The Life Cycle of a Business-Wonder

I once worked for a boss who believed that any business goes through four distinct phases in its existence, from its beginning to when the doors close down.  The overall success of the business will be determined on how well the leadership navigates through these stages and continues to remain relevant to its revenue source.  The ultimate challenge is for a business to avoid the last stage and to continue into stage three.  The four stages are: wonder, blunder, thunder and under.

Wonder:  Have you ever watched a young baby or toddler explore the world around them?  Have you ever gone on a trip to a new place that you always wanted to go?  In either case, you can see the wonder that surrounds the person as they explore their world.  The explorer’s eyes are big, and they tackle assessing every detail possible about their environment with inexhaustible zeal.  It has always fascinated me to watch people passionately exploring the world around them. 

This stage applies to businesses as well.  In many ways, MBS is in the wonder stage.  There are so many opportunities for a well-run business and agriculture CUSO.  We are located in the strongest economic growth area of the country that is being driven by multiple industries, a business friendly state and local government (compare that to much of the rest of the nation), a desirable place to live, and wonderful, hospitable people.  The demand for our services is off-the-chart as we are swamped with new deals, even when we have not actively solicited new business.  We are also gaining new, experienced people, who are excited about the possibility of building a company and making their mark on it.  Every day when I come to work, I am excited and amazed with the possibilities set before MBS.  We are truly blessed.

All start-up businesses go through this stage.  But not only start-ups, this stage can also apply to an existing business introducing a new product or service as well.  This stage is marked by characteristics that are necessary for a business in any stage to have, if it is to grow.  Any firm who wants to be better cannot just be satisfied by the status quo.  They must desire to achieve greatness.  The leadership must be willing to explore the world around them and discover ways they can become relevant with a new product, service, or a new way to make something existing better.  This is why large companies have strong research and development departments. 

My oldest son is interested in pursuing a major in game design in college.  We recently visited with a professor at an institution that offers a degree in this area.  As he spoke, you could see the wonder that he had for his field.  And as he spoke, his passion also transformed his wonder into actual wonder owned by my wife, son and myself.  You see, wonder is transferrable, and the passion of an executive can be shared among an entire team.  Someone once said that you can gain an audience if you set yourself ablaze first. 

 In that meeting, I learned that game design is not just about a nerd in his parent’s basement building some shoot-em-up game to be stocked at the local Game Stop.  Design involves an intricate team of professionals working together as one.  You have a story-teller who writes and designs the script of the game.  Graphic designers turn the written idea into pictures.  Three dimensional graphic artists make the game appear to be in the real world.  Scientists help keep the game grounded, using natural laws of physics or creating the game to defy those laws.  Computer programmers turn all this work into an actual game on some sort of platform.  Marketing professionals take the game and figure out how to distribute and sell the game.  They also get feedback from the market for improvements or for the next game.  It also takes leadership to make sure all these areas work together at once for one goal.

As the professor’s eyes sparkled while he described the process, I realized that successful companies in this industry are built upon a collaborative company model.  In many ways, these companies are textbook examples of how a business can run and work as a team.  Communication between the different players is important to achieve the final goal.

The industry is not just about what you buy your kid at the game store for his X-Box.  Games are being used for medicine, in rehabilitation of patients with brain injuries and training students.  Companies are beginning to use games to train their employees as the employee will retain more knowledge in an interactive environment that involves more senses rather than just reading or listening to a lecture.  Even large financial companies like Wells Fargo are looking to gaming as a way to train staff. 

The degree is challenging, with students taking classes such as physics and calculus.  Graduates compete for jobs with students from MIT.  Starting salaries are often above $80K annually.  But the possibilities are endless.  This is an industry in a wonder stage.

Some companies never leave this stage.  Now it is great for companies to always have some wonder in them, for that keeps them growing.  But to never leave the wonder stage is like always remaining a toddler.  A problem in this stage is focus and long-term planning.  It is easy to become so enamored with your surroundings that you go nowhere and are constantly running from one opportunity to another.  Strategic planning is essential. 

MWBS Can Help Increase Your CUs Earnings with Farmer Mac

Midwest Business Solutions is excited to add another tool that can help make your credit union money—Farmer Mac loans.  MWBS is now a direct seller to Farmer Mac.  FM offers a variety of fixed and variable rate financing on farmland, ranch land and farm facilities.  Leased farm ground may also be eligible.  Variable rates can fluctuate monthly, or on a one, three, five, ten, 7/1, or 10/1 year basis.  Fixed rates can be locked up to 25 years.  Amortizations on these loans can run up to 30 years.  The property must be involved in production of an eligible commodity as those listed by the USDA and must have at least $5,000 of annual gross agricultural sales.

FM also offers an AgEquity Line of Credit that gives the farmer a 5 or 10 year draw period followed by a repayment period of up to another 25 years.  The payments during the revolving draw period are interest only and will fluctuate monthly. 

Mortgage amounts are typically up to $11 million, and the maximum loan request for any one borrower is up to $30 million.  Payments can be set up monthly, semi-annually or annually for your borrower’s convenience.  The interest rates will be directly competitive with those at FSA or with an insurance company who finances farm ground.

These loans also represent no risk to you, as they are all sold into the secondary market.  You can think of it as a FannieMae or FreddieMac loan for farmers.  Since this is the case, your institution does not need to have an experienced ag or business lender on staff.  Any institution could participate in this loan.  Those CUs who have ag loans on their books, may find this product valuable to manage your balance sheet exposure.  You can move the term debt on the land to a FM product while you keep the equipment and operating line debt.  This can also help manage duration risk of placing a large fixed interest rate loan on your books while giving your farmer a product he wants.

The best thing is that even though this product is sold into the secondary market, you still have an opportunity to make money.  You can make money at origination and also can make servicing income throughout the life of the loan, even though it is not on your books.  If you had a FM loan with an average balance of $1 million and were making 50 basis points on the servicing side, this would translate into another $5,000 of non-interest income for your credit union. 

You can find out more about our FM loans at www.mwb-s.com/farmer-mac.   Our site also has information on the different FM loan types, an underwriting grid for various FM loans and a series of questions to help you talk about this product to your customer. 

We will be sending out rate sheets on a weekly basis for the Farmer Mac products.  If you want to get on our rate sheet email list, email me at phil.love@mwb-s.com.

How MWBS Manages a Participation Loan

Do Participation Loans Scare You?

The proper answer here is:  “They should!”  Especially if you do not have a clear idea at any time how the file is being managed.  Concerns over what information is or is not present in a file and if the risk profile has changed from what you know will keep you awake at night.  Thinking about how an examiner will treat a participation that lacks proper loan documentation is downright a nightmare!

 Recently, we closed a major participation loan.  Even after the closing, there exists some confusion among the participants as to what role MBS plays in the transaction and what role the credit union plays.  In this blog, I thaought it valuable to provide an overview of what each stakeholder does in a MBS participation.

