Does Your Use of “It’s Our Policy…” Hack Off Your Clients?

We all have experiences when we have had the term said to us, “I am sorry, I can’t help you.  Our company policy forbids us from…”  I would suppose from time to time we all have used that term where we work.  In almost every case, the use of these words reminds us of negative experiences when the customer left apathetic or as mad as a wet hen!

The most recent experience I had with this was when my wife and I were shopping for a new vehicle.  We were quite undecided as to what type of car or truck we wanted.  But one factor was how much we could get from our Trailblazer in trade.   We figured if we had a dealer that would offer us close to the NADA trade-in value; we would know we were getting a fair deal. 

After test driving some models, we settled on one to get our quote.  We handed them the keys to our vehicle to review it and see what they would do for our trade-in.  After 20 minutes or so, the salesman came out to the table that we were sitting at and handed us a piece of paper.  He began to go over the deal line by line and sped quickly through the trade-in value.  My eyes widened when I noticed the trade-in value they were giving us was less than a quarter of the value we had looked up.  I questioned where he got such a low value.

He replied, “I noticed some concern when I showed you this value.”  (No duh Sherlock, I saw the value and was ready to slap sense into you).  He continued, “Based on the age and condition of your vehicle, it is our company policy that this is what we will give you.”

My wife was clearly agitated and also restraining her desire to slap the salesman as well, as she asked more of why the value was so far below the actual value.  All in all, I think we both did a great job in being calm.  The salesman retreated to his finance manager for another 20 minutes and came out with another offer.  Now we were at least over 25% of the value but were not even at half the book value.  He painstakingly explained what they could do.  We decided to leave and were met on the way out by the sales manager.

“It is our company policy to not put vehicles as old as yours on our lot. We wholesale them to other lots, so we cannot offer as much as the value of your vehicle,” he explained.  Now I have two incidents of someone throwing out the “company policy” excuse to us.  As we left, I asked my wife if she thought it was their company policy to hack off their potential customers.

Two weeks later, we bought a truck my wife loves from a different dealer.  We never heard back from the salesman.

I can never think of a time when I had the words “our policy” thrown at me that turned into an enjoyable experience.  I am interested if anyone else has had any positive experiences when the phrase was used on you.  I think that we, in the credit union world, have an edge on our banking brethren in that we view our members as players on the same team.  But I still bet we slip up and use the “policy” explanation when we cannot do what a customer wants. 

Note, I am not advocating that we give the customer whatever he wants.  There are clearly things our members will want that we cannot or will not do.  But we need to change our attitude toward our customers, and stop using the “policy” word.  We need to act on principles instead.

Remember, the member is why you get a paycheck.  Your attitude toward them will determine the level of service you give and ultimately, your own success.  Every interaction with a customer is an opportunity to deepen or slowly kill the relationship.  Members contact you when they need help, and their value is much more than the annual revenue you will get from them.  Once your interaction with your member is complete, that is when they will start talking.  And customer testimonials are much more powerful than the money you spend in marketing.

Take responsibility for why you will not be able to meet your member’s request.  Act on principle; do not hide behind policy.  People respect you when you shoot straight with them.  Realize how you want to be treated, and treat others the same.

Jeffrey Gitomer once wrote, “’Give me liberty or give me death’ is a principle.  People are willing to die for their principles; very few are willing to die for their policy.  Are you?”

Why We Should Fear Default on Government

No matter your political stripes, I think it is important to understand we all lose if the government defaults on its debt. I fear there is an attitude that the world hasn’t fallen apart due to a government shutdown, so how much worse would things get if we defaulted on payments?

A default would be a lot worse; worse than any of us could imagine. Let me try to explain.

The debt the United States generates is considered risk-free to investors. Why? The American economy is an awesome, flexible force not matched by any other in the world. Based on our population size, no other economy comes close in terms of productivity per person, innovation and income. This means our economy is robust, and our government should have little problem collecting taxes and repaying anything they borrow. Investors do not fear that we cannot repay our debt. The problem we are facing is whether or not we want to repay our debt.

If we don’t pay our debt, or at least don’t pay timely, US debt will no longer be considered risk-free. This means investors will demand a higher interest rate on our debt for taking more risk. Why is this a big deal? It will force interest rates everywhere to go up. Interest rates are really the price of money.

To better understand the pricing model, imagine for a second we weren’t talking about money but were talking about a different product, like gasoline. Say you pull up to a gas station pump, and you see you have three different grades of gasoline. The price for the cheapest grade is $3.00/gallon. The next cheapest grade is $3.20/gallon, and the most expensive grade is $3.40/gallon. Now say there was a shock to the oil market, and suddenly the cheapest grade is $3.50/gallon. You know that the other grades are going to move up in price. You will probably see the mid-range grade jump to $3.70/gallon and the premium jump to $3.90/gallon. The point is, with US debt being the baseline for the least risk and the cheapest debt out there, if the price of our debt increases, the price of all debt will also rise. If interest rates rise on our government debt (because now it is “riskier” due to a default) debt everywhere will become a lot more expensive. Car loans, home loans, business loans or any loan will increase in price via the interest rate.

How this will affect the economy can be best understood with the simplistic model put forth by economists, which says Economic Output = Government Spending + Investments Made + Consumer Spending + Net Exports. Now, we see with sequestration and the government shutdown, that government spending has decreased. That has a negative impact on economic output. But, this hasn’t caused backwards movement of economic output. Why? Because consumer spending has increased at a faster pace than government spending has decreased. Like I said, the American economy is robust! But a default will have different consequences. This is because it will also greatly impact consumer spending.

It would be helpful to understand how much each piece of the model contributes to economic output. Here are the numbers I was able to readily find for the annualized 1st quarter of 2010 (I couldn’t use 2013 data since the government shutdown has led to a denial of access their current databases):

                Total Economic Output :   $14.6 trillion

                Government Spending :      $3.0 trillion (21% of the economy)

                Consumer Spending:         $10.3 trillion (70% of the economy)

                Investments Made:             $1.8 trillion (12% of the economy)

                Net Exports:                          -$0.5 trillion (-3% of the economy)

As noted earlier, a default will cause interest rates to rise. When interest rates rise, that will decrease both government spending and consumer spending. The government will need to use more of its funds to pay interest and will have less money to spend on public works and services. Likewise, consumers and businesses will use more of their money to pay interest and will have less money to spend on products and services. Remember, consumer spending is 70% of the economy, and government spending is 21% of the economy. That means a default will certainly impact 91% of total economic activity. A recession, which is when economic output shrinks, would result. If interest rates rise suddenly, government spending and consumer spending will drop suddenly. The immediate recession could be far worse than the housing crises we experienced 5 years ago.

How bad the recession would be will depend on how high the interest rates go. Nobody knows how high the interest rates will go. Frankly, I don’t think it is worth the risk to test it. One default will be enough to permanently shift interest rates, and the U.S. will likely never be considered risk-free again. In this sense, one default opens Pandora’s Box, and there will be no going back, as we will always be stuck with higher interest rates.

There is another idea floated which suggests the government could make its debt payments but not make domestic payments due to government agencies or citizens. This is a weak argument within the financial community. In finance, when we look at someone’s ability to make debt payments, we look at total cash flow. We expect the borrower to be able to pay all expenses and pay all debt. If we know the borrower does not have enough money to pay both, we will likely not grant them a loan. Would you give a loan to someone who argues they make enough money to pay their debt, but cannot pay utility bills and employee wages? This is risky, and that means interest rates are sure to go up in this circumstance anyway.

One certainty about the impact of increased interest rates is it will impact all of us. Unlike the housing recession that hit some regions harder than others, the increase in interest rates will infiltrate every community in America. The extent as to how much it will impact our Congressmen and Senators is harder to predict. As of 2011, the average net worth of a representative in the House is $6.5 million, and the average net worth of a Senator is $11.9 million. While members of Congress will also be impacted, it will clearly impact the average American household far worse whose average net worth is estimated to be $77,300, which is 1% of that of the average member of Congress. Perhaps this is why Congress fears the default less than us of the general public.--Trevor Plett

Farmer Mac as a Balance Sheet Management Tool

We recently closed a Farmer Mac loan financing crop land on a long term fixed rate.  There were lots of benefits to the credit union member which included a long term fixed rate on the loan, a lower annual payment than what the couple previously had, a loan that does not balloon, and the ability to complete a contract for deed.  The borrower was quite happy at the closing.

As credit union folks, we do enjoy finding ways to serve our members by meeting their financial needs.  But have you considered the benefits to the credit union?

The correspondent credit union received a portion of the origination fee at the closing. All finance people are looking at ways to generate more income.  The origination fee will provide extra earnings.  But, the non-interest income is not the only source of income for the credit union.  The credit union priced the loan so they would earn money with each payment. MWBS allows for each correspondent to add up to 75 basis points to the interest rate.  This provides an annuity stream of income for the credit union through the life of the loan.  In the first year, the CU will recognize over $4,200 of income on a loan that is under $500K which is not even carried on their books! 

It is easy to see the non-interest income benefits to Farmer Mac once the checks come in.  The benefits to the balance sheet of the credit union are often overlooked.  The first benefit is the elimination of the duration risk associated with the long term fixed rate.  No institution should feel comfortable with giving a 25 year fixed, knowing that at some time the margin will be compressed or may even be negative compared to the cost of funding.  So off-loading longer term agricultural land and facility credits that want fixed rates will be a wise asset-liability management strategy.

