouri, the area of the country I grew up in.  My wife and I have had the pleasure in seeing our youngest son graduate with his bachelors and then are in the Show-Me State to visit my father as he is turning 90 this month.  The trip has given us lots of windshield time as we drove to take my son’s beagle to him.  One topic that is making the miles pass quicker is my reading on the upcoming Current Expected Credit Loss, or CECL. 

CECL is an attempt by the Financial Accounting Standards Board (FASB) to make a better estimate of loan losses over the life of a loan or a portfolio.  Publicly traded banks will be moving from the traditional Allowance for Loan and Lease Loss (ALLL) calculation to CECL at the end of this year.  Privately held institutions and credit unions will follow suit in the next couple of years.  There is a large amount of uncertainty in how to comply with the new guidelines. 

One of the triggers for this move was the crash in 2008.  The problems hit rapidly.  Very few institutions had adequate reserves to cover loan losses since credit was deteriorating quickly and lenders were not recognizing these changes in setting aside more money for losses.  The bank I worked at during this time had all the commercial lenders reanalyze the risk on each credit over one million every quarter.  We tried to adjust for loan losses but even this was futile in some cases as the problems may not have surfaced in previous historic financials that were happening with the borrower at that time. 

Then, as we came out of the crisis in 2010, we found that we had too much in loan loss reserves as we were attempting to do forward looking ALLL calculations based upon history.  Basically, all any of us can do is to look at the past and make some predictions for the future. 

The idea behind CECL is to remove the backward-looking loan loss reserve method that is used currently and gaze into the future to see what possible losses will be in a loan or portfolio throughout the entire life.  FASB’s final guidance allows institutions to use different methods for CECL estimation depending upon the size and complexity of the lending.  This is where the confusion lies.  All institutions need to determine what models are needed, and what factors to watch to satisfy the requirement.  Further confusion will come with our examiner friends as they review models which will be in place but in the early CECL years, have not been historically tested for level of success. 

Foreseeable future is a vague term, and this is a concept of CECL.  History is concrete in terms of loan losses.  It also may be possible to have a prediction for loan loss changes with possible changes in the economy over the next 12-24 months, which could be argued as foreseeable.  Once you get beyond that time, possible changes in the economy, business, and credit strength is very vague.  The challenge here is that you will have credit exposure which could continue beyond the foreseeable future.  Exposure within the foreseeable future can sometimes vary well beyond original predictions as we noted in North Dakota when oil prices crashed in 2015. 

Models can go awry by failing to look at pertinent factors, weighing factors incorrectly, or not estimating assumptions correctly.  These can also have many different factors to look at like GDP, unemployment rate, commodity prices, inflation, interest rate projections, and so forth.  An institution may also have a different model for ag loans that may have a driver of commodity prices, while a model to predict housing defaults may look at something like unemployment rate, since housing defaults are more likely to occur when someone is out of work. 

On the commercial side and with other loans as well, a projection for the exposure at default (EAD) is a conceptual driver behind what is needed for CECL.  EAD is a combination of the probability of default (PD) and the probability of attrition (PA).  PD is a measurement we do in risk rating.  Based upon several factors of our choosing (e.g. Debt Service Coverage Ratio, Current Ratio, Debt/Worth) that we believe to be good indicators of financial stress in a company, what is the probability of a default in the near future?  PA attempts to answer what portion of the loan balances will still be outstanding at the time of the default.  Loan balances should be lower than what they are today with principal reductions from amortizations and accelerated principal paydowns from borrowers.  Loans with a substantially higher interest rate compared to the current market rate will have more of a chance of being refinanced and you losing the entire loan balance.  Your institution’s exposure at the time of default is a combination of the PD x PA. 

The next factor to consider is what is the loss given default (LGD).  When EAD hits, what will my LGD be?  This differs greatly from loan to loan.  A credit leveraged at 80%, secured by accounts receivable will have more LGD than a real estate loan leveraged at 40%.  In some cases, perhaps like the last one, the LGD will be 0.  Low LTVs on collateral that is marketable, government guarantees, and cash collateral are some factors that will lower the LGD. 

Many lenders will have one risk rating scale that combines factors considering the probability of default and the possible loss if a default occurs.  Given these changes with CECL, institutions may move from a single risk rating scale to one that measures the PD and a separate one that measures LGD. 

The EAD and LGD are concepts to consider when starting down the road to inspect the possible CECL impact on a loan or on a portfolio.  Understanding the logic here, forms a basis that expected losses can be estimated.  Then you can utilize your various data points to measure the possible changes in the environment that will impact you CECL. 

How Taxes Touch Us Everyday

A couple of weeks ago, we all celebrated Tax Day on April 15 by spending large amounts of time and money in preparing, filing, and paying our income taxes.  Now while income taxes are heavy on you mind currently of the year, or perhaps in the fall if you file and extension, and you think of taxes when you write the check to the county to pay for your property tax, do you ever think of how taxes impact your life every day?

When I get up in the morning, the first thing I do is check my cell phone.  I use it as my alarm clock.  But have you noticed when you go into the cell company to get that great plan with the unlimited data, text, and talk for $70 that your monthly bill is much higher?  Taxes average another 15-18% of you monthly cell bill.  Some of these were designed and go to things you do not directly use like telecommunications equipment in areas you do not live.  Some are for special purposes.  Chicago has an extra cell phone tax that was originally used to help Chicago attract the Olympic Games.  Chicago did not get the Olympics, but residents there still pay the tax.

The Chicago tax brings up an interesting point about taxes.  Sometimes, taxes that were originally designed for a purpose, continue long after the reason for the tax in the first place has stopped.  Pennsylvania put in a tax in 1889 to help rebuild the city of Johnstown after a devastating flood.  In a few years they raised tens of millions of dollars and rebuilt the city.  Yet the tax remains today. 

You may next turn on the TV to see the news while you toast your bagel.  Cable or satellite TV is fraught with another 15% or so in taxes on top of the regular bill.  Perhaps that may be a reason why many people are moving away from that expense.  As you toast your bagel, if you are in New York City, there is an additional 8 cent tax if you purchase the bagel already sliced compared to if you buy the bagel whole and decide to slice it yourself. 

You get in your car and drive to the office, but you must stop at the filling station on the way.  Federal gas excise tax is 18.4 cents per gallon and 24.4 cents per gallon on diesel fuel.  Then you add state taxes to the mix.  These average 28.7 cents more per gallon of gasoline.  If you live in Pennsylvania the highest gas taxed state, expect to have 59 cents of each gallon go to state gas tax. If you are lucky and live in Alaska, your rate is only 9 cents per gallon more. 

Then say you have lunch at a restaurant with co-workers.  The farmer and rancher who produced the food had to pay property taxes and if they are profitable, income taxes.  Then this is shipped by truck which the trucking company is paying property, wage, and fuel taxes.  The company that bakes the bread or cuts the meat is paying taxes on its people, property, and profits as well.  All this comes to the price of the sandwich you purchase, and you pay more sales tax on this as well.  In some states like Colorado, restaurant food is taxed higher than grocery store food. 