Pre-Underwriting to Term Sheet

The interaction between MWBS and the member is determined by the lead credit union.  In the most recent loan we closed, the lead was not familiar with lending in the borrower’s industry.  They provided us the contact information, and we met directly with the partnership group to discuss the project and gather all necessary documents to underwrite the loan.  We also met directly with the general contractor and the developer of the retail/office development.  After these meetings and our collection of information, we worked with the lead credit union as to acceptable terms for the loan.  These terms were documented to the client in a term sheet.

Each interaction with a commercial or agricultural member is different.  It is the responsibility of the lead credit union to determine when and to what extent to involve MWBS directly with the client.  I have spent over 20 years in the field.  I hated when my relationship with the client was usurped by a manager who had nothing better to do than to meddle.  Sometimes I had to apologize to the client after the meeting just to keep the relationship going.  At other times, directly bringing in an expert from the credit side of the shop helped strengthen the customer relationship and navigate the credit request into a closed loan. 

So it is my belief and also the position we take at MWBS, that the level of direct interaction between MWBS and your customer is determined by you as the lead.

Underwriting to Loan Sale

Once the borrower approved the terms, we then continued the underwriting process by analyzing all relevant information and preparing a comprehensive write-up.  The lead credit union reviewed both the write-up and all source documents, made suggestions for improvements on the credit analysis and then approved the deal.  In this case, the credit union did not want to own the entire credit, so a participation sale was needed.  MWBS revised the write-up for the sale and began to market the opportunity, first to MWBS members, then MWBS subscribers, and finally to any other interested funding source.  In each presentation, the interested loan buyer had access to both the credit presentation and all source documents to make their own judgment about the appropriateness of the credit for their portfolio.

At the same time, all other things necessary to complete the underwriting, such as the appraisal, environmental report and title work, were all ordered and reviewed by MWBS.  These documents, along with MBS reviews, were presented to the participants.  

Closing

Closing documents were prepared by MWBS.  We have a loan document system that allows us to prepare appropriate closing documents, applicable in any state.  In this case, we had participants in North and South Dakota, a borrower in North Dakota and a project in Minnesota.  The document set was sent to all participants and borrowers for review prior to closing. 

MWBS worked directly with the title company to arrange the closing and utilized the title company to close the transaction and handle the filing of all appropriate lien documents. 

Construction Management

MWBS will manage the construction process on this loan.  We have contracted with a title company to handle all disbursements and lien waiver collection.  We also have a third party architect that will provide percentage of completion inspections throughout the process.  This is in addition to the general contractor and architect of the borrower signing off on each draw request. 

Draw requests and inspections will be presented to the participants when funds are needed.  Each participant will be able to review the request and will then electronically transmit the funds to MWBS’ account.  MWBS will then directly pay the title company, who will pay the construction bills.

Loan Servicing

MWBS services its own participations.  All bills and statements are generated by MWBS and sent to the customer.  Any other customer communication, such as sending tax statements, comes from MWBS.  Payments are sent to MWBS and applied to the loan, utilizing the core processing system of MWBS.  Monies are distributed to each participant, along with a detailed breakdown of how they should be applied.  It is the job of the lead and its participants to apply their payment appropriately.

Loan File Management

It is my belief that if you are the participant on a loan file, you should have access to whatever is in the file.  We provide that through a secure electronic file that can be accessed on-line.  Each credit union participant has its own folder set up on our servers and its own unique password.  A credit union can log in and view its loan files in an indexed fashion whenever it wants. 

File management is ongoing, and MBS utilizes an electronic tickler system to track when information is required to be placed in the file according to the loan covenants.  Notifications can be sent directly to the borrower and communicated to the lead credit union, if assistance is needed to collect documents.  MWBS reviews these loans in light of the current financial information on an annual basis.  A term loan review is prepared, along with a new risk grade, reflecting the current condition of the credit.  All this information is placed in the electronic file.  Loan owners can access current information that has been processed by MBS inside the file.

The Role of the Credit Unions

The loan owners may find this structure is different than other participations they are involved in.  The lead credit union helps determine the direct level of involvement MWBS has with the client.  The lead may assist MWBS in obtaining all the necessary documents for underwriting, but the lead does not produce the loan documents, close the loan, accept payments from the customer and pay all participants directly.  All this is handled by MWBS. 

I would like to say the participants can just sit back and relax after the loan is closed, but I would be lying if I told you all you had to do was to clip payment coupons that we send you.  The loan participation is still an asset on your books, and as with any asset, you must watch and monitor it as if this were money from your own grandmother.  The MWBS structure gives you the proper tools to do that.

Selling from the Front Porch

I used to love going with my parents to my Aunt Betty and Uncle Andy’s house when I was young.  They lived on a farm in the country.  We would usually get there in the late afternoon and begin to spend some time fishing or picking fruit and vegetables from their large garden and orchard.  The work was followed by a hearty supper, which always included some form of meat.  Andy was a hunter, and you were never told what you were eating until after the meal. 

We typically would retire on the warm Missouri summer nights to the front porch, where we would work on processing the garden produce.  Oftentimes, we would have a glass of sweet tea or some homemade ice cream.  We would sit together, talk and share our lives with each other.  It was what happened after supper that taught me some of the best lessons on sales that I have ever learned in my life. 

Saying you were sold something is always a negative, saying you bought something is always a positive.  Jeffrey Gitomer says it like this, “People hate to be sold something but they love to buy.”  I first learned this one night when a neighbor of my uncle’s dropped by to complain about the “lemon of the truck he was sold.”  The salesman had “sold him a bill of goods” about the truck’s ability.  My uncle, who has always been a proud GM owner, began to rave about the Chevy truck he recently bought. 

If you listen to yourself and to other people, you will find this principal to be true.  Every time you have a bad experience with something you bought, you never want to take ownership that you actually made the decision to buy it, but that you were “tricked” into acquiring the item by a salesperson.  When you make a purchase you are proud of, you tend to puff out your chest and announce to the world how smart you are.

People don’t care how much you know until they know how much you care.  I saw this with a few salesmen who would wander up the driveway when we were snapping beans.  One guy, who was selling encyclopedias, was interested in only finishing his well-rehearsed sales speech and ignored some of the questions my aunt had.  He was only interested in getting to the close.  He ended without any sale, because he did not care about the customer. 

The knowledgeable salesman was in stark contrast to a fuel salesman. My uncle used a bit of fuel around the farm in his equipment.  One evening Joe, the fuel salesman, came by.  He did not have a well-rehearsed sales speech and was not in a hurry.  Instead, he sat down in a chair on the front porch and began to shell peas with the rest of us.  He was genuinely interested in my family as we shared life together.  He did not get the sale that evening.  It did take several more evenings of snapping beans and shucking corn on the porch, but eventually, he did get my uncle’s business, the business of the rest of his family and also the majority of the neighbors.

People find it easier to buy from people they know and like than from strangers.  Not only that, but if they know and like you, they will refer other people they know to you.  The adults in my family would frequently recommend mechanics, butchers, ag suppliers and anything else that they had a good relationship with and they trusted.  They were also not afraid to tell about those they wouldn’t touch with a ten-foot pole.