Next, consider concentration risk.  The credit union may want to provide as many services as it can for the good ag member.  What do you do when the farmer’s borrowing needs exceed your capacity?  Do you send him to the banking institution down the street?  Well that is often the path that is chosen.  An alternative is to allow MWBS to provide secondary market financing with Farmer Mac to off load the farm or ranch land and facilities financing and allow the credit union to continue financing the equipment and operating lines.

Another benefit is getting a loan off the books that the credit union should not have done in the first place.  This does occur from time to time.  There are cases of a credit union closing an ag loan for a member when they do not have the regulatory blessing to do business lending.  In this case or in the case of a concentration limit, moving loans to Farmer Mac provides a way to clean up the balance sheet.  In our recent closing, enough debt was moved off the credit union balance sheet to leave a small balance below the $50,000 limit.  This can be managed easily by the CU. 

The next time your farm or ranch customer has a land or facilities financing need that you either cannot or do not want to do because of balance sheet management goals, consider MWBS.  We can help the client with good secondary market financing that will keep you in the customer relationship and also allow you to continue to make income through the life of the loan.--Phil Love

Conditions: Understanding the Market and Understanding the Borrower in that Market

When considering a request for a commercial loan, we are concerned with mitigating all possible things that could go wrong. We try to corral all risk into 5 categories which are called the 5 Cs of credit. If our 5 Cs are strong, the loan probably has a high chance of success. The 5 Cs are Character, Capacity, Collateral, Capital, and Conditions. Character examines the borrower’s experience and capability to remain in good standing. Capacity evaluates whether the business can generate enough income to repay the debt. Collateral provides a contingency plan should the income from business fail to pay the debt. Capital is also evaluated to assure the business has resources to fall back on in unforeseen events, and capital assures the lender is not taking all the risk in the transaction.

The remaining C that needs to be discussed is Conditions. Conditions are concerned with the business environment in which the borrower is operating. But what is unique about business conditions is they can be both external and internal. It is not difficult to understand that if the business is in a struggling industry, the business itself may be struggling.

Understanding “conditions” starts by understanding the current market. Every market will have two basic components, which are supply and demand. It will likely be impossible to exactly determine supply and demand in the specific market, but that doesn’t mean market conditions should be ignored! There are often various reports that can be used for different business types. Hotels will have Smith Travel Research (STR) reports, and there are several real estate research firms that help determine supply and vacancy of various real estate types. In dealing with commercial and industrial operations (C&I), supply and demand will be more challenging to determine.  Detailed reports will not always exist for every industry in a specific market. The burden is on the lender to better understand who the borrower’s customers are, and whether they will have a continued demand for the borrower’s products or services.

One of the common mistakes I have observed is too much faith placed in reports that are available. There are firms that specialize in producing reports on specific industries, but what these reports provide is a broad overview of the national market that will not capture unique local conditions. For example, perhaps the fertilizer market will face a downturn if the national economy experiences a recession because of overbuilding in residential real estate. Several people leave their homes or are foreclosed upon, and then the lawns of those homes will be left unattended. While national data may show the fertilizer business is struggling because fewer people are buying fertilizer for their lawns, in the agricultural states like the Dakotas, the need for fertilizer for crops may be booming because of high commodity prices.

The internal conditions of the business are important too. We are interested in knowing if the business looks and operates like similar businesses in the market, and if the business can restructure itself if the market were to change. Internal conditions we are most interested in are profit margins and operating leverage. Profit margins tell us about the health of the business, as well as, the market that business is in. Stable profit margins from year to year indicate the business is effectively operating in its market and that market is likely stable too. Erratic profit margin reflects the opposite. What an ideal profit margin should be is hard to speak to, since this will vary depending on industry type. Generally speaking though, I think net profit margins that are 5% of revenue or less are concerning, no matter the industry type.

Profit margins will also be affected by operating leverage, which is the degree to which expenses are fixed. High fixed expenses means high operating leverage. This means as revenue increases, expenses will remain relatively the same, and profit margins will increase. This will also mean the business will suffer if revenue declines, because it will be unable to lower costs. In an ideal world, most expenses would be variable so they can track upward or downward with revenue to preserve a constant margin. It is the lender’s responsibility to understand the borrower’s operating leverage, so it is understood how well the borrower will handle changes in the market.

Just like there are reports that tell us about different industry markets, there are reports that compile different business operations to give averages and benchmarks. You can consult these reports to see typical profit margins and operating expenses for similar businesses. Again, we need to take these reports with a grain of salt, because the operation of a business should be put in context of the local market and not national averages. Nationally, widget manufacturers may have small profit margins because of strong competition, but if there is less competition in your local market coupled with strong demand, you would expect to see the local widget manufacturer to have a bigger profit margin.

To summarize, understanding the conditions of the business are also important because it gives us insight into the viability of the borrower. We should be careful to lend to borrowers in struggling markets or borrowers who have poorly structured operations. To understand the market, we need to understand supply and demand. Obtaining local data is paramount, and even though exact supply and demand will likely not be determinable, local studies by economic development bureaus and local information from federal agencies is helpful in understanding the market. To understand the internal conditions of the borrower, it is the lender’s responsibility to work with the borrower to know the business’ primary customers, the extent to which expenses are variable or fixed, and what the profit margins of the business are. If a lender cannot adequately understand the profit margins and expenses of a business, the lender is taking a big risk by extending credit without fully understanding his/her situation.

To wrap up the 5 Cs discussion, it is important to understand that extending credit really boils down to common sense.  In reality, the 5 Cs are an exercise in sound judgment and common sense. Don’t the 5 Cs seem like readily obvious questions to address?

The goal of credit analysis is to assess whether credit can be repaid. If there is a concern that a loan may not be repaid, it can likely be articulated as a weakness in one of the 5 Cs that has been addressed.  It is impossible to anticipate all of the reasons a loan could go bad, but if the 5 Cs are strong, it is likely the borrower will be well positioned to handle those risks, which means the institution will be well positioned to be repaid.--Trevor Plett

Stress Testing

Every now and then, a topic will become in vogue with regulators.   It can make them more excited than my dogs when I have some rib bones left over from a BBQ.  One topic in recent years has been stress testing loans or the loan portfolio.  Sometimes, the examiners will ask if stress testing has been done but not give any advice as to what kind of stress testing should be performed.  I have heard from several institutions that these questions we recently made by their auditors.

Putting a loan under “stress”, is to change some of the variables of the loan or the financials of the company and see how those changes will impact the performance of the credit.  These items should be done at the initial loan underwriting, at some term loan reviews and also during exam or audit time.

For individual loans, one of the most common ways to stress the credit is to imply a higher interest rate on the loan and measure how the loan will perform.  Will the company be able to make debt service?  How much free cash is left over?  Clearly, this stress is not applicable for a fixed rate loan.  The lender may not have the same need to stress the rate on a loan that has a locked rate for a reasonably long period of time, as compared to a variable rate loan.. 

Common interest rate stressors would be to increase the by 100 or 200 basis points.  Some large institutional lenders will impose an artificial interest rate upon all their loans to see how they act.  Recently, this rate was between 6-6.5% for most commercial real estate loans in the capital markets. That is, all loans would have a rate of 6.5% imposed on them to measure their debt coverage.  If the credit would  pass the minimum threshold for DSCR, the credit was acceptable. 

Another way to look at as individual credit is to check changes in the LTV with changes in the cap rate.  An increase in the cap rate will result in a decrease in the value and a subsequent increase in the LTV.  Increasing a cap rate to a more normal market rate could show a possible loss and the extent of the loss if the loan were to go bad. 

A third way to sass a loan is to reduce top line revenues that will result in a decrease of net operating income and subsequent impairment of the firm's ability to make its obligations   Some options here would be to use an average of a growing firm’s NOI over several years or take the worst year's performance of the several years that are reviewed.  In some cases, a percentage drop in the NOI will be used.  If the firm is able to produce an adequate DSCR, the loan is deemed to be good. 

This option is tricky.  Just an across the board reduction of a certain percentage of gross income will not necessarily equate into the same drop in the bottom line money available for debt service, owner’s profit and capital improvements.  The same percentage reduction in the top and bottom line assumes that all expenses for the firm are variable, when actually only some of the operating expenses will be variable, some a fixed and some are a mixture. 

Another factor in stressing a loan is to look at the balance sheet of the firm and the guarantors.  We recently looked at a loan that would be considered marginal if the rate or the revenue were stressed.  Yet the company and the owner had a year’s worth of payments in cash.  This cash helps mitigate any surprises in the cash stream. 

Some creditors will do a “breakeven-analysis”.  This measures how far the cash flow available for debt service can fall or how high rates can rise until a DSCR of 1:1 is reached.  The larger the gap between the actual performance and breakeven limit, the safer the credit.

It is valuable to stress the loans during underwriting.  It also may be valuable to stress test loans at term loan review time.  I would suggest utilizing a possible combination of the methods listed above and use it thoughtfully.  Follow sound logic behind the stress testing and you will not only be able to please the auditor, you will also be managing the credit better. 

Capital: Borrowers Must Share in the Risk of Their Loan

I am continuing to talk about the 5 Cs of Credit. Already, I have addressed Character, Capacity, and Collateral. In this piece, I address Capital.

Capital is best understood through the accounting equation of Assets = Liabilities + Capital. In a simplistic financial institution, assets are loans and liabilities are deposits. Capital is funding provided by the owners. Now, let’s say a $1 million loan goes bad and is not repaid. Assets will be reduced by $1 million. Since Assets = Liabilities + Capital, that means Liabilities or Capital must also be reduced by $1 million. Since the Liabilities are deposits provided by other people, regulators will force the institution to reduce $1 million in Capital, so the owners take the entire loss and not the depositors.