This brings up another interesting point.  Corporations do not pay taxes.  They build the tax into their final product and charge it to the consumer.  Some politicians who want to charge taxes as high as 75-95% on corporate profits seem to lack basic economic knowledge of this reality. 

If you were in California and wanted fresh fruit as a snack, you can purchase this at some vending machines.  But there is an extra 33% tax to purchase fruit at a vending machine compared to a grocery store.  This shows a principle that some taxes are started when one group of people want to gain an advantage over another.  In this case the grocery store lobby was successful in protecting their interest over vending machines. 

Let’s say you were in Philadelphia when buying your lunch and wanted a Coke with the meal.  Philadelphia has a tax of 10 cents per ounce on sugary drinks.  Your 12-ounce soda is costing $1.20 more.  Now has this tax curbed sugary drink consumption in Philadelphia?  Probably not as much as you think.  Residents there will travel to New Jersey which does not have this tax to purchase their soda.  This brings up two truths.  First, people will modify their behavior to avoid taxes.  I remember as a kid how my dad would try to avoid buying gas in Illinois since the tax was so much higher there than Missouri or Indiana.  Second, taxes are often sold the public to influence societal behavior are really hidden ways just to generate revenue.  Philadelphia did not care about how much soda people consume.  They just want the tax revenue. 

At the end of the day, as you are frustrated with all the taxes you have paid so far, you decide to go to happy hour at the neighborhood bar.  Now if you have beer or wine, you tax is much cheaper than if you have liquor.  Liquor has tremendous taxes from the Federal and State government.  These are taxed at $13.50/gallon or about $2.50 per fifth on the Federal side.  State taxes can go up as high as another $7 per fifth.  If you stay with beer, only about 40% of the cost goes to taxes.  If you are celebrating in Minnesota and buy champagne, you have an extra surtax there.  Perhaps that is why beer and wine are consumed more there. 

So, after you have been inundated with all these taxes every day of your life, be aware of some of the more oddball ones that are there.If you take a tethered hot air balloon ride in Kansas, you must pay an entertainment tax.But if the rope is cut, there is no entertainment tax since this is now treated as transportation.

Status of the CU and CUSO Industry

I recently attended the National Association of CUSO (NACUSO) conference in San Diego.  One of the presentations was given by Dennis Dollar, a former NCUA Chairman and Principal of Dollar Associates.  He provided some wonderful information on the status of the industry which I am passing on in this blog. 

Now that Congress is divided, what will be the new impact on Credit Unions?  The Democrat majority in the House and Republican majority in the Senate will result in stalemates.  The House may try to push new regulatory legislation unlikely to make it through the Senate.  The Senate may try new reg relief that will not make it through the House.  The House may take up hearings on the CFPB or NCUA to force them into more action.  The House has also shown interest in Senator Elizabeth Warren’s proposal to expand CRA into the CU world (this would be very problematic for CUs which are SEG based).  More likely, the House will be consumed with their angst against the President.  The Senate will streamline the filibuster rule to speed confirmations for agencies and the courts through.

What is the state of the CFPB?  The CFPB’s head of Mick Mulvaney is succeeded by Kathy Kraniger.  She is a kinder version of Mulvaney but holds to the philosophy of limiting the expansion of the agency and its regulatory actions. 

Status of the NCUA?  The NCUA has a full Board in place with the addition of Chairman Rodney Hood (R) joining Todd Harper (D) and McWatters (R), whose term expires in August 2019.  It is likely that McWatters will go on to other things which will leave a vacancy.  Hood is a strong believer in effective and not excessive regulations.  Harper has been big on promoting an expansion of CU membership and making CUs and CUSOs more accessible.

Any taxation threat on the horizon?  We had our first major tax overhaul in 2017.  Last one was in the Reagan administration.  CU taxation was not proposed in this overhaul.  This is a good sign there is not congressional appetite to deal with taxing CUs, especially in an election year.  A full tax of CU net income would only produce a little less than $2 billion in tax revenue for a country with over $23 trillion in debt.  The threat may be lessened but we need to stay vigilant. 

Will Risk Based Capital rules be implemented in 2020?  This was extended from 2019 to 2020 and will be likely unless McWatters joins Hood to a further regulatory delay.  One major victory here is that CUSO investments are treated as an equal dollar for dollar risk compared to one of the original proposals where CUSO investments were 2.5x riskier than other investments. 

What role will CUSOs play?  CUSOs are still part of the answer.  CUs still need to build capital.  Some of the nation’s top ROA performing CUs are driving income from CUSOs.   Also, 80% of merged CUs had no CUSO investment.  The NCUA will begin to have a focus on the efficiency ratio.  CUs who are moving some operational expenses into a collaborative CUSO for some of the lines of business can improve the CU’s efficiency.  The NCUA is now also five years into implementing the CUSO rule and the implementation has been reasonable so far.  However, there appears no statue that gives the regulator authority over vendor regulation. 

What is the trend in CU mergers?  In 2018, 192 CUs merged or 3.7% of the total of institutions.  The total number of CUs is around 5,375 at the end of 2018 which is down by 65% from the 15,000 CUs present in the mid-1980s.  The new Merger Disclosure Rule is not slowing a move toward mergers as marketplace, member service, and supervisory pressures are driving more merger discussions.  The new rule is making the process longer, requiring more disclosures and longer times to complete.  The biggest single deterrent to mergers is not the disclosure rule.  It is the lack of field of membership flexibility at the federal level.  This drives more mergers to the state charter rules which are more open.  The merger activity is slowing but not stopping. 

What about the regulators?  Regulators may call you on the carpet for a decision, but you should be able to make a sound business case as to why you did what you did.  The changing of the prescriptive MBL policy to a principles-based policy is a good example of this.  Play within the rules and respect the refs but do not allow fear of the refs to dictate your play calling.  Play your own game confidently and stay away from areas where you are not familiar or bring in experts to help you. 

Watch the examiner and attorney opinions that come from the NCUA.  In 2019 so far, these have been very few.  There was one on loan participations dealing with the difference between securitized loan pools and groups of loans.  Also, the use of the verb “banking”, when talking about CU services is not out of bounds like some on the bank side want it to be. 

What changes may CUSOs see from the NCUA?  There has been talk of expanding CUSO powers and adding different types of loans they can manage.  CUSOs are viewed favorably by some in the regulatory agency who have oversight for MBLs.  They like the expertise and support given by these groups to CUs as they continue to service their membership and communities. 

There is a push at the NCUA to have authority over vendors, any vendor, used by a CU.  If used, this could extend to CUSOs, technology providers, leagues, independent accounting firms, and any other supplier for CUs.  Most of these vendors are covering areas that the agency has no expertise in providing informed oversight or can render an educated judgement. 

It appears that the members of the NCUA Board want vendor authority.  Part of this may be that their counterparts at the FDIC and OCC have this authority.  The initial reasoning in asking for this is for cyber security concerns regarding various core banking products used by CUs.  But this information is currently available to the agency through the FFIEC.  Core providers are currently regulated by other regulators and have been for years.  This information can be obtained by the NCUA without expanding vendor authority.  This proposed expansion can be easily abused and prone to over-reach.  As the saying goes, “Power corrupts, and absolute power corrupts, absolutely.” 