In order to sell, you must first come up to the porch.  No matter if you like it or not, we all must sell to survive.  Even though credit unions tend to be more relational than our banking brethren, we still must sell ourselves and our institution.  The most successful sales people are those who are wise enough to take the time to join your members and future members on the front porch or the back deck.

These are two places where life slows down.  Everyone on the porch is a real person who has hopes, dreams, history, fears, successes and things that keep them up at night.  You can be successful on the porch if you show interest and are genuinely curious about other people.  It is in the sharing of life that relationships are built.  As those relationships are built, your credit union will grow as more members come into your group.  They will not do so because you had the best rate or the best product.  They will do so, because they believe you are the best one to meet their financial needs.

Someone once asked me how I could so naturally visit with business owners and walk away with loans and deposit accounts.  I smiled and said if I ever lose my bearings, I just close my eyes briefly and step onto their porch.  If you want to be successful, sit down and pour a glass of tea.  You may find the pace a little slower than the telemarketer, but you will find some friendships that will last a lifetime.

Coverage Ratios: Is Your Company a Little Exposed?

Coverage ratios are designed to measure how well a company is able to meet the demands of its operational expenses and debt requirements. They are similar yet different from leverage ratios. In leverage ratios, we measure the lender’s margin of comfort in the event of liquidation. Coverage ratios indicate the cash flow margin of the company as a going concern. Highly leveraged companies or businesses with high debt requirements are vulnerable to an economic downturn or a drop in top line sales, because the fixed payments from the debts may conflict with the reduced cash flow from the falling sales. The company will have to do whatever they can to provide cash to satisfy their obligations. Ultimately, an answer will be to find a way to de-lever the company and reduce its obligations.

Times Interest Earned Ratio (Interest Coverage) is used to show the ability of the company to meet its interest obligations. It is used a lot by public bond rating agencies and banks monitoring revolving lines of credit, revealing the amount of company earnings needed to pay interest on its debt. The reason for the focus on just the interest rate exposure is that many bonds and lines of credit do not require any amortization.

Since it does not take into account the principal portion of payments, the ratio will have its shortcomings. But it is a valuable picture of what impact an increase in borrowing rates will have on the company’s cash flow and the extent which earnings pay the financing requirements of the firm. The ratio must be at least greater than one, since a ratio below one will indicate the company does not make enough net cash flow to pay its interest requirements. This is the case in several European countries now.

The ratio is as follows:  (Net Income Before Taxes + Interest Expense) / Interest Expense

Debt Service Coverage Ratio is the granddaddy of the coverage ratios in the eyes of the lender. This measures the ability of the company to perform on its debt obligations. In simple terms, it is defined as:  Earnings Before Interest, Taxes, Depreciation and Amortization (EBIDTA) / (Interest Expense + Current Portion of Long Term Debt (CPLTD))

This is designed to show, after paying all the operational expenses of the business, how does the debt requirements compare with the EBIDTA. A ratio of 1:1 would indicate that the company is able to pay all its obligations but has no money for anything else. Lenders will often use this as a loan covenant or measuring tool to assess the health of the business. They will also have different thresholds for different industries, ages of collateral and types of collateral.

There are some concerns with this ratio. If a company makes large capital improvements and then expenses them, this could lower their EBIDTA to a point where they may be in violation of their loan covenant. A prudent solution is to keep separate financials according to GAAP while having another set that complies with the tax law. An example here would be a manufacturer who is able to fully expense $200K in capital improvements to their plant under repair and maintenance in the year the work was completed. This reduction in EBIDTA may put the company in violation of the DSCR requirement.

A shortcoming with using the DSCR is that the expenses for taxes are real cash expenses. Using the DSCR they are not regarded at all. Another problem with using EBIDTA is if a business has regular ongoing capital expenses each year, necessary to continue operations. Ignoring those expenses may show an adequate DSCR, but miss the overall shortfalls of cash needs the company may have in order to keep operations intact.

Another issue with DSCR is how to treat large salaries or personal expenses of the owners. These would be treated as ongoing operational expenses, but if excessive, may show the company in a worse light than what it is. If the excessive salaries are added back, then a look at the global picture of the owners, the subject company and their other businesses may be appropriate in judging the financial ability of the company.

Funded Debt/EBIDTA Ratio and the Debt Yield are used by some banks to see a comparison of the balance of all funded debts to EBIDTA. The ratio for Funded Debt/EBIDTA is:  Balance of all Funded Debt / EBIDTA = Funded Debt to EBIDTA ratio.

If you have a company with a ratio of 2, this would mean that the entire balance of all funded debt is only twice the amount of EBIDTA. The reciprocal of this is the Debt Yield which is figured by:

EBIDTA / Funded Debt = Debt Yield and is usually expressed as a percentage. So if we have a ratio of 2:1 in the above ratio, this one would be 50%. These ratios are used by some lenders to judge the amount of leverage compared to the net operating income of the company.

Challenges with Available Collateral and SBA Loans

Small Business Administrative (SBA) loan requests are not to be declined solely on the basis of inadequate collateral.  Lenders can use the SBA program for borrowers that can show they have an adequate repayment ability and cash flow but have inadequate collateral to fully secure and repay the loan if it defaults. 

SBA will require that the loan must be “fully secured”.  This means that the loan must have a security interest in all available assets with a combined liquidation value up to the loan amount.  “Liquidation value” is the net amount expected to be received after the asset is sold.  This net amount considers all care and preservation expenses and existing liens have been taken care of. 

As a lender, the SBA requires you to identify all available collateral and determine the liquidation value of each one.  The liquidation value may be determined by the lender based upon their conventional or SBA lending policies. These must be consistently applied from loan to loan.  The SBA does not define exactly how a borrower’s personal residence should be valued.

In the SBA Standard Operating Procedure (SOP) 50 10 5(E), Chapter 4, the SBA does require that lenders secure each loan to the “maximum extent possible up to the loan amount”, utilizing the assets tied to the borrowing business as well as the personal assets of each principal.  It does not matter if those personal assets are owned individually or jointly.

If the loan is not fully secured, the lender should determine and certify that no additional collateral is available.  This should be documented in the file.  If there is a collateral shortfall, this should be mitigated by the other strengths in the file.  If other assets are available, they should be taken as collateral.

In the SBA 7(a) loan, it is a common practice to take the borrower’s primary residence as additional collateral for the loan to prevent a shortfall or impairment to an SBA Guaranty, in the event of liquidation or default at a later date.  There are two exceptions to this rule:

1.  A personal residence that has equity less than 25% of the property’s fair market value.

2.  When there is a legal impediment, such as an irrevocable trust or a prenuptial agreement, that prevents the borrower from using a spouse’s individually-owned property to secure a loan.

In the SBA 504 loan, it is extremely rare for a Borrower’s personal residence to be taken as additional collateral.  This may be more desirable to the member.

Proper handling and securing of collateral when using an SBA loan will provide protection for your Guarantee.  The SBA program should not be used to place a marginal loan on your books.  A problem loan that has an SBA guarantee will require a lot of your time and effort to manage the credit.  The SBA program should be viewed as a way to help mitigate the risks for a good credit that may have some weaknesses in the collateral coverage.  