Capital, in a commercial lending transaction, is the investment the borrower has at risk. When an institution makes a large commercial loan, they are putting millions of dollars at risk. Even though Capacity, Collateral, and Character may look great, the bank should not provide financing unless the borrower has some of his/her own money at risk as well. Why? Because if a project goes bad, then the lender will experience all the loss and the owner will lose nothing if they have invested nothing.  And if the owner has something at stake, the owner does not only suffer part of the loss should it go bad, but it he/she will also have incentive to make the loan work.

A common ratio used in C&I and Agriculture is the debt-to-net worth ratio, although a debt-to-assets and equity-to-assets are also used, and they all effectively measure the same thing. When we look at debt-to-net worth, we are dividing total liabilities by net worth to determine how much of the balance sheet is funded with debt, and how much is funded with owner’s capital. Going back to the equation of Assets = Liabilities + Capital, we can tell all assets are funded with either Liabilities or Capital. Liabilities are someone else’s money; Capital is the owner’s money. The more assets are funded with capital, the more risk the owner is assuming. The more assets are funded with liabilities, the more someone else is taking the risk.  Naturally, we would like to see the owners take as much risk as possible with their own capital and as little as they can with liabilities from someone else.

For example, let’s say we have $10 in assets and $5 in liabilities, which gives us $5 in capital. Debt-to-net worth, which is total liabilities divided by capital, comes to $5/$5 or equals 1.00. This means for every $1 of debt, the owner contributes $1 in capital to fund all assets. Now let’s say we still have $10 in assets, but now have $9 in liabilities, which means we have $1 in capital. Now debt-to-net worth is equal to $9/$1 which is 9.00. As you can tell, Liabilities (or other peoples’ money) are funding almost all of the business assets, and the owner is contributing very little of his/her own money. The owner is only providing $1 for every $9 he/she borrows! Generally speaking, the larger the ratio, the less risk the owner is taking and the more risk others are assuming.

The appropriate amount of capital for C&I operators will depend on the specific industry. For example, service providers will likely have only a small amount of fixed assets like computers and telephones, but they will have a high amount of A/R and accounts payable (A/P). Because A/R and A/P grow rapidly together, debt-to-net worth may also increase rapidly. A/P is a liability, so if A/P increased and capital remains relatively constant, debt-to-net worth will increase. In general, a high debt-to-net worth ratio for a service provider is 3.00 or higher.

For C&I operations that require a substantial amount of fixed assets, like land and large machines, there will be a more stable level of assets constantly on the balance sheet and any resulting term debt should remain at a stable level too. Because of this, we would expect debt-to-net worth to remain more stable.  But, we want to see the ratio lower because the asset values of these fixed assets are subjective and can vary, and they may be specialized and illiquid. It is normal for capital-intensive C&I operators and Ag operators to have a nominal debt-to-net worth ratio of 1.50 or less.

In commercial real estate (CRE), there are also ratios to judge a borrower’s capital position. The most common you hear of is loan-to-value, or LTV for short. As the name would imply, this means dividing the loan amount by the value of the real estate to obtain a ratio. Generally, we like to see an LTV between 70% and 75%, but this could be higher or lower depending on several circumstances. This implies the owner would have 25% to 30% equity invested into the property. This seems good in theory, but consider the following example: An investor needs to borrow $1 million to purchase land and $1 million to construct an apartment building. An appraiser estimates the finished apartment building will be worth $3 million. The investor comes to your institution and wants to borrow $2 million, and can prove he will have a 67% LTV loan ($2 million loan / $3 million finished value). With an LTV of 67%, does the borrower really have 33% of his capital invested in the project? No, he doesn’t, because he is asking for 100% of the cost of the project. This brings us to the second CRE measure of capital; loan-to-cost or LTC.

LTC is the loan value divided by the cost of the project. Much like LTV, we like to see LTC around 75%, and it could be higher or lower depending on the circumstances. Often with CRE, there can be some unique wrenches thrown into the LTC calculation. When we want to see an LTC of 75%, what exactly constitutes the 25% capital that the owner has to provide? Total cost is made up of several components: land, materials, labor costs, developer fees, architectural work, engineering, etc.

Capital is a tricky element to assess in this situation, but instinctively, we like to see cash up front before any costs are incurred. Cash has a determinable value, and having to forego other uses for that cash really ties the borrower to the project. Other sources of equity are less desirable, but may be considered, depending on special considerations. One example is allowing a developer to contribute equity in the form of land. That may be acceptable, since land has an easily determined value, but the true value of the equity is less reliable than seeing cash in hand. Other forms of equity deserve more scrutiny and generally should not be considered under normal circumstances.

Now that we have looked at the role of capital in both C&I and CRE, we see that capital actually serves two unique purposes. Capital ensures that the borrower also shares in the risk by facing the same consequences and losses the lender faces, and capital also provides a buffer for the unknown and unexpected. For C&I, when debt-to-net worth is adequate, borrowers can fund a significant amount of assets themselves and not rely entirely on borrowing. This should provide borrowers with the ability to handle any unforeseen events.

Equity in real estate is measured differently. As discussed in my Collateral article, I noted adequate LTV protects from changes in market value or unforeseen issues with real estate. In this way, LTV assures equity remains in the property and also serves as a buffer for the unknown. Capital should also be controlled through LTC to prevent 100% financing.

To summarize, Character assures us the customer can remain in good standing and continue to repay. Capacity evaluates whether the borrower’s business operations are satisfactory to repay the proposed debt. Collateral provides us with a contingency plan, if cash flow from the business is unable to repay the debt. To assure the customer is well invested in their business and can handle the unknown, we like to see an adequate level of Capital. The last C we need to investigate is Conditions, which we will look at next week.--Trevor Plett

Interest Rate and Cap Trends--Fall 2013

Last Friday, the Federal Open Market Committee (FOMC) announced their decision to leave the monthly $85B bond buying program unchanged for now.  This action is countered with the consensus that the Fed will begin tapering its bond buying program within the next year, thus lowering demand for bonds and increasing the interest rate.  The Fed realizes there are significant struggles in the economy and different signals that are opposed to each other.  While unemployment is down, the labor force participation rate is the lowest it has been in decades and new job growth has largely been part-time in nature.  While inflation seems to be in check with the Fed’s measurements, anyone who has gone to a store recently can tell you otherwise.  While housing seems to be recovering, the impact of higher mortgage rates and underwriting standards tend to mute those gains. 

The decision to continue the Quantitative Easing caused a steep drop in 10 year rates, which have raised over 100 basis points this year.  This should benefit the residential sector.  If underwriting standards ease, this expanded access to credit is a prerequisite for a sustainable economic expansion.  A continued accommodative lending environment will aid in the refinance and restructuring of maturing loans and more capital will favor real estate as a sound alternative to low-yield bonds and volatile equities. 

But even with the sharp increase in rates this year, Treasuries remain close to their 50 year low and are at less than half of their long term average.  Cap rates on real estate, defined as the net operating income divided by the price, have declined to an average of 7.2% on all commercial real estate.  The gap between the 10-Year Treasury and commercial cap rates has fallen from 490 bps down to its present level of 440 basis points.  This is still 60 bps above the long term average.

A wide range of factors have come together to change the structure of commercial real estate values.  The intertwining of the US and world economies, deep integration of debt and equity markets, and the addition of financing vehicles such as REITs and CMBS have all contributed to the change.  Data transparency, deeper liquidity and broader investment strategies have also helped better measure investment risk.  All these factors have pushed overall cap values down for the past 20 years. 

Cap rates tend to remain within a certain range during economic peaks and valleys, with typical variances of 100 to 130 basis points.  Cap rates behaved quite similar in the last two recessions, though the duration and severity of the economic downturns were different.  Current cap rate trends have also differed between major metropolitan markets and other markets. So far for this year, apartment cap rates are down 20 bps in the major markets and 40 bps in the secondary markets; retail is down 10 bps in the primary markets and 40 bps in the secondary; office is down 30 bps in the primary and 40 in the secondary; and industrial is down 40 bps in the primary markets and 80 in the secondary.  Here in the Dakotas, we would be classified as a secondary market.  We can also attest to possibly more cap rate decreases in this area due to the strong economic growth prevalent in our area.

If you believe the consensus of the experts, we can expect interest rates to stay low in the short term and begin to rise as the Fed slows down its bond buying.  Cap rates should continue to decline slightly which will continue to increase commercial real estate values.

Collateral: Plan B

To recap on the 5 Cs of Credit so far, we’ve mentioned Character matters, because your borrower can’t repay you from jail. We learned Capacity should be about selecting the right credit structure and then focusing on cash flow as a primary source of repayment. So if you have an honest customer with a good ongoing source of repayment, what is there to worry about? Realistically, there will be little reason to lose sleep. But we do live in a world of infinite risk, and there is always something unforeseen that can happen that neither you nor the borrower could have ever conceived. Unfortunately, even the best loans can go bad for reasons nobody could have envisioned.

Recently, the CEO of Goldman Sachs, Lloyd Blankfein, summed it up best during a seminar he participated in. He said, “Most risk management is really just advanced contingency planning and disciplining yourself to realize that, given enough time, very low probability events not only can happen, but they absolutely will happen.” This is why, even with the best loans with no repayment problems, there is still a need for a contingency plan in case they do go bad. The most common solution is taking collateral which could be sold as a secondary means of repayment. Collateral is really “Plan B” to your initial credit decision. All good credit decisions have at least one good backup plan if the first source of repayment disappears, and really good credit decisions will have more than one backup plan.