Is Development Slowing on the Horizon?

In most core and secondary U.S. real estate markets, new development and leasing activity growth is slowing due to factors like stock market volatility, uncertain interest rates with a slightly inverted yield curve, the waning impact of tax cuts, rising wages, labor supply shortage, and fatigue after a record-setting period of economic expansion.  Globally, economies have stagnated in Europe and even China is showing signs of slowing. 

One factor is companies seeking new locations.  We see this with Amazon and Apple expansions that impact Northern Virginia, Nashville, and Austin, Texas.  The massive growth effects here will be localized to areas where there is large company and government growth.  We expect to see some growth in the Black Hills area with the new B21 bomber moving to Ellsworth AFB.

Another factor are companies moving from higher tax and regulated states to those where it is more affordable to live and easier to operate.  McKesson Corp. recently announced it was moving its headquarters from San Francisco to Dallas.  The company cited low taxes, affordable housing, good schools, and a business-friendly environment as reasons for the move.  With the new tax laws in place, residents of high tax states like New York, California, and Massachusetts are considering relocating to states like Texas, Florida, Tennessee, and the Carolinas where taxes are lower.  Since as a country we are at full employment and have the lowest unemployment in two decades, companies may select areas where it is easier to retain employees.  Low taxes and regulations and good community amenities are factors.

When considering various sectors of commercial real estate, industrial, senior housing, and manufactured housing are going strong.  Most of the primary industrial markets in the U.S. have vacancy rates under 5%.  In all the port cities and large metros like Atlanta, vacancies are under 2%.  Low vacancy rates are driven by a revitalizing of manufacturing and consumer spending and e-commerce.  Retailers reported e-commerce sales jumped 26.4% around the 2018 Thanksgiving holiday compared to the previous year.  As e-commerce continues to grow, strong demand in industrial will come from the need to warehouse products. 

Multifamily and hospitality are seeing rising construction costs.  Currently, some of these are hitting 12% annually.  Office markets are mostly flat nationally with some markets like Houston, New York, and San Francisco as exceptions.  Companies that are adding office related jobs are also shrinking space needs per person.  Work benches, open cubicles, creative spaces, and in some cases the ability to work remotely using a VPN network are all lessening the office demand space per person. 

Nationally, retail development has stopped.  Malls are experiencing large vacancy rates and bankruptcies.  In recent years hundreds of malls have closed as major retailers have closed with a combination of changing purchase habits and high debt loads.  Some retail areas that are doing well are smaller neighborhood, food-anchored shopping centers, home improvement stores, furnishings, and off-price stores like TJ Maxx and Ross Dress for Less. 

Self-storage real estate sector rebounded in 2013 and is breaking record valuations in 2015.  This type of property is seeing strong demand among lenders with a new national increase of 8.7% over existing supply according to MJ Partners Real Estate.  Some areas are seeing double digit increases so there may be some concern with overbuilding.

Some secondary and tertiary markets are seeing strong growth.  Salt Lake City, Orlando, and Central areas in Florida and Wisconsin are all strong demand with interest that has not been seen in years.  So as the old adage for success in real estate is based on location, location, location continues to be true.   Other factors, as they always do, impacting commercial real estate, are the availability of equity and debt capital, and inflation of material prices.  A new issue this year is if the accounting regulation changes for handling of leases will have an impact on demand. 

The lender and investor should understand the current forces in the market nationally but really needs to understand the local trends in his own area.

5G Technology, the Next Industrial Revolution

Most of us have heard of the upcoming advance of the 5G network that is touted by cell phone providers.  But do you know what this is and how this could change our everyday lives? 

The “G” in 5G stands for generation.  The first generation was the ability to have sound on cell phones.  Some of you may remember your first cell phone.  Mine was in a bag the size of a small suitcase, with an attached antenna that went on top of my car attached with a 10-foot long cord to the carry-on bag.  Those were the days!  The second generation gave us the ability to do texts.  Third generation gave us the internet on our phones and surfing the web.  The fourth generation took all the previous three and made the system around 10 times faster. 

5G takes the 4G data and now accelerates the speed by ten-fold.  4G can download info at around 2 gigabytes/second.  5G can download data by 20gb/second or quicker.  The Chinese company Huawei claims that an 8gb movie that took 7 minutes to download, can be downloaded in 6 seconds in a 5G environment.  Basically, 5G communicates in real time with a lag of one millisecond.  The ability to transmit and receive data live and in real time provides huge opportunities.  Driverless cars would have the ability to know what all other vehicles on the road are doing.  Remote doctors could consult real time with medical specialists all around the world as they work on a patient.  Remote rural communities can have the same access to information as those in large, well-wired cities.  The possibilities with transmitting data immediately are endless.  Some have called this the next industrial revolution. 

5G technology requires an entirely new infrastructure.  The signal connects with computers with more of a line-of-site and has a much shorter distance than what we have with 4G.  As such, more 5G transmitters, which are about the size of a notebook, would have to be installed every few hundred yards or so to have a solid network.  The large US cell carriers are expecting to have 5G networks available in large scale by 2020.  Samsung is seeking to open 5G throughout South Korea later this year.

This industry is huge and could eclipse $1.26 trillion in size by 2026.  China is the fastest growing country in implementing 5G.  GSMA estimates that by 2025, China will have 40% of all global 5G connections which could be up to 3.2% of China’s entire GDP, 8 million jobs, and 2.9 trillion in yuan by 2030.  Spending in R&D by Huawei on 5G is more than 3 times the combined 5G R&D spending of the three major US equipment manufacturers.  China’s spending on 5G is a large part of their “Belt and Road” initiative to link China with various countries throughout Asia, Africa, and Latin America.  China is also providing equipment to 60 different countries. 

Newt Gingrich has a wonderful podcast called “Newt’s World” which I would encourage you to listen.  In one of his latest episodes, he had General Robert Spaulding, a former Senior Director of Strategic Planning for the National Security Council.  One concern that was brought up is the impact of big data and technology privacy.  5G will provide data that anticipates what you want and need.  Some may think it would be OK for their connected refrigerator to send a message to your phone to pick up eggs since you are low.  Personally, I still think that is a bit weird.  Next my fridge will criticize me if I sneak down for a midnight snack!

But, what do you do when a totalitarian regime with control of some 5G network uses data available on you to influence people around you in ways that you did not intend?  What if various “artifacts” could be left on the web that could cause a breakdown of social order?  If nefarious people control the data, they may be able to have the same impact as weapons of war have without ever firing a weapon.  What if the manufacturer of your equipment refuses to allow you access to your money unless you agree to their views on things? 

True, there are security and privacy risks that must be mastered.  5G has the potential of revolutionizing our lives.  The challenge is how do we get a network developed when private sector companies still have 4G tech investments to work through.  They also are subject to the shareholders and the performance quarter by quarter.  In the past, the government sometimes sees this as the responsibility of the private sector.  Yet, we are in a tech race that rivals the space race that started when Sputnik went into orbit.  The country that dominates 5G technology and prepares for the next generation after that, can dominate militarily, economically, and in sheer knowledge.