The Power of Persistence

In college, most fraternities and sororities tend to headline some of their most successful members:  CEOs, athletes, celebrities, great scientists and presidents.  It was during my freshman year that I became acquainted with Calvin Coolidge, the only US President who came out of my fraternity.  Coolidge is not as well-known as many other Presidents.  He was known as a man of few words.  One time, at a party, a lady guest bet the President that she could make him say more than three words.  Coolidge calmly replied, “You lose!” and walked away.

When Coolidge spoke, his words were very pithy.  It is his comment on persistence that has made an impact on my life.

“Nothing in the world can take the place of Persistence.  Talent will not; nothing is more common than unsuccessful men with talent.  Genius will not; unrewarded genius is almost a proverb.  Education will not; the world is full of educated derelicts.  Persistence and determination alone are omnipotent.  The slogan ‘Press On’ has solved and will always solve all the problems of the human race.”

The wise commercial or agricultural lender knows that persistence is very important in the sales process.  True, it is good to have some easy deals that can be done quickly, but the real “golden members” often take months and years to cultivate.  These are not transactions, but long-term relationships with people who own and run the businesses.  These people are the same as you and I, in that we all have hopes, dreams, ideas and things that will keep us up at night.  We all aspire to do great things beyond ourselves, for that is how we are made.

After being on both sides of the credit union/banking fence, I think that the relationship building aspect comes easier to the credit union folks.  I may be wrong on this, but I feel the credit union culture is more focused on people and relationships than profits and bottom lines.  Relationships take time to build, sometimes years, but the outcome can be rewarding.

When I was banking in Missouri, one of the clients I was handed had a $500K loan with our bank and was a large developer.  The client had a small group of financial savvy individuals he would work with on large condominium projects.  My first strategy was not to ask for more business, but to learn more about them and their company.  I grew to know all the players and their families over several years of meetings, lunches and site visits.  When I left that bank, we had over $12MM of various projects and term notes that we financed for them.

My longest persistence story came when I was in Colorado.  About a year after I began banking there, I was introduced to a small company that was growing rapidly.  They were in a segment of the construction industry that did not experience the economic slowdown and was the recipient of large sums of Federal, State and bond funding.  I met and began to get to know the CFO and one of the owners. 

I spent time with them and learned about their industry, their company and developed a relationship with them personally.  After a couple of years, we closed a large construction crane lease of over $1MM.  We still had no deposit accounts nor did we have their main lending relationship.  My strategy was to continue to get to know them.  I made office visits, had lunch and breakfast appointments and took them to sporting events.  Around 4 ½ years into the relationship building, the main partner completed a large job in Missouri and Australia and moved back to Colorado.  We opened personal accounts and closed on a mortgage and equity line for his new house.  We also began to discuss moving the main source of financing to my bank. 

Eventually, after 5 years of developing a relationship, we established a relationship with over $15MM of loans and another $20MM of deposits.  It was one of the largest new deals our bank did that year.  This was done with a combination of genuine interest in the people and the company, willingness to invest time with them (even sometimes investing your time for the long haul instead of the quick easy deal that comes in the door), and persistence.  The commercial and agricultural sales cycle is sometimes quite long.  But if you are persistent, it is rewarding.

Labor Market Outlook

Look at the pictures below.  The picture on the left is a lettuce robot.  It travels down the rows and picks heads of lettuce.  The picture in the middle is a strawberry robot.  The robot travels around the strawberry plants and gently picks ripe strawberries with it foam fingers.  The picture on the right is a GPS in a combine harvester.  This is used to drive the combine down the rows to maximize the harvest in the most efficient manner.​​

So what is in common with these three items?  They all do work and reduce the number of workers needed to complete tasks that used to be completed by people.  Today in agriculture and business, more and more tasks are being accomplished using technology, which requires fewer workers.  The architect may have ¼ of the staff he had in the past, as he relies on CAD equipment instead of a large group of draftsmen.  Factories are now staffed with robots, where they used to be filled with people to complete tasks.  Credit Unions operate with less tellers and staff, as more people use other ways like online banking and ATMs to access their money. 

This is both a blessing and a curse on the US Economy.  The blessing is that we are the most productive country in the world.  The curse is that it will continue to take fewer workers to create the same economic output.  Note the chart below of industrial production and employment.

Note in 2009, the US had $600B of labor costs for $2.4T of industrial output.  This is by far the most productive economy in the world.  This trend has been continuing for years, as is shown in the next chart.

More and more GDP goes to capital and less and less to labor.  So when you hear about manufacturing returning to the US, which it is, that may not translate into the same increase in labor as it did in 1970 or even a decade ago.  In the 1950s, a young man could get a job in Detroit, attaching the rear wheel to cars as they go down the assembly line.  He could make a career with that job and make a nice living for his family by just doing that one task.  Now, that same job is handled by robots, which do not require all the costs of benefits and salary the worker does.  The economy has changed.

We now live in a world economy where globalization and high technology will leverage top talent.  The talented can now be seen and demanded by a world audience instead of a smaller local or regional one. Areas that were completely closed to capitalism in 1980, like the old Soviet Bloc, China and India, have now embraced it.  This has created a larger supply of labor around the world and has also created many more customers. Highly demanded processes can reproduce at a breakneck rate like Amazon, Starbucks, Wal-Mart and Apple apps.  Top CEOs and professionals will use the world market to bid up their income.  This equates into a growing gap between those in demand and the ordinary worker. 

Today, it is important to grow and acquire skills that are in high demand.  This could make the difference between financial struggle and success.  I would encourage everyone to study the chart below.  Note the difference in wages between changes in wages among the highly educated and those with the least.

We all know a graduate degree will not guarantee success, and there are those dropouts that occasionally end up on top; nevertheless, it is still important to gain as much training and skill sharpening as you can to develop talents that will be in high demand in the coming years.

The US Economy: A Good Future?

Despite all the problems with the US Economy after the crash in 2008, we are still the only developed economy to have a higher GDP than what it had prior to the crash.  In some ways, we are the best house in a bad neighborhood.  Here are some positives and negatives in the US:

+ We have an energy bonanza fueled by hydraulic shale fracturing (“fracking”) which will continue for decades.  This has provided an abundant low-cost energy resource.  There is a wide gap between the price of natural gas compared to the price of oil.  Gas prices are 4xs more expensive in Europe and 5xs more expensive in China than they are in the US.  This provides low cost energy to fuel our economy.  Natural gas provides some cleaner environmental benefits compared to other hydrocarbons.  Fracking is also friendlier to the environment than traditional drilling as there are less holes drilled in the ground.  An interesting aside is the only place in the world where there is not the presence of shale gas is in the Middle East. 

+  The US has the world’s most innovative and productive economy.  We have the highest gap between what industrial workers are paid ($600B) and industrial production ($2.4T) of any country in the world.  We are still the place of great innovation and new ideas that fuel new industries.