Because collateral may have to be used as a source of repayment one day, it will command a lot of attention and analysis just like cash flow. I can think of a handful of times where I had to spend more time analyzing the collateral than I did cash flow. By now, it should not come as any surprise that there is no one-size-fits-all analysis that assesses collateral, but rather, each underwriting project will be tailored to the lending type and credit facility of the specific loan.

For revolving lines of credit, the collateral tends to be the output from the resulting business operations. Take a widget for example. A finished widget could be used as collateral, but let me ask you, what is a widget worth? I’m really not sure, and that makes me a little nervous to take a widget as collateral. I suppose it really depends on how easily I could sell that widget, which is described as “marketability.” Good collateral is marketable. How can you be repaid from selling collateral, if you have collateral nobody wants to purchase?

A widget is effectively inventory. Inventory can be broken into three components: raw materials, work-in-progress, and finished goods. Some guidance suggests finished goods are most marketable, but logically, raw materials could also be just as good, if not a better source of collateral. If the demand for widgets disappears, there may still be demand for the materials that were used to produce a widget (say for example, if raw materials were metals and aggregates). I believe it is universally agreed upon that work-in-progress is a poor source of collateral. What is half a widget worth, and who would need one anyway?

Once those widgets are sold, the business is waiting to collect on an account receivable. Those receivables can also be used as collateral. There are people who will purchase accounts receivable, and they are called “factors.” An account receivable is really only as good as the business or person who has to pay it, and the lender may have no way to know a receivable’s wherewithal to pay. In an ideal situation, receivables will be from several individuals or businesses, so if one didn’t pay, it would only represent a small loss to the business collecting the receivable. Concentration of receivables is a big risk, because one large customer struggling to pay could lead to large losses if they prove uncollectable.

Turning to term debt, the marketability issue becomes a large concern when financing equipment and machinery. For example, say a lender finances a widget-stamping machine. Naturally, he or she will take the stamping machine as collateral. What if the lender had to foreclose and take the stamping machine? What is a widget-stamping machine worth, and what else could it be used for? Some equipment is highly specialized and could have even been designed especially for the defunct business in foreclosure. This could leave the lender with nobody to resell the machine to. Because of these issues, it is not uncommon that equipment and machinery will require large down payments, and that often, this debt may also be secured by additional collateral the business owns, like real estate.

Real estate is a relatively preferred source of collateral for most term-debt financing, whether or not the subject debt was used to acquire real estate. Why do lenders prefer real estate? First of all, it is easy to find. To collect on inventory, receivables, or even some equipment, it will be challenging to locate where the collateral actually is. But as for real estate, you always know exactly where it is. Also, real estate usually has a readily determinable value, because there are several investors that usually establish a market for it.

With all collateral, although it is easily observed in real estate, there is a conundrum that can result with the market value of your collateral and the borrower’s ability to repay. If your customer is struggling, it may be an indication that the market value of your collateral is also deteriorating.

For example, say debt for Widget Inc. is secured by industrial real estate valued at $1 million. Widget Inc. goes out of business, because it is a recession and nobody is buying widgets. The lender forecloses on the industrial real estate, but finds nobody wants to buy industrial real estate. Why? Because it’s a recession, and no industry is expanding! The real estate was worth $1 million when demand was nominal, but now demand has dropped and buyers in the market won’t pay more than $650,000. Hopefully, the lender didn’t extend more than $650,000 in credit, even when he or she thought the property was worth $1 million. Generally speaking, it is unwise to lend the full value of the collateral. Leaving a margin between the value of the debt and full value of the collateral allows for changes in the market value of the collateral and any costs to foreclose and sell that collateral.

The costs to foreclose and sell are not only monetary, but they eat up a lot of time for several people at the institution. Depository institutions are set up to lend money and collect money, and liquidating property takes away from peoples’ primary job function. Cash flow should always be the primary source of repayment, and collateral should realistically be your contingency plan. If the reason for lending is based primarily on the fact that the collateral would have substantial value if liquidated, the institution isn’t accounting for all costs of the transaction and potentially originating a problem asset. It may be true the institution will not lose the principal being lent, but the time and effort to recover the principal will be costly and have unquantifiable burdens.

Collateral is really code for “contingency plan.” If there is no contingency plan for when your original plan for repayment deteriorates, then the likelihood of credit loss increases substantially. By asking yourself what your collateral position is if the worst possible scenario occurs, you actually think through a contingency plan to get repaid. Some institutions are in the practice of identifying three sources of repayment for each credit decision. The first source is usually the cash flow generated from the operating business. The second and third sources are typically reliance on selling collateral and having a guarantor provide some means of repayment. Additional sources of repayment could even come from collecting on cash or collateral from another source outside the business and its immediate owners. The important concept to grasp is the more means there are of getting repaid, the more likely it is the loan will be repaid!--Trevor Plett

The Economic Competitiveness of the Dakotas

Recently, the American Legislative Exchange Council produced its 6th edition of the ALEC-Laffer State Economic Competitive Index.  This study uses fifteen different policy variables to measure the economic competitiveness among the states.  Some of these variables are:  marginal personal and corporate tax rates, property and sales tax burden, estate taxes, recently legislated tax policy changes, public debt service as a share of tax revenue, quality of the state legal system, worker’s compensation costs, state minimum wage, right to work state, and tax or expenditure limits. 

I find the study fascinating.  The beauty of the American system is that states have a fair degree of autonomy to choose the best mix of policies for their own citizens.  It is as if we have 50 different small “laboratories of democracy” that produce test results to see what works and what does not.  The conclusion from the study is the states with growth as a primary objective continue to grow if they follow free market policies.  States with redistribution and regulation as their main objectives continue to lose jobs and economic vitality if they continue with their policies.  It seems there is a steady movement of human and investment capital from high tax, high regulation states to low tax, low regulation states.  This has been occurring for decades.

The Dakotas fared extremely well in the economic performance and outlook.  The economic performance is a backward-looking measure based on the states performance in three categories as listed below.  Note that in each case a “1” is the best and a ranking of “50” is the worst.

North Dakota ranked first in state domestic product growth with a 110.9% increase.  South Dakota ranked 12th with a growth rate of 59.1%.  In absolute domestic migration cumulative from 2002-2011, North Dakota lost 4,367 people, ranking 30th in the nation.  South Dakota gained 11,502 for a 27th rank.  North Dakota topped the states in Non-Farm Payroll Growth of 22.2%.  South Dakota came in 10th with a 7,7% increase.

Even though these results are impressive, the performance is more impressive considering that the majority of the growth in both states seems to have occurred since 2007.  If one were to look at this over the past five years, the results are much higher.

As important as it is to look at the past, using present policies will be a good predictor of the future economic growth for the states.  To do this, ALEC organized fifteen different variables and ranked the states accordingly.  Both states fared well with the lowest top marginal personal income tax rate.  South Dakota is one 9 states in the US with no personal income tax and North Dakota has the second lowest state personal tax rate at 3.99% as its top rate.  Between 2001-2011, the 9 states without income tax have seen a 15% increase in population, a 63.5% increase in GDP, a 12.7% increase in non-farm payroll employment and a 76.3% increase in state and local tax revenue.  Compare this to the 9 states with the highest personal income tax rates.  There population growth was only 40 percent of the no-tax states at 6%, GDP only grew 45.3%, non-farm payroll rose a small 4.9% and state and local tax revenues grew at 47.9%.  Clearly the economic growth trends favor those states with lower taxes.

On the corporate tax side, South Dakota comes in first with no corporate tax.  North Dakota came in a 11th with a rate of 5.15%.  North Dakota has the 10th smallest property tax burden at $25.30 per $1,000 of personal income.  South Dakota was 17th at $29.65.  Both states have higher than average sales taxes with North Dakota the 34th lowest in the nation and South Dakota at 43rd.  The remaining tax burden is close to the median of the states with ND 31st and SD 27th.  Neither state has estate taxes. 

The states tend to manage their money well.  Debt service as a percentage of state revenues is 5.9% in North Dakota, the 4th smallest in the nation.  South Dakota is at 8%, the 21st lowest.  Both states have a higher than average number of public employees per 10,000 residents with North Dakota the third largest in this category and South Dakota the 20th largest.  Perhaps some of this may be due to the smaller populations in both states. 

The states are friendly to business in that their score in the liability survey places them both in the top 10 of the country.  Average workers comp costs are low with ND at $1.01, the lowest in the nation, and South Dakota at $1.91, the 28th lowest.  Both states are right to work states.

Overall, the Dakotas fared extremely well again, with North Dakota with an Economic Outlook of 2nd best in the nation and South Dakota at 3rd best.  North Dakota has seen a steady climb in this index with the state increasing from 18th in 2008 to where it is today.  South Dakota has ranked between 2nd and 5th in the economic outlook over the past six years.

 It is also interesting to see how the states that surround the Dakotas:  Montana, Wyoming, Nebraska, Iowa, and Minnesota fared in the study.  Montana ranked 9th in economic performance but a dismal 42nd in the economic outlook category with additional regulations and burdensome requirements on business there.  The Bakken boom that is driving much growth in North Dakota is a mere trickle in Montana.  Minnesota ranked 34th in economic performance and 46th in the economic outlook.  High taxes and increased regulations are forcing businesses there to assess their location.  Iowa ranked 25th in both categories.  Nebraska ranked 21st in performance and 37th in economic outlook.  The legislature there is considering lowering tax rates which will improve the economic outlook there.  The best performing state contiguous to the Dakotas is Wyoming, with a ranking of 4th best in each category.