Opportunity Zones vs. 1031 Exchanges

For years real estate investors have enjoyed and understand the benefits of the Section 1031 Exchange program.  This allows the capital gain from a sale of business or investment real estate to be deferred with the reinvestment of proceeds into another like-kind property.  Like-kind is very broad when it comes to real estate, as this means any other piece of real estate used for production of income. E.g.  an apartment sale can 1031 into a track of vacant land or an office can 1031 into an apartment. 

In the Tax Cuts and Jobs Act of 2017, code 1400Z-1 and 1400Z-2 created qualified opportunity zones to encourage investors to move money into economically distressed areas of the U.S.  This investment may allow taxpayers to defer or even possible exclude any capital gains from taxation.  The opportunity zone refers to investments in a Qualified Opportunity Fund (QOF), which has been established under the code and regulations. 

There are several differences with the 1031 and QOF in terms of the investment characteristics.  The QOF can defer capital gains from any assets, can use any funds, and only are required to invest the gain amount.  The 1031 requires the exchange must be like kind in nature, funds must be tracked to purchase the new property, and the new property must be equal, or more than the value of the property being sold.  The QOF allows you to invest only the gain you have on stock into an approved fund without any capital gains.  The 1031 would require you to reinvest the $1MM of value you sold the office building for to another piece of real estate of $1MM or higher in value. 

The QOF Investment (QOFI) can be into any qualified QOF.  The 1031 has strict rules such as the 200% rule, three property rule, and 95% rule.  The QOFI allows for capital gain reduction of up to 15% after a 5-7-year hold and 100% after a 10-year hold.  This effectively makes the capital gains on the investment tax free.  The 1031 has no capital gains reduction, only a deferment of taxes due to a later date. 

The 1031 has 180 days to identify and close on replacement property.  Advance notification must be made for replacement property prior to closing.  The QOFI does not have the same limits.  The 180-day period may be just the beginning for the QOF to invest funds and even longer for electing partners in a partnership that did not make such an election.  The QOF also requires no advance notice prior to investing.

The 1031 allows you to defer the gain on the sold property indefinitely.  The QOF deferral is only until 2026.  In that year, investors will have tax on corresponding income.  The 1031 is broad in allowing you to invest in any other real estate used for income, while the QOF must be in an approved QOFI.  The 1031 investment may not require additional investments while the QOF may need more improvements on the property. 

The 1031 provides great flexibility to finance, sell, or exchange the replacement property after purchase, whereas the QOF may have some lost benefits if not held for 10 years.  The QOF starts the 180-day clock when capital gains would otherwise be recognized and there is no indication that an investment be entered into before that time would benefit from this election.  The 1031 allows more flexibility here with the possibility of a reverse 1031 exchange, which allows the investor to purchase the replacement property first and then sell the disposition property, while still enjoying the deferral. 

These outline just a few differences between the 1031 and the QOFI.  The real estate investor should consult with tax advisors and other professionals to see which one would sever him best in the current situation when considering some deferral of capital gains taxes.  The analyst should have a knowledge of both programs when completing analysis on these types of properties. 

What Sport is Your Business Playing?

One of the fundamental needs of a business is for all to understand and buy-in to a common goal.  That is why organizational planners have companies set out a common mission, vision, and values.  It is crucial for success to have everyone understand these, or else, it is like aiming at whatever target the team member thinks is best at the time. 

But even when there is commonality of mission, vision, values, and goals, undue friction and conflict may crop up.  Some of this is due to the normal growth patterns of a business, organization, or a church.  As growth increases, complexity increases and the rules of the game change even though the goals may stay the same.  To illustrate, I will use the analogy of sports.

Track is a sport where you practice with others, but you perform alone on most events.  Your goal is to beat your personal best every time you are there.  Sole entrepreneurs are like decathletes.   They may go to conferences and seek advice of others, but ultimately, they are the ones selling the product, answering phones, completing orders, administrative work, and dealing with customer complaints.  Here the limit is how good you can perform each event of the decathlon.   When I first started with Pactola, I was the only person here.  I looked for loans, developed new business, was the IT department, web designer, main underwriter, policy drafter, and HR department.  I was a jack of all trades, but a master of none.

As a business grows, it will move from a decathlon to golf.  Golf is often practiced alone but played in a foursome.  It is highly relational but is performed alone.  The relational factor is why so many business meetings are held on a golf course.  Your performance, though alone, is seen by everyone in your group.  These events are often recounted back at the clubhouse where all the good and bad shots are replayed over refreshments.  A golf organization is one where everyone knows about everyone else’s life. 

As business grows, it will move from golf to baseball.  Baseball is highly relational but begins to have a division of roles or positions.  You have pitchers (starters, middle relievers, closers), infielders, outfielders, utility players, designated hitters, and coaches.  Each of the roles are unique but are highly dependent on each other.  While everyone knows what everyone is doing on the field, not everyone sees everything about each fellow teammate’s life.  Organizations will grow beyond the baseball stage, but players may get stuck and complain that they don’t know everything anymore that they used to.

The next stage of organizational growth is football.  Here the team is so large it may not travel in the same bus together.  Football is divided between offense, defense, and special teams.  Only one of those divisions is representative of a team on the field at any one time.  Each of these divisions also have their own coaches and then assistant coaches for various positions, such as a quarterback coach, receivers’ coach, and offensive line coach.  All the coaches report up to one head coach.

Here not all people know what the others are doing.  The special teams do not get upset when the offense sets up a new pass play.  The quarterback should not be tweaked when a defensive coach shows a new technique to the linebacker and does not include the QB in the training.  Large organizations are like a football team where players may have a general knowledge of the execution of plays of all areas of the team but not a highly specific understanding.  And that level of understanding is OK.

Undue friction may come when a group moves from one sport to another, or where some players on the football team may still be back at the golf stage in the business execution and may yearn for the good ole days when the group was small, and everyone was a close friend.  Maybe you are a small business who is trying to divide up as a football team, when you really need more relational interaction and team execution as a baseball team.  The leader needs to watch for and be aware of players who may be stuck in one sport when the organization has grown in complexity beyond the sport stage they are stuck in.

Look for a sudden increase in low-level frustration.  Maybe Linus in accounting, was upset that Sally did not tell him when she finished the website changes, when all this used to be discussed in the past.  When people who once knew all are now not knowing all, they may feel left behind.  This may just be a part of the natural growth of a business.

Next watch out for meetings that go to long.  People often are getting involved in things they don’t need to be a part of and which are not part of their roles.  I often joke that I have two rules for meetings that come from my Southern Baptist roots.  (1) all meetings should be 20 minutes or less and (2) if you violate rule #1, bring food!  The corporate meeting is often the main roadblock to productivity.  Treat the minutes spent there as precious knowing you will never get any of them back.