+  The US banking and credit union system has been largely repaired and is well-capitalized.  There is a slow renewed growth in lending. 

+  There is a slowly accelerating business formation and job growth, but this is primarily in several areas or regions of the economy, as opposed to being all across the country.

+  The housing market appears to have bottomed in many areas and is moving up.

+  The US has decent private-sector growth and has some government shrinkage, especially at the state and local level.

-   There is a lot of uncertainty in a “fiscal cliff” deal and how that will actually impact the economy.  We need a strong and stable plan to work through the issues now and not just push this into the future.  If a decent deal is done, the economy could surprise to the upside.

-  The US has a large growth of entitlement spending with a record number of people on food stamps, unemployment compensation, Social Security Disability, and now healthcare.  We simply can’t afford this.

-   There is an uncertainty in the private sector, with a tsunami of government rules and regulations.  This is increasing the cost of doing business and will lessen productivity.  It will also force some companies to cut back or close altogether.

-   By far, the largest threat to the US economy is the large amount of domestic debt we have in our country.  This is at a level that we have never been at in the history of our country.  Highly encumbered households do not spend.  Governments at all levels will cut back.  Companies lack the top line growth and don’t expand capacity, and political games will paralyze decision making.  This will hamper growth for years to come.

Take a look at the chart below.  This measures total debt in our economy as a percent of GDP.

Total Domestic Non-financial Debt as a % of GDP

Source:  Ned Davis Research, March 2012

Note the drop that shows up around 2009.  This is not from retiring debt.  It is from mortgage defaults and the reduction of debt that came from foreclosures.  One thing to note is that we have had huge debt bubbles in the past.  Note the following chart that has tracked Federal Debt since 1791.

Source:  Blanco Research

Note that the federal debt from WWII was higher than it is today.  One difference today is that a greater percentage of Federal Debt is not held by the public.  How did we drop from the high after WWII to a low of 28.9% in 1975?  Did the government pay off that debt?  The next chart shows the key.

See, there is no way to pay down the debt without inflating the currency and retiring a fixed amount of debt with inflated dollars.  Note this happened after WWII with an inflation rate that reached 20%.  It is possible, but I don’t think that we will have that high of inflation.  If the inflation rate rises to 4-5% per year over a 10 year period, you will get rid of the majority of the debt if you are not incurring new trillion dollar deficits each year.  So the take away here is to expect higher inflation in the future. 

The Eurozone: What Impact Will It Have on the US?

In spite of how slow or bad our economy seems, we are still the only developed economy in the world that has a higher GDP now than it did before the 2008 crash.  The largest industrialized economy, in terms of population, is the Eurozone.  As interconnected as the world economies are now, it is important to see what is happening in other places to see how this may impact our lives.

The Eurozone was created at the end of the 1990s.  Seventeen of the 27 European countries are in the European Union (EU).  The original structure seemed great for all these countries to ban together with a common currency, common contracts and a common economy.  But, the set-up is deeply flawed, and fixing this, if it happens, will take decades. 

The first problem is that the EU joined together good credit risk countries like Germany with poor credit risk countries like Greece.  At the time of the start of the EU, Germany could borrow around 3.5% while it was nearly 14.5% for Greece.  The Greeks have gone bankrupt every 25 years or so after they won their independence from the Ottoman Empire.  In the old days before the Euro, when a country went bankrupt, they could devalue their currency to a point that made sense and still continue doing business.  With the EU, all countries, from the Germans to the Greeks and all those in between, can now borrow at the former German rate.  Prudent financial management would dictate that countries with higher interest debt could refinance this for lower rates.  Foolish financial management means countries that could not borrow in the past, can now borrow to do anything they want.  In the case of several of the EU countries, this is like lining the table with vodka shots in front of an alcoholic.

The creation of the Euro led to a larger bubble than we had in the US.  Spain’s real estate bubble was 2.5xs as large as we had here.  The Netherlands had the 2nd largest housing boom in the EU.  The Euro also led to rampant borrowing for social welfare benefits, pensions and private borrowing in most EU countries.  This happened, as many ignored the need to increase productivity.  As such, the cost of production shot up.  Germany has some of the highest paid workers in the world, but they are also some of the most productive.  In France, the employment taxes a company pays is 50% of the salaries they pay their workers.  So even though it is higher to pay German workers, it is still cheaper to make stuff in Germany than it is in France.  This has led to uncompetitive cost of production relative to Germany and the rest of the EU.

The EU now has a banking system that is nearly insolvent.  Almost every EU bank would fail the capital requirements that are imposed on US banks.  This is from bad European house loans, bad purchases in US mortgage-backed securities and bad European sovereign debt.  In Europe, 80% of national debts are lent and held by the banks, as they do not have as sophisticated of a capital market system as the US.

The EU is also faced with governments having exploding debt obligations.  This is a lesson for the US.  As austerity measures of higher taxes and lower government spending will be forced on the countries of France, Spain, Portugal, Ireland, Italy and Greece, this will cause their economies to spiral further into recession and default, as these cures are being applied.  This will impact the world as the largest country that China exports to is the EU. 

Of all the countries, watch France.  The French government controls the banks and has forced banks to lend to insolvent and bankrupt companies.  There is lots of delusion in France with their leaders spending even more money for more social programs than before.  Their current administration immediately cut the retirement age to 60.  They have since raised it to 62 to try to salvage the pension system. 

The EU has a lot of lessons that the US can learn.  Explosive government spending, massive social programs and a lack of financial restraint lead to gigantic amounts of debt.  This debt can starve a country’s economy and prosperity for years.

Small Business Survival Tips for Tax Time

Well tax season is here again!  While many of us struggle just to keep our records straight, we need to take a moment and look at tax strategies available for the small business.   Many of your members are small business owners, and it is important for them to understand how taxes affect their business, how to properly file their returns, how to avoid audits and how to claim the right tax deductions. After all, one of the first steps to achieving wealth is to lower your tax liability to the lowest legal possible amount.  Here are some tips to ease the burden of the upcoming tax season and to help your members prepare for the April 15, 2013 deadline.

1. Keep Good Records and Understand Available Deductions - Your accountant may be able to advise you on the various tax credits and deductions that are applicable for the 2012 tax year, since their tax software programs are usually updated to ensure they don’t miss a single deduction. However, many accountants are overwhelmed this time of year and become focused on tax preparation and not tax planning.  It is important to form tax strategies to help lower your liability.  Your records should be kept as if you expected to be audited.