None of our neighbors, with the exception of Wyoming are close to the rankings of either North or South Dakota.  The lesson from the study is that a state with a low tax and regulatory burden is more attractive for a business to open its doors and operate in.  These opportunities create more jobs and hence, more wealth for that state’s citizenry.  We are truly blessed to live in wonderful states that have a pro-growth mindset coupled with abundant natural resources and hard-working people.  The future for the Dakotas is bright!--Phil Love

Capacity: The Right Loan for the Right Purpose

To recap, I have recently been writing about the 5 Cs of Credit. The world is full of infinite reasons why a loan could go bad, and we try to classify all those risks into 5 buckets: Character, Capacity, Capital, Collateral and Conditions. Generally speaking, if all the 5 Cs are strong, then risk should be well mitigated. In reality, some of the Cs will have weaknesses and others will have strengths, and a team of people will need to debate whether the balance is appropriate.

We have looked at Character and discussed why it is important to know your borrower personally, as well as conduct background checks and other independent investigations. We also discussed Capacity and the importance of making sure a loan matches borrowing cause and the timing of the asset conversion cycle.

The assessment of Capacity gets a little more complicated because the asset conversion cycle has both short-term and long-term components. Generally speaking, all business operations can be broken into the “operating cycle” and “capital investment cycle.”

The operating cycle tends to be a short-term cycle of production that generates cash or profit. An example of the operating cycle would be buying raw materials for widgets, stamping the widgets, packaging and selling the widgets, and repeating the process all over again.

The capital investment cycle is a long-term cycle of providing and replacing the means of production. An example would be purchasing the widget stamping machine. Recovering the expense of the machine will take several operating cycles; but that is okay, because the machine should last for several cycles.

Now that we have these key principles spelled out, we can really address how to assess capacity accurately! Borrowing cause that arises from the operating cycle will almost always be coupled with short-term credit facilities; whereas, borrowing cause tied to the capital investment cycle usually calls for long-term debt.

Commercial & Industrial Lines of Credit 

Let’s start by looking at borrowing cause associated with the operating cycle. For example, Widget Inc. invests all their cash into making widgets for a single order. Widget Inc. delivers the widgets and is waiting to get paid. Meanwhile, Widget Inc. gets a second order and needs to borrow cash to start production since they haven’t been paid yet from their first order.  The best type of loan to solve this problem is a line of credit. Think of this as a credit card with a high limit, but there is a catch.

The limit will always be determined by the amount of sales (accounts receivable) that are waiting to be collected; therefore, if there are no sales, Widget Inc. will not be allowed to borrow. To control the credit limit, Widget Inc. will need to send a report to the lender every month showing what sales (receivables) are outstanding and for how long they have been waiting to collect. The only payment required for the line of credit is interest on the outstanding balance. Actual repayment of the debt hinges on the expectation that the principal will be repaid once the sale is collected, which will be verified with the monthly report of sales (accounts receivable aging report) sent to the lender.

Because the operating cycle is likely to repeat several times, it would be a hassle to constantly get a new loan each time the company needs to start a new order and doesn’t have the cash. A solution is to allow the customer to repay their line of credit and re-borrow as the need arises. We call this a “revolving” line of credit. Again, it works just like a credit card with a high balance, except it is well-monitored.

Real Estate Construction

Not all lines of credit should revolve, because not all short-term needs are recurring or easily justified. For example, construction of an office building will require a short-term demand for funds. Because the building will not generate rent until it is constructed, it is not practical to require principal to be repaid in the short run. In this case, it makes sense to extend a line of credit for construction as well. In this way, the owner will only be charged interest on the amount of money they are currently borrowing until construction is complete, but once construction is complete, principal must be repaid.

The important concept to bear in mind is lines of credit are usually repaid from the conversion of an asset to cash. In real estate, this means permanent financing (which requires payment of principal) can replace short-term financing, or hypothetically, the building could be readily sold to an end user. In this case, if debt is fully repaid, it does not make sense to allow the customer to re-borrow for the same purpose. Why not? It is difficult to identify how real estate will be repaid, and before the project is started, there is substantial analysis of the market and/or end user of the real estate. This level of analysis should be completed for each real estate project because the market changes and/or the end user may be different. It is too risky to invest a large sum of funds into a single project to see it fail. A non-revolving line of credit is appropriate in this circumstance.

Term Debt and Useful Life

When machinery or equipment is needed, it is understood that cash received in one operating cycle is likely not enough to make the needed purchase. Since these assets will likely last for years, it is permitted to take years to repay them. All long-term assets have a “useful life,” and the loan for a long-term asset should not exceed its useful life. Ideally, a loan term should be shorter than the useful life of the asset to provide added protection to the lender.

Term debt characteristically has equal payments of principal and interest until maturity, although this does not have to always be the case. It is common for payments to be due monthly or quarterly, but could be due semi-annually or annually. Which is the best payment method? I would direct you to the operating cycle to answer the question. Structure regular payments to be due when you expect the customer to have the best ability to pay, which is when the operating cycle produces cash. It is fairly common to have predictable income on a monthly basis for most businesses, and a business could have several operating cycles complete in any given month.

A good example of matching term loan payments with the operating cycle can be observed in the hotel industry. The useful life of a hotel could be up to 25 years or more, so a good lender will expect the hotel to be able to repay on a 20-year plan (amortization). A hotel in a tourist destination may see a boom in summer months and be flush with cash, but the hotel may not be able to break even in winter months. Some hotel loans require 3 or 4 large payments during the summer months when the hotel has cash, and no payments during the rest of the year when they likely have little cash. In this situation, a hotel could even close down in the winter months to keep from losing cash without worrying about missing loan payments!

Recurring Cash Flow

Now we have established the need for a term loan arises because of the capital investment cycle and will take several operating cycles to repay the debt. We know the payments should retire the debt within the useful life of the asset, and the timing of the payments should coincide with the timing of the operating cycle. Now, how do we know if business is profitable enough to repay debt if the loan is structured correctly? We need to dissect the business’ income to understand this, because not all profits are cash.

Income can be recorded for a variety of reasons. When dealing with accrual accounting, income can be generated from completing a sale before cash is collected, it could be the result of appreciation of the market value of an asset, or a host of other reasons that don’t coincide with the inflow of cash. To truly analyze capacity, it is necessary to examine where cash is coming from and not necessarily income.

The most common way to approach cash flow is by adding non-cash expenses back to net profits - this calculation is called EBITDA (Earnings Before Income Taxes and Depreciation). But, this is problematic for several reasons. Taxes are a necessary expense that must be paid with cash, but it is often mistakenly added back. EBITDA is a business school concept of comparing cash flows of two similar businesses, and adding taxes back is done to filter out the distortions the local tax authority may place on cash flow when comparing two like businesses. When it comes to repayment of debt, taxes should be treated as a necessary expense that must be paid, and really, the focus should start with EBIDA (without T) instead of EBITDA.

EBIDA is still problematic, because it only adds back non-cash expenses and does not subtract out non-cash income. EBIDA also will fail to indicate whether or not the source of cash flow is recurring and misses other accounting distortions. Say you bought a widget-stamping machine for $500,000 and sold it for $300,000. EBIDA will reflect a loss of $200,000. However, the actual cash inflow to the company will be the $300,000 cash received from the sale. But, if we are constructing a pro-forma to demonstrate the recurring ability to repay debt, should we include the $300,000 cash inflow? We don’t want to depend on the constant sale of machinery to repay debt, do we? Really, we want the cash flow from the sale of widgets to repay debt! To make matters worse, say a new widget machine is purchased for $700,000. The entire purchase of the machine will not be reflected as an expense, but rather expensed through depreciation over its useful life. In reality, the company just experienced a $700,000 cash outflow that EBIDA did not catch.

If your head is spinning, that’s okay; it should be. The key takeaway is income does not equal cash flow, and EBITDA or EBIDA isn’t an accurate measure of cash flow for debt repayment. The only way to truly understand cash flow is through careful study of the financial statements and understanding how changes in the income statement and balance sheet are linked to cash accounts. This takes a fair amount of training. In accountant-prepared statements, these interactions will usually be reflected on a Statement of Cash Flow, but not all borrowers will have this quality of financial statements.

Putting it All Together

While this appears to be a large volume of information to digest, important principles should now be easy to identify. For example, term debt should not be provided to finance production of inventory or services, because those are related to the operating cycle and best matched with lines of credit. A revolving line of credit is practical for an operating cycle that constantly repeats, but isn’t appropriate when invested into one large project such as real estate construction. It doesn’t really make sense to measure repayment of lines of credit with cash flow models for term debt, because lines of credit should be repaid from collection of receivables, which should be extensively monitored through monthly reports.

Term debt should be evaluated based on recurring cash flow sources, not necessarily on booked income. Term debt should not extend past the useful life of an asset, and the repayment of the debt should coincide with the timing of the operating cycles. And lastly, EBITDA is not a catch-all for cash flow. The burden is on the analysts and other decision makers to understand what is occurring on the financial statements and where the true cash flow is. A good practice is to determine which sources of cash flow are recurring, and decide if it is acceptable for underwriting purposes.--Trevor Plett

The Web of Business Failure

When I was in grad school, one of my business classes showed a flowchart diagram that identified three major causes of business financial failure:  low gross margin, inadequate net operating income, and excessive leverage.  The picture showed causes and effects of each of these major factors.  It also identified how all these items are interconnected.  In the end it was a large web with the poisonous spider of business failure lording over the structure.  Unfortunately, many business owners do not have the ability to escape from the web when they are trapped in it.  If they could, they may be able to save their business instead of succumbing to the financial poison of failure.