Lastly, watch out for an increase in a team-members hurt that results from mis-communication.  As a company grows, especially from the highly relational stages to those which are not as relational, the lack of sharing in some areas which used to be common, may be only because the group has grown to the next sport level where roles take you away from the intimate golf stage. 

The highest performing organizations have shared missions, vision, values, and goals.  They also have team members all playing the same game. Leaders need to be aware when the complexity in the company has caused the game to change and help bring along those who may be stuck playing an old game.

The Power of Collaboration

Today as I write, is the first day of Spring, my younger son Josh’s birthday, and a mere 8 days away from the opening day for baseball season.  These events that mark spring are much anticipated by me and many others.  I thought about these events a lot while trapped in an airport because of a blizzard.  My only hope now is that we have seen the last winter storm of the season!

As I, along with many others were able to experience more of the amenities at the Minneapolis airport on this last trip—more than I ever cared to—it did give time to ponder the credit union industry after the recent conference I had attended.  One theme that is evident in this industry more than others in the financial arena is collaboration.  In my career in finance, I have worked for savings and loans, banks, insurance agencies, and now for credit unions.  Of all of these, I have found credit unions to work together the most for common goals. 

I think much of that is ingrained in the credit union DNA.  From the beginning, credit unions that started in factories realized they would be stronger if more worker-families used the credit union for their financial needs.  Community-based credit unions realized they could server more people when more people in the community joined.  With this natural bend toward financial services that benefit the entire group rather than those driven by profit to the shareholder, it seems natural that credit unions would join with other credit unions to conquer common problems.

This is quite evident in our institution, a credit union service organization or CUSO.  From what I know, there are no banking service organizations or insurance collaborative companies.  Yes, all financial sectors do have common trade groups or user groups with different vendors, but none have groups like a CUSO, where its credit union owners have vested ownership and a stake in making the CUSO successful, which in turn will help make the owner credit unions more successful in one area or another. 

The CUSO model also embodies the spirit of collaboration.  Individual CU owners who are vested with the CUSO will make decisions that may not be the best decision for their individual CU but will benefit the CUSO.  The short-term sacrifice will turn into better long- term gains for the industry and for the individual CUs.

We see this a lot as we work with the collaborative power of funding large commercial loans.  Some of these could not be individually funded by one institution and they need the help of others in the funding.  The institution that purchases a portion of a commercial or agricultural participation will receive a higher yield than other alternative investments.  This provides more earning benefits to their individual membership. 

But the purchaser provides much more benefit than just higher earnings.  They help the selling institution win the deal.  This makes the seller a more viable financing option for future business loans by others in their community.  Helping here strengthens and builds up that credit union.  This helps to strengthen and builds up credit unions as a whole.  More business owners and farmers will see working with a credit union for their financial needs as a viable option when they hear of fellow businessmen who have gained financing for their building expansion or new land purchase through a credit union.

The loan buyer benefits from this increased awareness of the credit union option.  They also could benefit from the present CU seller helping them when they have a large project that needs to be funded.  This collaboration is shown when we help our brother and sister institutions.

The collaborative benefits extend to the CUSO which can provide and service more accounts and help facilitate more loans with servicing income earned from managing each credit.  The income also allows the CUSO to expand its services in its support of credit unions.  Again, the power of collaboration is evident throughout this model.

As an individual CU, how have you reached out beyond your group and collaborated with others?  This brings the possibility of new ideas, new members, and new business for all of the group which will allow your individual CU to grow beyond all efforts solely done on your own.

Business Owners:  Open Your Eyes to Business Lending at a CU!  CUs:  Open Your Eyes to a CUSO!

This week, I had the opportunity to attend the Credit Union National Association’s annual Governmental Affairs Conference.  One of the themes this year is to improve the credit union brand across the nation.  Many people know that we exist, but 72% of those who know about CUs and do not use our financial services, would not consider a CU to be an option for them. 

I bet the percentage would be even higher if you asked the general public about if they would consider their business needs with a credit union.  That number of those who would not consider a business loan at a credit union as an option would be even higher still.  Unfortunately, many in the CU industry also don’t realize that the CU can be a resource to help small businesses and agricultural producers.  Too many times I have heard CUs turn down good business opportunities because they don’t do commercial loans, or the loan is too big, or the business is too hard to understand.

It is time for credit unions, members, and those-who- are-not-members-yet-but-can-be to open their eyes to the possibility of a business relationship with a credit union! 

It is also time for credit unions to open their eyes for the collaborative resources of a business CUSO!

Let’s say you have no business department but want to begin to serve small businesses in you community.  Perhaps you want to help business owners employ more people, make more products, and create wealth—but you don’t know where to start.  Open your eyes to Pactola, as we can help create the structure for a business department with policies, procedures, and best practices. 

Perhaps you already have a business department but are short on staff.  Maybe it is for a short season or perhaps it is a longer season of time as you have good field lenders but not enough back office support.  Open your eyes to Pactola as we can help with underwriting, document preparation, risk reviews, and government guaranteed lending. 

Maybe your department is very good at either commercial or agricultural lending, but not at both.  Your community and membership base are in need of you servicing both areas well.  Open your eyes to Pactola as we work with both credits to finance farms and businesses.

Another scenario is that your CU has decided that utilizing governmental guaranteed lending is a good option to increase your reach, while managing your risk.  Open your eyes to Pactola as we can help with SBA, FSA, and USDA Rural Development guaranteed lending.

Your biggest business member just got too big for you to handle.  The company brings in the opportunity to finance a $25MM commercial real estate project and you have only the capability of taking 10%.  The project is strong and has great cash flow.  Don’t turn them away!  Open your eyes to allowing Pactola to underwrite, syndicate, and manage the credit on our participation platform for you!

Loan demand may be slow for you.  Don’t worry!  Open your eyes to the possibility of helping your CU brothers and sisters finance projects they are part of by taking part of one of our loan participations. 

Financing businesses, farms, and ranches is a great way to impact your community by creating jobs, growing wealth, and making the dreams come true for the owners.  It is time for the CU to open their eyes to making a difference and for members and future members to open their eyes toward a CU as their trusted business financial partner.  Our CUSO, Pactola, can help get you there.

A Closer Look at Profitability of Loan Types

Auto loans across all credit unions totaled $30.4 billion, compared to $7.2 billion in commercial loans in the third quarter of 2018.   One of the most popular loan investments among credit unions for years has been the auto loan obtained through indirect lending.  For those of you not familiar how this works, a lender will set rates for new and used auto loans.  These rates and terms are provided to car dealers, who are hungry for outlets to finance their vehicle sales.  Many CUs have used this as a strategy to gain higher earnings than other options.

The process may vary a from institution to institution.  Typically, the buyer will complete an application at the dealer’s desk and the finance manager at the dealer will review multiple options of lenders who provide their interest rates to the dealer.  These usually will come with some form of incentive from the lender to send the paper to them.  The interest rate the borrower will receive is usually based on their credit score, LTV on the vehicle, and debt ratios.  Competition for this credit is fierce, with at times the major auto producers offering 0% finance rates, from time to time, when they need to move inventory.