2. Utilize the Small Business Jobs Act Tax Provisions - The Small Business Jobs Act of 2010, signed into law by President Obama, has over 17 tax provisions to decrease tax burdens for small businesses. Several of these provisions may be taken advantage of during this year’s tax season.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Small-Business-Jobs-Act-of-2010-Tax-Provisions

3. Remember the Tax Credits within the Affordable Care Act – These tax credits will allow small businesses to recover up to 35 percent of the health care premiums a small business pays to cover its workers. In 2014, the tax credit will increase to 50 percent.  There are also some tax benefits for small employers who reimburse employees for out-of-pocket medical expenses.

http://www.irs.gov/uac/Small-Business-Health-Care-Tax-Credit-for-Small-Employers

4. Avoid Common Audit Traps - Your accountant can assist you in ensuring you are not placing ‘red flags’ in your return. An example is classifying employees as Independent Contractors. Independent contractors and employees are not the same, and it is important to understand the difference. Here is the ‘test’ provided by the IRS.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-(Self-Employed)-or-Employee%3F

5.  Home Office Deduction - Know how to determine if you are eligible to claim this deduction, and if you are, be certain you do it properly using this IRS guide:

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Home-Office-Deduction

6.  Charitable Donations - Be specific and label every deduction on the check or receipt for non-cash donations. This link is the IRS Guide for non-cash charitable giving:

http://www.irs.gov/pub/irs-pdf/i8283.pdf

In fact, here is an online mini-course covering all IRS regulations with regard to charitable giving:

http://www.stayexempt.irs.gov/Mini-courses/Can_I_Deduct_My_Charitable_Contributions/can_i_deduct_my_charitable_contributions.aspx

7. Keep Business and Personal Expenses Separate - Maintain separate bank and credit card accounts for your business and personal use. This provides easier record keeping and makes your business expenses more defensible in the eyes of the IRS.

8.  Learn the Laws that Govern Estate and Gift Taxing.  Many small businesses and farms are controlled by families.  It is important to learn tax law as it applies to transferring all or parts of the business to heirs.  Without proper planning, large tax liabilities could be incurred.  Here is the link to the IRS publications for estate and gift taxes.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Frequently-Asked-Questions-on-Gift-Taxes

As you see many members preparing for tax time, it is a good time to review the financing structure of the business or farm.  Perhaps there is an opportunity to plan for future expansion or a need to refinance existing debt with better terms or structure.  Feel free to contact us to help you serve your members.

Megatrends in Agriculture

We often tend to focus on our day to day activities and do not spend much time surveying the landscape.  Every now and then, it is good to pop above the tree level and get a view of the entire forest.  What follows are a few thoughts on the megatrends in agriculture that are present in agriculture.

Massive growth in food demand will continue into the future.  Currently, there are slightly over 7 billion people on the planet.  The U.K. Food and Agriculture Association predicted the population will increase to 9 billion before the middle of this century.  This is a huge increase in the demand for food.  We also have increasing middle classes in countries like India and China.  As people move from a lower class into a middle class, they will tend to consume more food.  This fact alone means that agriculture is full of opportunity.

A continuing ramp-up in efficiency and new technology will dominate changes in agriculture.  If the population will increase by 30%, then the current food output must increase as well.  Yet, there is little new arable land available in the world.  Additional production will have to come from smarter and more efficient ways to produce food to meet the growing demand.

The graying of agriculture is a serious trend as the average age of a farm operator is now at 57.1 years old according to the USDA.  This means that eventually these farms, if they are to continue in operation, need to be transferred to younger owners.  Succession planning for your farm clients is important for them to consider now instead of being blindsided by it in the future.  The wise farmer who prepares and navigates around the pitfalls of taxes and operational challenges will have a better chance of leaving that farm to his heirs.

An upcoming generation in farming will embrace new technological advances.  Farm finances can be tracked much better now.  Yields per acre have increased with the use of GPS.  The trend toward more innovations will increase in the future.  Yet, these young producers have never faced a downturn and need to learn from the seasoned veterans how to weather an economic storm.

The growth of mega-producers’ dominance in agriculture presents new challenges.  These entities can produce a concentration risk, and understanding the various attached entities that would be impacted if problems occurred with one of them is important.  For example, a grain elevator may expand to accommodate the production of a large corporate giant, but if something occurs that severely curtails the revenue the elevator would receive from the mega-producer, the elevator may face financial challenges.

Labeling and packaging will drive agricultural decisions in the future.  Take a look at bananas.  Did you know that Chiquita has come up with a special membrane that doubles the shelf life of the product, by regulating the flow of gasses through packaging?  Naturepops are wrapped in a bio-degradable film made from plant matter.  Look at how many different changes are coming in, and how the food that we buy is labeled and packaged.  Each of these innovations impacts our industry.

The energy opportunity in rural areas is huge.  We understand this impact here in the Dakotas, with North Dakota as the second largest producer of oil last year, behind Texas.  The revenue from oil and gas can be a real game changer to the family farm.  There is a push to make our country energy-independent, and oil from the Bakken will play a big part of that.  Other types of energy like wind, solar and biofuels will play an important role also.  The US Department of Energy expects alternative fuels to provide 5% of our energy needs by 2020, which is up from under 2% today.  Europe plans to have a usage of 20% biofuels by 2020, and Feed & Grain estimates fuels from agricultural feed could replace 25-30% of US petroleum imports.  Of course, these factors will increase our prices of food at the table, but it will also mean even more agricultural demand.

Agriculture will continue to be relevant.

  I recently heard of a legislator from a city, who was complaining of folks in rural America and saying they were not relevant today.  In my view, as long as folks like to eat, put fuel in their car, and use many of the products they use today, the farmer and rancher will still play a big role in their lives.

Leverage Ratios

Leverage Ratios measure relative levels of financial risk taken on by creditors and shareholders of a business. This risk is based upon the fixed payment requirements of debt. They show how much protection the company’s assets provide for a creditor’s debt since all assets are funded by debt or equity. This is where the equation assets = liabilities + owner’s equity comes from.

The Debt-to-Worth Ratio shows the degree of protection that is provided by the company’s creditors. The higher the ratio, the more leverage there is in the company and the more of the company’s assets which are funded by debt. This measures the company’s ability to liquidate its assets in order to retire debt. It can also be used by the reader to measure how much a company can reduce the valuation of its assets before creditors may sustain a loss.

This ratio can vary greatly between industries and companies in an industry. It can also vary by how a company is set up. For instance, S-Corporations, partnerships and some LLCs are set up as a pass through entity where the tax liability is transferred from the corporate level to the personal partners or members. Often, distributions will be made to the owners to help them satisfy tax liability that was created by the company operation. This can reduce equity in the company.

The ratio is calculated as follows: Total Liabilities / Net Worth = Debt-to-Worth Ratio

If a company is in a negative equity situation or has assets with values that are lower than the total of the liabilities, that company is considered insolvent.

If we have a company with $2MM in liabilities and $1MM in equity then the Debt-to-Worth (D/W) is 2:1. So for every $1 the owners have at stake, the creditors have $2 at risk. These relative values could be much different if the market or liquidation values differ greatly from what is shown on the balance sheet.

The Debt-to-Tangible Worth Ratio is slightly more conservative than the D/W Ratio. This removes any intangible value from the equity side of the equation. If our company above had $500K of value in goodwill, a patent, trademark or other intangible asset, this would be removed from the equity side of the equation.

The calculation here is: Total Liabilities / (Net Worth – Intangible Assets) = Debt-to-Tangible Net Worth Ratio.