A few years ago, I met with a business owner that had been on my problem loan list for several years.  They had made several moves to improve their business, but were still struggling.  I shared with him the financial spreads with industry comparisons for his business over lunch one day.  There we identified all three major causes of business financial failure, which happened to be present in his company.  It was my goal to help free him from becoming another statistic.

The first main factor of business financial failure is low gross margin.  The company had worked hard to build his client base, but had done sacrificing profit for business growth.  They focused only at the top line revenue.  The cause of the problem was inadequate pricing and high cost of goods sold (COGS).  The poor gross margin did not leave enough money for them to pay their operational expenses, thus a shrinking NOI.  To survive, they had to borrow more funds, putting too much leverage in the company.  They were losing money but were going to make up for it with higher volume!  (If you don’t make enough money for your product, selling more of it will only make the problem worse and not better.)  In this case, the gross margin was over 25% lower than the lowest quartile of the industry.

The owners learned to adequately price their work.  They installed minimum pricing standards and walked away from jobs that did not meet their requirements.  They also learned to not take low margin jobs in an attempt to build future business.  This construction company found that they chased after fewer jobs and the ones they pursued they were able to devote more time, performing the work at a higher standard and more profitably. 

The next major problem the company had was a negative NOI.  Causes of this began with the inadequate gross margin.  Other factors were operating and interest expenses were too high for the company.  The negative NOI required more money that had to be injected from the owners and additional, poorly structured borrowing.  The additional borrowing increased interest expenses, making the problem worse. 

The company had too many employees for their work.  Any owner hates to let people go, but if you can’t do something profitably, and do not have the ability to print money when you need more of it, you will eventually not be able to employ anyone at all.  My client also had kept excessive equipment, which had ongoing maintenance costs.  They began to sell equipment they did not use on a regular basis.  This not only reduced maintenance expense, but also reduced some of the principal of the debt they used to fund the equipment.

The third major problem was the high leverage.  The industry average was a debt/equity ratio of 3.5:1.  This company was close to 14:1.  The company needed equity and they needed it quick! 

The cause of the equity drought was from several factors.  First, excessive losses from poorly priced and jobs where they were not paid had eroded away their equity.  The next factor was increased borrowing.  The increased leverage and decreased equity took the company to a point of insolvency.  The expenses to maintain the debt also ate into cash flow, forcing the company to shuffle bills around and work payment plans for their accounts payable.

The solution came from two sources.  First, the owners raised money in from their family to put into the business as equity.  The increased equity injection did not cause any loss or control for the owners.  Next, the company identified a division of the company that was profitable, but also cost time and resources from their core business.  They sold the division, retired some of the debt, and put the rest of the money into equity.  This reduced the debt/equity of the company down to 2.8:1.

My last meeting with the owners came into a term loan review less than a year after all these changes were put in place.  We visited in the company conference room.  The company president leaned across the table and said, “Phil, we have a new problem with our company.  We don’t know what to do with all the excess money we have!”  The company was retiring debt at an accelerated pace, began to match employees contributions into the profit sharing fund, and, built a cash reserve of several months of all operating expenses. 

The job I had as a trusted financial advisor was complete.  The owners had freed the company from a web of financial failure.  I also won a bet I made with my head credit administrator that the company could survive.--Phil Love

Capacity: How Debt Gets Repaid

Assessing a borrower’s capacity to repay debt can be a very elaborate discussion and the subject of an entire text book. It generally varies based on lending type and term, and the effect of having guarantors always presents a wild card. Like I had mentioned in earlier articles, analysis really can’t be a one-size-fits-all approach, but nearly all credits will have some key things in common.

First we must make an assumption, and perhaps we should refer to it as one of the axioms of credit: Cash flow should be the primary source of repayment! That is a fancy way of saying the repayment of any commercial loan should come from cash generated from that commercial enterprise; therefore, you should first ignore all other factors, like collateral and guarantors, and see if the operating business makes enough money to repay the debt by itself.

How businesses generate cash varies by lending type. The process of a business producing goods and services and receiving cash is referred to as the asset conversion cycle. For example, Widget Inc. manufactures widgets. The business must first use cash to purchase raw materials to form the widgets. Then they must pay for labor to assemble and produce widgets. Once the widgets are complete, they must sell them and wait to collect payment for the sale. Once payment is received, Widget Inc. has cash again, and hopefully, more than when they started! What will they do with this cash? They will either repeat the process all over again, save it for a rainy day, or maybe pay the owners.

Say Widget Inc. gets a big order for widgets, and they use most of their cash to buy materials and pay for production. Now let’s say Widget Inc. gets a second big order before the first order is complete. Widget Inc. has a problem. They used their cash to start production of the first order, so they do not have enough cash to start the second order. Widget Inc. may need to borrow some money to start the second order. This is what we call borrowing cause.

Generally speaking, if a lender wants to give Widget Inc. a loan to fulfill the second order of widgets, then the lender should be repaid when Widget Inc. finally receives payment for selling the widgets. This is a crucial concept. The credit facility should not only match the borrowing cause, but also the timing of cash flow from the asset conversion cycle. This is necessary to increase the odds of repayment.

Where most lenders make painfully long-lived mistakes is by giving a borrower an improperly structured loan. If the loan is not structured to reflect the borrowing cause or timing of the asset conversion cycle, the borrower usually struggles to repay the debt in the long run. Either the borrower will have cash when a loan payment is not due, or a loan payment will be due when the borrower does not have cash. The loan becomes a recurring problem.

To summarize, the loan should be repaid by cash profits (cash flow) of the business. The reason for the loan should have a clearly identified borrowing cause. And, payments should coincide with the timing of cash received from asset conversion cycle. To give the customer a loan that does not coincide with the borrowing cause or asset conversion cycle results in a poorly structured loan.

Lastly, it is import to point out if the expected cash flow will be unable to meet loan payments, generally the loan will not work and should not be granted. You should not try to structure the loan around what the borrower can afford to pay, but you should only structure the loan around what the business should realistically be able to pay and when. Lowering payments to coincide with weak cash flow is referred to as troubled debt restructuring. I shouldn’t have to explain that means you are headed for problems!

How to Win at Referrals

I worked for a short while for Met Life between my first and second bank jobs after college.  I have always enjoyed talking to people and thought since I had an uncle who was an insurance agent, how hard could it be?  There, I was first exposed to the concept of getting referrals from customers to build your business.  After a presentation to a client (and hopefully a sale, which did not occur at all for me), we were to ask the following:  “If what I have presented is of benefit to you, can you give me the names and phone numbers of three people you respect, and who respect you in turn, who would also benefit from this service?” 

Since I never reached a close on a life policy sale, I never had the opportunity to ask the question.  I often wondered what to do if someone gave me the name of a deceased person.  Clearly, those survivors could use the live proceeds!  I eventually left Met Life because I was accustomed to several necessities like eating and paying rent.

Several years later, I attended a seminar on sales that was hosted by the savings and loan that I worked for.  It was there the same idea of how to generate referral business was presented.  I thought this was a great idea and that this would generate so much business, I would be as happy as a pig in a mud puddle.

So I decided to try it.  My next closing was with a couple who was buying their first house.  I strategically positioned myself at the head of the table between them and the door.  There was no way that I was not going to get three referred names from them after the closing had finished.  I would just block them in until they gave me the names.

So the closing finished and I asked my golden question to get my referrals.  I was met with silence.  The couple shifted nervously in their chairs and the Realtors looked annoyed as there was no sound except for crickets chirping.  Finally, the couple half-heartedly gave me one name and told me that was all they could think of.  Then they asked to go as their moving van was waiting for them.

I gave up on the begging for referrals soon after that.  I thought the idea was stupid and each time I asked, I was met with silence.  I don’t think I ever received one good referral from those requests at the closing table.  So I concentrated on being the best at what I could at residential and personal loans, which were the main lines of business for our savings and loan.  I became an expert at figuring out how to get the loan to the customer while still managing the risk to the S&L. 

Before long, I was receiving unsolicited referrals.  I even closed over half of the real estate transactions for the largest real estate company in my hometown.  Our branch was swamped with new business.  Yet, I never stopped to figure out why so many referrals were coming to us.  It was not clear to me until I was visiting one of my Realtor friends at his office one day.  He presented me with a new referral and said, “Now I don’t want you to get a big head but do you know why we go out of our way to send you business?  It is because you are the best banker in town who gets the deal closed.” 

It was then I learned the first great principal of referrals.  To get a referral, you need to be someone worthy of getting a referral.  Think about when you recommend a movie, auto repair shop or vacation spot.  You are not doing it because you have “give a referral for___” on your to do list.  You do it because it is something that is worthy of a referral in your estimation.  Referrals are something we do every day, whether we realize it or not.  We only recommend those we believe in. 

The second principal of referrals I learned soon after learning the first, if you have a raving fan of your product or services, you sometimes get a referral by being strategically introduced by your fan to your prospect.  This is best done when it is unsolicited by you and it will not happen unless they believe in you.  The best place to start receiving referrals is to be someone worthy of getting them.

Character, the Good, the Bad and the Ugly

Character is not credit criteria that can be normally quantified, but it is important to lending. I used to tell my students, “Your borrowers can’t pay you if they are in jail. Character matters!”

How can a lender possibly come to understand someone’s character? The obvious way is by simply getting to know him or her better. We all know what it is like when we get a gut feeling that someone is lying to us or up to something suspicious. A lender should be a “relationship manager,” and the lender should have an ongoing relationship with the borrower, so he or she has a good sense of the borrower’s character or moral compass.