Let’s look at an example from a CU in the Midwest. We will call them Car CU.   As of early 2019, they were offering interest rates of 3.75% fixed for a five year fully amortized auto loan for their highest credit rated customer.  To get this loan with the dealer, they must provide a benefit of 0.50% back to the auto seller. Now we have a net rate to the lender of 3.25%.   Most of these people also have no relationship with the Car, or they may have gone to their Car first, as we hope.  So, these loans will come with a typical nominal account to obtain membership.  Car also has little control over the interest rate as all members who fall in a certain profile get a certain interest rate.  So no differential can be made for differences in market areas and other factors. 

Let’s assume the Car writes $1,000,000 of these loans at an average loan of $40,000, which would give us 25 loans.  Over the first 12 months, this package of loans will have an average outstanding balance of $900,198, assuming a 5-year term.  Loan serving expenses and loan losses from auto loans averaged 30 and 60 bps in Q3 2018.  Multiplying this by the average balance gives expenses of $8,281. 

Car CU lines up with the median cost of funds in the industry of 0.30%.  Now, this issue is another blog as I contend that an accurate measure of loan profitability is not using the cost of funds for the CU but using an index like U.S. Treasuries or FHLB Advance rates.  This view assumes the CU must go out into the market to fund the loan with borrowing the funds from at the market.  This helps focus on the net spread using a matched fund principle.

For this example, we will go with Car CUs cost of funds.  Now we have a net interest rate of 2.95%.  Over the first year, Car will earn a net interest of $28,966, after factoring out the cost of funds.  Taking out the loan management costs of 30 bps and loan loss of 60 bps will produce a net income of $20,685.  These new loans will produce a ROA of 2.30% ($20,685/$900,198) from this loan package. (Note the loan servicing expense and loss provision are averages for the industry in the third quarter.)

Let’s consider other loans.  Since we work with commercial loans, I will use Business CU lending $1,000,000 on an equipment loan with the same 5-year term and amortization.  We recently looked at a new loan on a highly qualified credit at a net rate of 5.33%, after our servicing expense.  This is around 2.8% over the current 5- year UST rate.  Now after the average cost of funds, Business CU has a net interest margin of 5.03%.   The average balance on the loans in year one will be $904,310.

Servicing expenses are very small since most of the loan servicing tasks of credit review and payment processing has been handled at the CUSO level.  In this case we will assume 10 bps.  Loan loss risk is higher and averaged 75 bps for commercial loans in the CU industry for 3rd QTR 2018.    This gives us 85 bps of servicing and loan loss expenses or $7,681.

This credit will produce net interest for Business CU at $48,961.  After the cost to manage the credit, the net income is $41,280.  This gives a ROA of 4.6% ($41,280/$904,310).  If Business CU had the relationship and required deposits which averaged $50,000, the ROA on the relationship would increase around another 100 bps.  This is because these deposits represent free money to the CU.

Clearly, the higher yield is with the commercial loan.  The ROA from those relationships of 4.6% compared to 2.95% is a no-brainer.  Now there are higher risks with more funds concentrated into one commercial loan than 25 vehicle loans.  But, the business loan borrower would be better known to the CU compared to the vehicle loans where the application is filled out in the finance department of the dealer.  A finance department that has a vested interest in, at times, in putting down what is needed to have the loan approved. 

Now actual ROA calculations on these loans will vary from institution to institution.  My figures here are based solely on call reporting averages and there may be other factors or costs involved in your shop.  But basically, the NIM and ROA on a commercial loan are much greater than what you pay for indirect auto.  If you want a higher yield on the indirect, you would increase the risk in the loans by going to C paper or lower. 

Also, note that I made a comparison between two loans of the same amortization.  The larger balances for Business CU will probably be in commercial real estate.  Here the rates will be lower, but will still be much higher than Car.  Also, the amortization will be longer, so the interest earned will not take as much of a hit.  The average car loan has a 3 year term and an average business loan has a 5-7 year term in the credit union world.

There may be a place for both indirect and business loans in the CU world.  But if you are thinking that indirect auto lending is the ultimate salvation to a sagging ROA, think again.  The results are dwarfed by a good commercial loan.  Indirect lending should be used as a gateway to get a bigger share of the banking wallet for those 25 new members, instead of just the $25 share membership.   A good business lending program must be added to increase yield while deploying capital in larger pieces which will make a bigger impact in their communities, providing increased employment and helping people achieve their dreams. 

Our CUSO has a mission to make those CUs we work with successful in the commercial and agricultural lending arenas.  Let us help boost your ROA and success.

Creating a Good Team by Watching the Door

A good friend of mine was appointed to a board position for a charity.  At the time he joined the board, two other members left due to term limits.  These folks were replaced by two gentlemen who each represented small fund-raisers that was held annually for the charity.  The new members and my friend settled into their new roles. 

Within six months, the board had turned to a complete state of incompetence.  One of the new members, who was an absolute rock star with the yearly gala that he ran, made everything about his annual fund raiser which provided about 10% of the annual revenue.  The other gentlemen spent most of his time fighting any new idea that came before the board since it was unfamiliar with how things were run in the past.  Others on the board ran with their own ideas and promoted those to the extent that no unifying mission could be executed by the board.

The problem began with the two new individuals who were allowed into the leadership group, not because of their ability to add to the team mission but because they successfully ran a fund raiser or had history with the charity.  This shows how you must watch the door because if you allow the wrong person into the room, it is very hard to get them to exit. 

The first step to watching the door is to speak up on the front end.  When you are afraid that a new potential team member will not work out and you can speak up, do so.  If you don’t speak up on the front end, you do not have a right to complain on the back side.  My friend knew the gent who was encased in the past.  He should have trusted his gut when it came to his analysis of people.  Watching the door involves courage.

Next, pick leaders and not representatives for to get into the room.  Remember you want a leaders on the team that work together toward common goals and not a just a house of representatives.   Have you ever been part of a group charged with oversight on an organization that had leaders made up totally of representatives?  Representatives tend to break into their own silo to serve their own constituency, instead of the good of the organization.

People should be let into the room because they fit the needs of the team.  You may have absolute stars that you are bringing in who may be just like people you already have in the group.  A baseball team does not win with a full roster of 25 great first baseman and no other infielders, outfields, or pitchers!  So, how do you determine who will be a good fit for the team.

First, consider character.  Avoid people with poor character, or who are untrustworthy.  Also, how well does the candidate work with others?  They will need to pull together as part of a team.  How flexible are they?  Moving for the good of an organization may require the ability to change when change is needed.  Can they do that?

Next, does the potential leader have philosophical unity with the organization?  All need to understand their role and execute in that direction.  If you want to form a restaurant that can provide an excellent five-course dinner, you don’t hire three bakers who can produce the best desserts.  What about the rest of the meal?  The philosophy and core value need to be the same.  There needs to also be a passion for unity.