$2MM / ($1MM-500K) = 4:0 In this case you can see that removing the intangible assets makes the leverage increase.

The Long Term Debt to Net Fixed Assets Ratio measures the amount of debt that funds the fixed assets of the company. If you had a value of 0.54, then 54 cents of each dollar of assets is funded by debt; the other 46 cents is funded by equity.

The Debt-to-Capitalization Ratio is often used by bond rating agencies like Moody’s and S&P to measure the permanent capital of a company—its long term debt and net worth. This shows what percentage of the company’s permanent capital is financed with debt compared to equity. This ratio ignores any short term liabilities that may be tied to financing receivables or inventory and may be repaid by current asset turnover or seasonality changes. This also shows how the company is relying on long term debt which finances assets and the level of profitable operations to support the leverage. The calculation is as follows:  Long-Term Debt / (Long-Term Debt + Net Worth) = Debt-to-Capitalization Ratio

If our example above has $1.5MM in long term debt and $1MM in net worth, the calculations would be as follows:

1.5MM / (1.5MM + 1MM) = 0.60 The company’s long term creditors would supply 60 cents and the investors would supply the other 40 cents of each dollar of capital.

Customer Loyalty is Golden

My oldest son took a seasonal position at Best Buy this past Christmas.  He is very skilled and knowledgeable at all things electronic, gaming and computers.  One evening, after work, we sat at our kitchen table, and he shared stories about the silly things various customers did that day.  After a half of an hour, I asked him how he liked his job.

“It’s great.  But if I could not deal with customers, it would be awesome!” he replied. 

His answer reminded me of a Peanuts comic with Linus and Lucy.  Linus has decided he wants to be a great doctor making a great difference in humanity as we know it.  Lucy tells him he cannot do it, because he doesn’t love mankind.  In the final panel, Linus declares, “I love mankind.  It’s people l can’t stand!”

If we are honest, often in the day, we have the attitude toward our members like my son and Linus.  So one day, centuries ago, some business owner came up with the idea that his company needed to satisfy his clients.  Customer satisfaction became the byword that has been charted, measured, surveyed and analyzed since that time. 

Satisfying your members or your clients is worthless.  Think about it.  If I go to a store or a restaurant and leave only “satisfied”, will I go back again?  Perhaps.  That establishment has gone into the pool of possible places to shop the next time I need that item.  Will I go there again?  Maybe.  But they will compete in my mind with all the other places where I was only “satisfied”.  My final decision will be based upon the cheapest alternative among all the shops that only “satisfied” me. 

I worked in a savings and loan in my hometown in the early ‘90s.  We did a lot of residential mortgages, so my goal was to develop relationships with each Realtor in town to get them to send their clients to me.  My goal with each one was to exceed the expectations of the client and the Realtor.  One year, the largest real estate company in my town sent half of the closings his office did to me.  They also did not recommend any other mortgage place but mine.  This happened, not because of mere customer satisfaction, but because of the relationship I built with them.

The true gold in them thar customer hills is loyalty.  If I my members are loyal to me, they love me. They know every time they do business with me, not only are they satisfied, but they have received added value to make them even more successful.  Coming back to me is an automatic response for them and not a decision based upon price.  They also will tell everyone they know about me, and their testimonial is precious.  If you are one of the very few lucky ones, they will even bring potential clients to your desk. 

Think about it.  My wife and daughter love Starbucks.  The price of the coffee and tea there doesn’t faze them.  They like the quality, taste, atmosphere and friendliness of the staff at Starbucks.  In one community we lived in, the only store where there were friendly people was at Starbucks. 

Now they can probably get the same product at another store, perhaps one even less expensive.  But is that in their decision process for good iced tea?  No, because they are loyal to Starbucks.

Customer loyalty is your goal.  Every contact you have with a business client is an opportunity you have to continue writing the story between you and that client.  What kind of story are you writing?  The first step toward loyalty is to treat your members the way you would treat your favorite sports hero, celebrity, friend, grandmother or yourself. 

New Business Ideas: How to Determine the Contenders from the Pretenders

A client sits across your desk and pours out a business idea that he needs financing for.  At this point, you don’t know if his idea is destined for failure or will be the next success.  After all, most successful businesses once started with someone with an idea sitting across the desk of a loan originator requesting a loan to get started or to go to the next level. 

Commercial and ag lending is humbling.  You can review the facts and make the best judgment possible on the loan request, but you never know if it was a good decision until much later.  The only good loans are those that eventually pay off.  So, hindsight is always 20-20, but there are some signs you can look for to determine if the idea presented to you is worth an investment in the form of a loan from your institution or not. 

Experience and Education.  Does the customer have experience in the business field that he wants a loan?  Borrowers who have the training and work experience in the field they will be operating in have an advantage compared to those who do not.  You would not want to give a loan to someone to open a medical clinic that does not have the background to operate the business.  This principle will apply to whatever business you are looking at. 

Not only do you need to look at the background of the borrower in front of you, you need to look at the experience and training of his key personnel compared to the skills required to make the business work.  For example, if you had a few good cooks with only culinary skills who want to open a restaurant, there may be some challenges since they do not understand such things like managing staff, running the “front of the house,” and optimizing cash flow.

Equity.  Successful business owners have “skin in the game.”  This can come from cash, property, or equipment they are bringing into the business.  You should run from any loan request where the borrower is expecting you to provide all the proceeds for the project and there is no investment from the borrower.  If the borrower’s idea is good enough, the request is for a venture capitalist not a credit union.

Earnings.  Good loan requests on established businesses will have a history of earnings that can support the request.  The challenge is what do you do when you are dealing with a new business venture or a huge increase in the business where there is either no history or not substantial history to support the request? 

A good lender will look for mitigating factors to combat this risk.  How reasonable is it that the business will succeed?  Does the borrower have other source of income to sustain his life while the business is in its early stages?  Can you look at some option like a government guarantee to reduce your credit union’s exposure?

Ease.  I call this the “ease test.”  Pretend that the only source of loan money was from your dear, wonderful grandmother.  She has worked her entire life for her meager nest egg and now is relying on you for investment advice.  If you took her money and lent it to your borrower, how easy would it be to explain to her your lending decision?  Would she be proud of your action?  Or, would you have to spin a verbal tale to her to justify your actions?  If you want to be a little more scared, you should be prepared to explain your decision to your management or to your regulator. 

Remember lending is more of an art than a science.  I cannot tell you that every request you have that meets these tests will end up as a good loan.  I also cannot tell you that if a request was lacking in an area or two if it will turn out to a problem loan.  I can tell you that lending involves looking at the overall picture and applying a good dose of common sense.

The Farmland Price Bubble

I recently heard of Iowa farm prices soaring to new record highs, some even as high as $20,000/acre.  The Realtors Land Institute reported in September 2012, that tillable land prices in Iowa increased by an average of 7.7% compared to the preceding 6 months.  In the 3rd quarter of 2011, the seventy Federal Reserve District reported land values increased 25% on a year-to-year basis.