Even if you have faith in the borrower’s character, the lender or underwriter should make use of public resources to discern as much about the borrower as possible. Younger generations are inclined to immediately do a Google search for the borrower’s name and check for any social media profiles. This is not a bad idea. This is a quick way to see how someone is presenting themselves to the public. If those searches turned up something questionable or objectionable, would you want to lend money to that person?

A public Internet search is only the tip of the iceberg. All lenders are familiar with pulling credit reports on individuals, and this may give you better insight into what type of customer you have. While credit scores are relevant, it is important to bear in mind, they tend to reflect only personal obligations and can easily be affected by close family members. The individual is likely not the sole source of repayment for a commercial loan. And, credit reports are limited in what they can tell you. For these reasons, credit scores are still relevant in commercial lending but to a lesser extent than when used in consumer lending. The report will probably not reflect commercial debt. Also, it will not indicate if the borrower has any criminal history.

A background check can be utilized to search for criminal records and even civil litigation. There are a wide variety of companies that provide background checks, and they range greatly in price and quality. Most resources tend to focus on verifying public records and a review of criminal activity; whereas, systems that check for civil litigation are harder to come by. The federal government has a repository for federal court activity at www.pacer.gov but this will not capture cases filed in State courts.

The extent to which I have suggested investigating a customer’s background may seem invasive, but remember, commercial lending typically involves the transfer of substantially more money than a consumer lending transaction. If a $20,000 loan does not get repaid because a customer is convicted or suffers from a lawsuit, your institution will likely persist tomorrow much as it did today. If your institution loses a $2,000,000 loan because of a borrower’s criminal conviction or a civil judgment, now your executive management may be concerned with capital ratios and face increased regulatory scrutiny. In this respect, you should not feel as though you are invading privacy, because your institution simply cannot afford to suffer a large loss of funds due to character flaws.

My advice is always do a character check for all significantly large loans and cast a big net. Pull a credit report, do some internet searches, find an affordable yet effective way to check into criminal records, search for the customer’s name at www.pacer.gov, and try to check any search engines provided by your local court system. And if you do find adverse information about your customer, don’t immediately assume your customer is a terrible person to do business with. Present your findings to the borrower in a professional manner, and listen to what they have to say. Your customer may have a reasonable explanation for your findings, and if they do, then it is your responsibility to check if there is corroborating evidence supporting their explanation. --Trevor Plett

Using a Guidance Line

Early in my commercial lending career, I had a client approach me about buying a series of houses that he would fix and sell or elect to fix and hold as rental properties.  He had a couple of houses in mind immediately, and could possibly be interested in buying up to 25.  He also needed a way to close rather quickly on the properties.

My first reaction was fear.  I knew the process we had to go through to get a loan approved.  The write up and presentation alone would take several days if not a week.  Much of the information would be duplicated and would require repetitive analysis.  I hate unnecessary repetition even though the industry I am in repetitive busywork goes with the job as much as jelly goes with biscuits. 

My mentor in the business provided me with a brilliant idea, use a guidance line.  We would underwrite the entire relationship up to the maximum that was comfortable by the lender and the borrower.  An agreement would be signed that covers the whole but individual loans would be booked for each property that was closed.  This allowed for the credit write up and approval to be completed one time, then loans could be closed as long as they fit the “guidance” of the guidance line agreement.

We specified in the guidance agreement what our lien position would be on each property, how much we would advance, how much the borrower would put in, at what level an independent evaluation would be required, the interest rate, amortization and repayment.  Other overall terms like the borrower, guarantors, and the length of the guidance line was specified. 

In this case we set out the guidance line for a year, so we could do adequate review.  Individual house loans could be closed under the line with an amortization of up to 15 years and term of 3.  The maximum we would advance on any one house would be 75% of his price and we would require a drive-by appraisal for any house over $150,000.  The smaller ones we would use the county assessment or a broker’s price opinion.  We also allowed him to have no more than 5 rental properties in the line at one time. 

The structure allowed us to quickly serve the customer needs once the overall structure for the individual credits to be approved.  The overall guidance line was not booked, only the individual credits under the line.  This allowed the overall credit to be approved at one time.  This saved a lot of time and hassle for all parties involved.

Over the years, I have seen guidance lines used for major development projects like construction of condominiums to purchases of pieces of equipment to acquisition of vehicles for a company’s fleet needs.  The structure offers flexibility to the borrower and certainty knowing how each loan will be reviewed and closed.  The loan committee did not have to see the same credit come before them with a hurried attempt to rush the deal through.  I, as the lender, could avoid some stress and duplication of effort and just manage each deal under the overall agreement.

If any deal fell outside of the outline of the agreement, it would require special approval.  The line was also able to be closed if we saw a deterioration of the financial position of the borrower.  The lender remained in control. 

This lending structure may be of benefit to some of your clients, especially those who seem to be buying equipment.  We often would approve guidance lines at the annual loan review time if we knew a client had upcoming needs for the next year.  This seemed to cover most of the needs of the client, unless some event came up that required us to investigate further into the borrower. 

Don't Bring a Knife to a Gun Fight--Doing Analysis Right

Credit analysis is the process of analyzing a borrowing request and determining under what conditions, if any, money should be lent. To do this effectively, it is important to know what analytical tools to use and when.

For newcomers, this can seem overwhelming. First of all, it is intimidating to think about the large volume of money about to change hands. Second, the number of adverse situations that can arise seems endless and impossible to fully understand. Both are good reasons for concern, but proven methods have helped us conquer these problems effectively.

Our first method for dealing with a world full of infinite risk is trying to categorize all risk into 5 buckets we call the “5 Cs of Credit.” All risk can be categorized as follows:

1.  Character, which includes reputation and payment history

2.  Capacity, which includes whether the enterprise provides enough cash to repay the debt. 

3.  Collateral, which is generally an asset that could be sold to offset the debt in default. 

4.  Capital, which is an assessment of how much the borrower has at stake in the transaction. 

5.  Conditions, which is an assessment of economics, industry, and operating environment of the borrower. 

Ideally, if each category looks strong, we should have little to worry about.  Most of the time, you will find some of the categories are weak therefore exposing more risk, and the question arises whether the stronger categories can carry the weaker ones.

How these 5 Cs of Credit should be investigated is where most analysts unknowingly run into problems. There are several analytical tools which can be used in credit analysis and it is confusing to know which one applies to each specific situation.

Not understanding what is in your tool box will lead you to making mistakes. Often I have seen an attempt to use every analytical tool simply to assure no stone is left unturned, but doing so can be foolish. It is like watching someone use a screw driver to hammer a nail or like watching someone trying to eat soup with a fork.

Using the right tool means first identifying what type of problem you are trying to solve. There are actually different areas of lending that will require you to look at different metrics. For the types of loans we typically encounter, there are three broad lending types:

*  Commercial Real Estate (CRE) 

*  Commercial and Industrial operations (C&I) and  

*  Agriculture

The 5 Cs still apply to each lending area, but the how they will be investigated will differ. Each lending type will require its own unique tools, and it doesn’t always make sense to use the same tools in each situation.

For example, take Capital. For a loan to acquire an existing commercial property (CRE lending type), capital will be measured using a loan-to-value (LTV) ratio. But for C&I and Ag, capital will be measured by a debt-to-net worth ratio. Even though you will use a debt-to-net worth ratio for both C&I and Ag, a ratio of 2.00 may be considered acceptable for C&I but will be considered unacceptably high for Ag.

Another area that often causes confusion in using the right tool is the term of the request. Short term credit will have different metrics than long term credit. For example, debt service coverage ratio (DSCR) is an adequate measure of Capacity to repay long-term debt, but it is a poor way of measuring the capacity to repay short-term debt. Why? Short term debt service is often interest only payments and does not account for the need to curtail principal. Therefore, when a DSCR is used for a short-term interest only line of credit, the capacity to repay the debt is not being reflected.

Often the real challenge with analysis is not failing to account for some hidden risk, but using the proper tool. Using the right tool will help report the 5 Cs adequately so an informed decision can be made. But, if you use every tool at your disposal regardless of lending type, the result is often white noise that nobody can understand.  That is why it is important to identify the proper lending type and then only use the tools that are relevant.

In my coming articles, I will explain each of the 5 Cs in the context of different lending types and suggest the proper tools you may use for analysis.--Trevor Plett

Checking Into Your Hotel's Financials

In the Checking Into Your Hotel post, I discussed the importance of the condition of the hotel in the annual review process.  A hotel with deferred maintenance items or improvements the franchise is forcing to complete may cause a problem in cash flow, both in the expenses for the improvements and a possible drop in top line revenues. 

This post will look into the finances and look at several questions the astute commercial officer should ask.  So is there anything else that must be done once you have reviewed the financials and tested the debt service coverage?  Once that is complete and the ratio passes the minimum threshold are you finished with your analysis?

Not yet.  A good analysis of a history of income and expenses from year to year is helpful.  This may show any large, one-time expenses in a year or also any deteriorating or improving trends.  A discussion with the owner will reveal if these trends are likely to occur in the future or if they will not.  This analysis may be an early indication of a problem loan in the future, even if all seems to be fine today.

Questions on the composition of the gross revenues should be asked.  Are there any large contracts for rooms?  Here we are not talking about a group that takes a block of rooms for a weekend.  We are talking about a large number of rooms being taken for an extended period of time.  If so are these likely to continue and how are they priced compared to other room rates.  A few years ago, the Southeast Missouri State found it ran out of dorm rooms for students with the increased enrollment.  They elected to have new apartments built by a third party and then enter into a master lease with the developer for the buildings, which they in turn, rented to students. 