Lastly, consider what personality or roles you need now in the group when figuring if you need to allow someone new in the door.  If you have a lot of high performers who are very vocal and highly execute on the mission, perhaps you need a quiet person who is a high-level thinker and can plan efficiently.  If your team needs someone who is great in Excel to complete analysis, consider a spreadsheet expert.  If you need new ideas that are outside of your industry to reach new folks, consider a skilled outsider to enter the room.

Much pain can be avoided on the team for months and years ahead if the door is guarded and admittance is allowed in a well-thought and strategic way.  Allowing the wrong person in can cause a tremendous amount of problems.

Why Your Cost of Funds is Not Your Cost of Funds

Accounting tells us that any asset is funded by a combinations of liabilities and/or equity.   If you ask any CEO or CFO of an institution they can usually cite their current average cost of funds of their institution.  This would be the average cost paid on deposits and capital that are then used to fund those assets or loans. 

For the past decade or so, with both short term and longer-term interest rates being low compared to levels seen in the 1970s-early 2000s.  Rates have been comparatively stable.  These stable low rates result in a very low cost of funds when looked at on a snapshot basis.  The question is if this is a correct manner to view your cost of funds.  After all, understanding your cost of funds is the first step in building the interest rates that will be charged on the loans.  The loan rate should be figured by taking the cost of funds, figuring an adequate margin which considers loan interest rate duration, loan loss reserves, and management costs.  I have seen some shops that subscribe to a logic of identifying the static net interest margin as they compete for loan deals with super-low interest rates.  This is often done without any consideration of the cost of managing the credit, booking and maintaining the loan, and loan loss reserve expenses. 

I argue that a simple snapshot view of your current cost of funds is not the best way to form the basis of your institutions cost of funds when forming the basis for the interest rate you will charge on your loans, today.  The global interest rate environment has been so low for so long could deceive you to understanding the cost of funds in the future.  One problem with history is that we tend to stay in our short attention span and make decisions in that scope without considering a longer-term view of where rates have been in the past.  As rates increase and the overall cost of funds rises, looking at your static cost of funds which have been so low for so long, will miss the expected future increases in the near term.  Even if rates stay where they are now, your cost of funds will increase as many non-bank and non-traditional banking sources will become an attractive alternative for many of your customers to move some of the 0% earning deposits that you have enjoyed for so long.  This may force you to begin to compete on rate for deposits, which raises your cost of funds.

Early in my commercial career, I learned the concept of pricing using a “matched fund” method.  This strategy assumes that you have no money on your own to loan.  You must reach out to some source like the US Treasury or FHLB in order to fund the loan.  The loan funding term will match the term of the pricing on the loan, i.e. a three-year ARM would be tied to a 3-year US Treasury, a five-year balloon would be tied to the 5-year FHLB rate.  The net interest margin (NIM) spread is the difference between the interest rate on the loan and the underlying cost of funds. 

Pricing loan using matched funds to determine the NIM gives a truer picture of the actual cost you would incur to fund the loan.  Tying adjustable rate loans to a similar index in maturity also give you a picture of your cost if you were forced to borrow funds when the loan matures or adjusts to re-fund the credit facility.  This is basically focusing on the margin pricing. 

This pricing strategy may increase your overall yield on the loans if you are currently figuring NIM on a very low static cost of funds.  It should help your earnings comparably to the static view, especially when involved in a low interest environment with possible increasing interest rates, such as we are now.  If interest rates and your cost of funds is very high at the top end of an interest rate cycle, adjustments to this strategy should be considered to maintain strong NIM profitability.

When Teams go Bad

If you have ever been part of a team, department, board, or church group, you may have been in the situation when the team was bad.  The result here may be infighting, incompetence, and inability to accomplish anything meaningful.  It is often quite painful to be a part of a dysfunctional team, especially when we realize how much we could accomplish but are unable to execute on.  I think it useful to find possible sources of what has spoiled the team when you are in this situation or when you want to avoid ever getting there. 

The first factor to consider is if the team members are all aligned toward the same common goals.  Years ago, I was part of a non-profit board which had almost as many goals as we had board members.  The only item that was accomplished was that of the strongest board member, and this was at the expense of all the other members.  Until we got together and figured out the direction of the organization, we accomplished nothing else. 

Alignment is also required in the large overall methods used to reach the goals.  My wife and I were part of a canoe race.  The first few minutes of the race actually had us rowing against each other!  We then began to move toward the goal in a large zig zag formation.  We lost the race, but if we had been in harmony on our method to reaching the goal, energy used to paddle against each other and in any path other than a straight line could have pushed us over the finish line.

Sometimes just the place where the group meets may be a deterrent to the team coherency.  One department team I was part of had weekly meetings every Monday morning.  We sat around the table and did deal with the critical issues of the week.  But no large, strategic goals were ever discussed there.  We met around dinner tables and on couches at coffee houses when we discussed the large issues that set the framework of the organization for years to come.  Had we stayed in the board room and not been in a relaxed environment to develop relationships where we felt comfortable sharing any idea, we would have never grown.  If your board is stuck in neutral, consider a change of scenery.

The next spoiler of team is the tendency to ignore relationships and concentrate only on the task.  But you can’t presume that people who share the same mission would naturally get along.  Relationships must be fostered instead of just assuming the work will bring people together.  Unity does not come from a shared mission; it comes from deepening relational connections.  What are you doing to bring the team together?

Sometimes, a problem with the team is not meeting enough.  Now I am not a huge fan of meetings, especially those which are without food!  But if you are meeting so rarely and whenever you meet large decisions must be made immediately, you may find the team stalled in neutral and people feeling pressured to make decisions without having time to think and talk through them.  A solution may be to add another meeting to discuss issues and advance any solution without making any decisions.  This, more relaxed meeting, will help strengthen relationships and advance great ideas that would not have been shared in a typical stressed meeting. 

Turnover is another struggle to trip up teams.  Turnover requires balance.  If you have too much turnover on your board, you spend a lot of time rehashing the organization history and bringing the newbies up to speed on where the group has come from and where we are going.  If you do not have any new members on your board, you run the risk that no new ideas will ever come into the group which could make a huge impact on the company.

Complexity can be a challenge for team success.  More people on the team mean more possibilities, ideas, and work capacity.  But this also means challenges among the relationships as more numbers of people are involved.  Consider if you have two members on a team, you have two lines of communication between person one and the person two.  When the next person is added, now you have six lines of communication among the three people.  Add a fourth person, you now have 12 lines of communication.  If you have five people, like our group, 20 lines of communication are in place.  If your group grows to 20, you have 380 lines of communication among one individual to another individual. 

Great teams are made up of strong relationships among the team members.  Huge accomplishments are made by strong teams.  If you want your team to win and avoid going bad, this requires cultivation and commitment toward developing the relationships among individuals in the group with each other.  If your team has turned bad, perhaps some of these items may point to source issues which need to be corrected.

The Debt Yield Ratio in Commercial Real Estate

In commercial real estate lending (CRE), we often use several calculations to measure the leverage and risk of the transaction.  One of the most common is a simple loan to value (LTV) calculation where the loan is divided by the value to get a percentage.  A 50% LTV would mean that half of the CRE is funded by debt and the other half by equity.  Another measurement is the debt service coverage ratio (DSCR).  Here the annual net operating income (NOI) is divided by annual debt payments.  If you had a company with a DSCR of 1.00, indicates that the company just earns enough NOI to cover its debt payments.  This company will have nothing left over in the year after all expenses and debt payments are made.