We have all seen farmland increase in price substantially since food prices began to climb in 2007.  Here in the Dakotas, the increase has grown exponentially in some areas with the discovery of oil or natural gas.  But an overriding question is, “Will the inflated bubble of land prices pop and if so what will be the effect?”  Will we have another disaster like we had in the 1970s in agriculture, or another crisis like the recent housing crisis?

In the farm crisis of the 70s and 80s, total farm debt to net farm income was as high as 14:1, that is $14 of debt for every $1 in income.  Currently, the debt to income ratio has been closer to 2:1.  Data from the USDA shows the debt repayment capacity of utilization (DRCU) ratio is falling.  DRCU shows the ability of the farm sector to repay its debt over time using just farm income is still under 40%.  At the height of the farm crisis in the 80s, the DRCU was near 110%.  Debt-to-equity values are at 11.7%, showing a strong reliance on equity instead of debt to fund farms.

Part of the reduction in the ratios is from farm asset values increasing, but a lot comes from a more conservative approach to farm debt with producers and investors applying more cash equity into the project and lenders applying lower LTV limits than what they did in previous times.  Entities like Farmer Mac have recently reduced their top LTVs they will look at in areas with steep land price increases.

Clearly, the leverage applied to farms is not near what was used in the housing crisis.  A 2010 survey by the Federal Reserve Bank of Kansas City showed an average LTV of 70% of the land value.  At the peak of the housing bubble, the National Association of Realtors reported in 2006 that more than 40% of borrowers bought a house with absolutely no money down, giving a LTV of 100%.

Even though the farm economy is rather healthy now, caution should be applied.  Some strong growth-oriented producers and young farmers may be leveraged highly or are using long-term, high-priced contracts for leased farmland.  Any correction in commodity prices will compress their operating margins to the point of making the credit a problem loan. 

The lending landscape in agriculture has changed.  In the 70s, farm debt was spread out over a large number of farms and ranches.  Now, it is more concentrated with 10% of the farms generating 80% of the agricultural revenue and carrying 60% of the U.S. farm debt.  The risk today is any third party risk and how US farm debt is interconnected.  Today, if a large producer has a down year, contracts, farm alliance obligations, and ownership interests can make the complex loan a risky portfolio concentration. 

Long term cycles tend to repeat themselves every 30 to 50 years and today we sit nearly 30 years since the last dip.  Some will argue that we are due for a correction, but how severe is yet to be seen and the lack of high leverage in the Ag community points to a softer landing. 

The Fallout from the Fiscal Cliff

Well, Congress and the President finally got their act together to avoid the fiscal cliff, right? And since they did, this should not have any effect on working class Dakotans, right? If you believe that, I can show you some wonderful oceanfront property in Bismarck! You should understand how the new tax law changes will impact your business, farm clients, and yourself. 

Payroll Tax will increase. Last February, the payroll tax cut was extended through December 31, 2012. Payroll taxes include Social Security payments that were cut to 4.2% instead of 6.2% for several years. The new law reverts taxes back to the pre-recession levels of 6.2%. The impact here is a reduction of every paycheck of 2%. 

Capital Gains/Carried Interest rates will increase to 20% for individuals with adjusted gross incomes more than $400,000 and married couples with AGI more than $450,000. Individuals/couples below the AGI thresholds will still pay 15%. The effect here is a renewed emphasis on the IRS Section 1031 Exchange for higher income individuals to defer gains on property sales. 

Alternative Minimum Tax rates are finally adjusted for inflation. The AMT will be less burdensome on lower-income level s with more exemptions for credits and tax deductions; whereas, higher-income levels will receive fewer exemptions. 

Estate and Gift Taxes will be taxed at or above the $5 million per person level and the tax rate will increase from 35 to 40 percent in 2013. This will cause the need for more estate tax planning in order to pass on family farms and businesses without a substantial tax penalty. Vehicles such as life insurance and gifting become more important to shield more hard earned assets from Uncle Sam. A checkup with a trusted financial advisor knowledgeable in tax and estate planning is necessary for higher wealth clients. 

Depreciation bonus of up to 50% for property and equipment (not including real estate) is available for businesses during the 2013 tax year. 

Leasehold Improvements are now on a 15-year straight-line cost recovery for qualified leasehold improvements on commercial properties in 2013 and is retroactive for 2012. 

Income Tax Rates are going up for individuals with AGI over $400,000 and married couples with AGI over $450,000 at a new tax rate of 39.6%. For other income levels, the Bush-era tax rates are permanent. This is something to continue to watch as some Democrats in Congress have suggested going to the pre-Reagan tax rates on high income earners of 70% should be looked at! 

In spite of the vast majority of Americans seeing their tax rates increase with this new law, virtually no discipline in Federal spending was put in place. Perhaps that may come with the debt ceiling negotiations that will occur in the next few months. These changes do require your customers to review their strategies to keep their tax liability at the lowest legal level possible.

Introducing Midwest Business Solutions

Greetings! I am the new President/CEO of Midwest Business Solutions, Phil Love. I accepted the position in May of 2012 and have been working to put all of the pieces together from scratch to make up a viable financial company. 

I was born and raised in Fulton, Missouri.  My hometown is notable because it is where Winston Churchill gave his famous “Iron Curtain” speech denoting the dangers of communism.  In Fulton, I took my first job in financial services while attending high school as a part-time bank teller.  I then worked my way through Westminster College as a teller and branch manager for a local bank. 

After college, I went to work for a regional savings and loan in Mid-Missouri.  We did quite a bit of personal and residential business and even some commercial lending.  I was able to grow my branch from the smallest in the organization to the largest branch outside of the home office. In the early 1990's, we were very busy financing residential loans as interest rates were at record lows. 

The savings and loan that I worked for went from a mutually held association to a stock owned company, and was sold to Union Planters Bank (UPB).  I stayed with the company and gravitated toward commercial and agricultural lending.  I also earned my graduate degree from the Graduate School of Banking at the University of Wisconsin while at UPB.  (UPB eventually sold to Regions Bank.) 

While I was working with the savings and loan, I met my wonderful wife, Angela, whom I have been married to for over 20 years now. We enjoy spending time with our three kids. 

After nearly 15 years working with those financial organizations, I left Mid-Missouri and moved to Colorado, taking a commercial and agricultural lending position with Vectra Bank, the Zions Bancorporation affiliate in Colorado.  I was there for six and a half years and built the largest portfolio of any officer outside of the Denver metro area. 

While at Vectra, I became involved with the property exchange networking group on a state and national level.  I also earned the prestigious Certified Commercial Investment Member (CCIM) designation in commercial real estate. 

In February, 2012, I received a call from a recruiter asking if I would be interested in leading a CUSO. I had no idea what a CUSO was at the time.  

As I met the different credit unions and people involved, the position intrigued me.  The ability to build a company from ground up and really make a difference in this area is exciting.  I do not want to just focus on making our credit union clients better in commercial or agricultural finance, I also want to assist them in becoming competent and trusted financial advisors to their members. Our goal at MBS is to support them in becoming a competitive force with the best commercial banks in their area.