Another measurement of leverage on a property is the debt yield.  This is not as well known as a typical LTV or DSCR.  The Debt Yield Ratio is calculated by taking the NOI and dividing it into the first mortgage debt balance.  As an example, let’s say you have an office building with a NOI of $500,000 and the borrower wants to finance a loan of $6,000,000 on it.  The transaction will have a Debt Yield Ratio of 8.33%.  What is a way to think of what this means?  Basically, if you were to foreclose on the property on day one of the loan, you would earn 8.33% annually as a cash-on-cash return on its money.

Now it is important to see what items are not include in the Debt Yield.  Items like the cap rate or discounted cash flow analysis which would be used to establish value in the LTV ratio is not a factor here.  The lender’s interest rate and loan amortization used to calculate the annual debt service is also not used here as it would be in the DSCR.  The only factor here is the principal balance of the debt compared to the NOI of the property.  This calculation helps take out the factor that a low cap rate, low interest rate, and high leverage would play in the analysis.  At times in the market when these factors were present, real estate values were pushed to the stratosphere.

Most money center banks and CMBS lenders that are originating some form of longer-term fixed rate, conduit-style commercial loans are using the Debt Yield in their analysis. Few credit unions and community banks originating for their own portfolio look at this ratio.  This does not mean that the ratio has no significance; it can be used as an important tool in measuring the leverage on a property. 

There are some weaknesses in the ratio.  Widely fluctuating NOI would be one factor.  If you sized a loan based upon one-year analysis of NOI which spiked, you could be over-leveraging the property.  It is also better used for CRE than a C&I or agricultural loan. Also note that acceptable Debt Yields will increase as the rate on alternative investments rise.  Finally, just as no ratio should be used in a vacuum, neither should the Debt Yield. 

What is a good Debt Yield?  Like all other answers in lending, it depends.  Acceptable Debt Yields will fluctuate between the property type and tenant.  A good multi-tenant apartment or strong NNN leased credit tenant property in good market may have a debt yield as low as 9% and in some very rare cases, in the mid 8% range.  Most other common types of CRE would have a Debt Yield of 10% that is acceptable.  Some types of real estate that are more labor intensive if the lender were to take them back and operate them may have a higher threshold for the ratio. 

If we use the example above and target a Debt Yield of 10%, the loan would need to be lowered to $5,000,000.  If your institution were happy with a minimum threshold of 9%, the loan would be $5,550,000.  A DY of 10% will produce an LTV in the 63-70% range.  Pushing the DY down to 9% would raise the LTV to 69-77%. 

The Debt Yield became more popular in the past decade.  For over 50 years, CRE lenders used the DSCR as the main determining factor to size the loan.  In the mid 2000’s, problems started to develop, bond investors had a strong appetite for CMBS, driving yields down.  The result was CRE owners could obtain long-term fixed rate conduit loans in the 6% range.  Dozens of conduits battled each other to win conduit loan business.  Each promised to advance more money than their competitor, driving up LTV ratios into the low 80%.  The CRE investor could achieve a historically high amount of leverage with a long-term fixed rate that was very low.  Demand for this money skyrocketed as did demand for CRE.  Cap rates on CRE plummeted. 

When the crash hit, conduit lenders found that many of their loans were significantly upside down.  Lenders began using the Debt Yield ratio to determine the correct size of a loan.  This ratio can be a good tool in analyzing the risk of a loan request and the risk of a particular loan in your portfolio.

Pitfalls of Critical Thinking

Once you have mastered the skill of critical thinking, the road ahead is a smooth drive for logical interpretation of issues, right?  Well, that may not always be the case.  Large potholes may lurk in your path and the road may lead to nowhere or lead you to a place you do not want to go.  There are several traps the critical thinker can get themselves into.

First, is jumping to answers too quickly.  I used to be horrible at giving answers before I fully understood the question.  This made the person on the other side, usually my wife, frustrated.  Finding the answer to the wrong problem is still the wrong answer no matter how right it may be.  Much of this can be avoided if you fully understand the problem statement.  What are the issues behind the problem?  Who are the people asking and what interest do they have in the problem?  Getting a clear scope of the problem and all the issues and players will frame the issues and start you off on the right path in thinking critically.

The next pothole is not breaking down a large problem down into smaller pieces.  Staring at a huge problem can lead to fearful intimidation of the vast size of the issue.  Thus, it is also important many times to take a large problem and break this down into small pieces by asking focusing questions.  Evaluating past efforts and problems will help understand the possible causality of the present problem and other past problems and circumstances.   Looking at the problems from different points of view will also help to understand the problem and its impact on others.  The problem will look very different from the CEO view compared to the front-line teller.  Breaking all this down may help refine the problem’s scope and reveal some areas that immediate solutions may be applied.

Another pitfall is to refuse to expand the problem space.  This may have you solving a symptom instead of getting to the root problem.  I once met with a business client who accurately identified that the company was having problems financially.  Sales were down substantially.  But the owner only wanted the magic pill, the silver bullet to fix the problem immediately.  I began to drill down into the root cause by asking several layers of “why” questions.  Another thing that helped was to have the owner figure what they would do differently if they closed the business and started from scratch.  These helped the owner see problems in bidding, sales commission structure, and inventory buying present in the company.

The next roadblock is to focus on what is unimportant.  An Italian economist, Pareto, once stated that 80% of the results comes from 20% of the effort.  Hence, it is important to find the 20% and focus on that to get maximum results.  Years ago, I had an analyst who spent weeks trying to figure out what amounted to 2% of a construction budget, at a time, when the borrower had over 50% of the budget in liquidity.  We lost the deal because of a focus on the wrong 20%!  The question needs to be asked, “If I solve this will it move the needle?”

Another detour happens when you take analytical results at face value.  Failing to ask what the analysis means can lead you to incorrect answers.  It is also important to understand any relationship between this problem and others.  Years ago, on the farm, we had an electric fence that would not work.  Figuring that this was a problem with the wiring since a portion of the fence was cut, we proceeded to rewire hundreds of yards of fencing.  Hours later, we discovered we did not have to do all this work.  We only had to fix the one connection and then plug the fence in!

The final pitfall is to not think through future consequences of your answer.  This is like driving down the road without a map, compass, or road signs to make a trip from Texas to Indiana.  Solutions need to be thought through to what results of the actions and responses to those actions as well.  This is when we need to ask several “so what” questions to figure out what can happen when you put your answers in action. 

It can be easy for good critical thinking can go off the rails.  Using some discipline and being aware of these pitfalls can help make this a fruitful endeavor to getting our hands around problems and fixing them.

In other things, we are working on our lender education plans for 2019 and want to hear from you.  What sort of topics are you interested in learning to add to your toolbox for commercial or agricultural lending?  Reach out to us with your ideas.