The apartment towers were several years away from completion and they needed spaces for students now.  The school officials contracted with several hotels to rent entire floors of hotels for student housing.  These contracts proved to be a blessing and a curse to the hotel owners.  It was a blessing with a large slice of revenues becoming more certain.  The school rents ran through the slower period of the winter months and still left the hotel open to travelers in the high occupancy summer months. 

But it also was a curse.  The block rents were below what the hotel could rent rooms for on a nightly basis.  The younger student room renters tended to be harder on the property than the average traveler.  This drove up repair expenses.  A challenge to the loan officer is to help understand when the large block revenue will end and what will happen to the hotel’s income statement.  In this case, the owner expected to have a drop in revenue by 10% without the university’s contract income.  They expected their room rates would increase overall.  Management also expected to see a substantial drop in repair expenses.

Some hotels are completely dominated by contracts from one source.  I once looked at a hotel in Kansas that had a contract to rent 80% of its rooms to the railroad.  The hotel was the only one in that small town, so it enjoyed this constant stream of revenue for years.  The only risk would be if the railroad decided they did not need the rooms or if more competing hotels were built in the area.

I always ask for the year ending Smith’s Travel Research (STR) Report.  This is offered free to the hotel owner in exchange of them submitting numbers for occupancy, rooms available to rent, and average room rates.  STR allows the hotel owner to select other hotels they view as competition in their market area and provides information of the performance of their hotel compared to the peer group. 

The STR is helpful in tracking trends in occupancy, average daily hotel room rates and also daily revenue per available room (RevPAR).  Caution should be used when looking at the peer comparisons. Since the hotel owner can select his own peer group, that selection may or may not accurately represent the competition. 

Questioning the components of the income statement further and an analysis of the STR report can be valuable tools for your annual check into your hotel loan.  These strategies may help you understand problems that will occur years before they begin.—Phil Love

Credit Unions Need to Rethink Capacity

In the past couple of weeks, I have heard from several credit unions that were interested in purchasing a construction and development (C&D) participation, but they were being mindful of the NCUA cap of 15% of net worth.  These credit unions were concerned that if they approached their 15% cap, then they would be unable to fund other C&D projects for their members.  I think it is important to be mindful of this, but it is a concern that can be mitigated by using the CUSO for leverage.

For example, assume you are a credit union that has only $1 million in C&D capacity.  It is important to understand that if you have a member who comes to you with a $2 million C&D request, you can still lend to this customer.  How?  The obvious answer is to find a participant who can fund the other $1 million of C&D.  You can then fully fund the loan, but now, you will not be able to make any more C&D loans to other members who come to you with requests.

There is also another way to do this without exhausting your capacity.  Say that same member needs a $2 million C&D loan, and you still only have $1 million in capacity.  You may participate out the loan to other credit unions; however, to do this, you only need to retain 10% of the loan.  That means, you can lead the participations with 10% of $2 million, which is $200,000, and find participants for the remaining $1.8 million.  The advantage to this approach is that you now have helped your member fund a $2 million C&D loan while only using $200,000 of your C&D capacity.  Therefore, if you have another member who needs a C&D loan, you still have $800,000 in remaining C&D capacity.

If a credit union only has $1 million in C&D capacity and is willing to participate with other credit unions, the lead credit union actually has up to $10 million in C&D loans they can originate.  That is what we call “leverage” in the financial world, and it is a common practice.  When a credit union or bank makes a loan, it actually uses a small amount of its own money to make the loan, usually around 10%.  Where does the other 90% of the money come from?  It comes from your deposits, other peoples’ deposits and businesses who deposit money at that institution.  Depository institutions leverage their own capital with deposits as their primary means of getting business done, so a credit union with $1 million in capital can use $9 million in deposits to make nearly $10 million in loans!

Leverage is one of the fundamental principles that make financial institutions work, but it will require a paradigm shift to understand leverage goes beyond simply deposits and capital.  Leverage is always about expanding capacity with limited resources.  If a credit union already leverages their capacity to make loans by using deposits, why should they be hesitant or skeptical to leverage their C&D capacity through participations?  The lead credit union can remain the face of the relationship, and most importantly, be able to retain a relationship regardless of size and internal capacity.  Again, this is the fundamental principle of leverage, which a credit union or bank uses every day.

And as a side note to C&D limits, I think it is also important to mention that by choosing C&D projects wisely, the utilization of the C&D capacity can be relatively short-lived.  When I say choosing wisely, I mean taking on projects that result in income-producing properties and are well underwritten to deal with typical construction risks.  This will result in a relatively short-lived C&D loan, which means a relatively short duration of occupying C&D capacity.  A typical construction project should be completed within 12 months, give or take 6 months.  I think it is important to consider this too when you consider to fund a C&D loan.  It may count against your C&D limits, but it should only count against your limit for about 12 months.  And the best part is, after having taken on the burden of using your C&D capacity for a short time, you should be rewarded at completion by holding onto a relatively low maintenance asset with a decent yield for years to come.--Trevor Plett

Checking Into Your Hotel Loan

It is time to ring the bell at the front desk of the hotel you now hold as collateral.  As all seasoned commercial lenders know, the work on a loan never stops when the closing is over.  The loan must be properly monitored, analyzed and new risk grades applied.  With any loan this requires obtaining updated financials on the borrower and the guarantors.  New tax returns are obtained from all parties and reviewed. 

But what else is done regarding a hotel loan?  Is there anything different that needs to be done to reveal the condition of the company?

Truth be told, there are several additional steps that should be done with the annual review process than the steps taken for a typical commercial loan.  This blog will focus on what to look for with the physical inspection of the property. 

A visit should be made to the hotel and with the owner.  Careful review should be made to the condition of the property.  Are there any deferred maintenance items such as any worn carpet, fixtures or furniture?  The finishes and items in a hotel are not designed to last forever and will require constant repair and replacement. 

Pay special attention to the common areas of the hotel since these tend to get more wear and tear.  The entrance area is also a showcase and the first experience a traveler has when he enters the property.  It is important this area is clean and attractive.  A good measure would be to ask if the property would be a desirable place for you to stay with your family.  If not, then that may raise some red flags.

But there are other changes that may need to be made even if everything is in good order.  Franchises often may change their required finishes, signage, and furnishings.  The new changes, along with the deferred maintenance items may show up in a Property Improvement Plan (PIP) from the franchise.  Most of these will give a required list of items that need to be changed and time frames for when the changes should be made.  If they are not made in a timely manner, the franchise may elect to not renew the franchise agreement with the hotel, a move that is especially used when the franchise agreement is coming up for renewal.  This could result in a problem with the continuance of the income stream for the property, if the hotel were to lose its franchise.

A recent example is Choice Hotel's decision to require all Comfort Inns to be at least three stories high and also to have an interior elevator and room entrances.  Many hotels that operated as a Comfort Inn were forced to correct the situation or lose the Comfort Inn flag.  In either case, fixing the deficiency or reflagging the hotel, could cost substantial amounts of money, Properties with only two stories or exterior room entrances found that the cost to rehab the structure to bring it into compliance with the new rules was unbearable. This forced them to move to a different flag.  Changing flags also is costly with complying with the finishes and signage of that property.  There will also be an upfront fee paid to the new franchise.

Most franchises inspect their hotels at least annually and also provide reports quarterly to the hotel owner.  These may be from hotel inspectors, secret shoppers, or a compilation of guest comments.  The Quality Assurance Report (QAR) also may provide some insight into upcoming PIP items that will be required of the property.  QARs may also contain items on customer satisfaction. 

Understanding what items need to be repaired or improved on the hotel, when these items need to be done and how they will be paid for is essential.  You will also find out that the best hotel owners are those who proactively make improvements to their properties before the franchise requires or it is absolutely necessary to do so.  The best hotel owners realize they are not working just on making the current hotel stay nice for the guest; they need to “wow” the guest into coming back.--Phil Love

Introducing Trevor Plett

Hello, I am Trevor Plett, the new head of the Credit function at Midwest Business Solutions. I officially started working here in the middle of June 2013 and have found this to be a great opportunity and the next logical step in my career.

I came here from the Washington DC metro area, but I am a native South Dakotan that was born and raised right here in Rapid City, SD. In fact, my career in finance even started here in South Dakota with working as a bank examiner for the State of South Dakota.

My story of how I was born in Rapid City and returned as a professional in finance is full of several twists. My parents moved our family to Pierre, SD in the 1990s to work for the State government. I graduated high school there and attended college at Iowa State University. After graduating from ISU, I joined the Peace Corps where I worked as a business educator in the former Soviet country of Ukraine, which is also where I met my wife Natasha.

When my Peace Corps service ended, we decided to move to Pierre to be with my family. Working for the State government in Pierre is how I would start my career in finance as a bank examiner. Working for the State I gained strong fundamentals in banking and my wife started her career in computer programming there as well.

My time as a bank examiner took me to the largest and smallest banks throughout South Dakota. I was primarily a safety and soundness examiner, which means most of my time was focused on evaluating management decisions and assessing loan quality. A secondary role I played was checking for compliance with federal and State banking laws. To accredit my skills, the State would send me to FDIC training schools in Washington DC. There I earned credentials to be a Certified Operations Examiner and Certified Credit Examiner.

Seeking a position with less travel and wanting to expand my expertise, I sought a job in Washington D.C. I started working as a credit analyst for United Bank, which is a regional bank there with approximately $8.5 billion in assets. While working there I gained great insight into real estate lending as well as commercial and industrial lending. I also had a unique opportunity to work on lending requests from non-profits, local governments, and build expertise in tax credit finance.

Midwest Business Solutions was able to convince me to return to South Dakota for several reasons. For one, now I greatly appreciate the higher quality of life our region provides. But, I also see the need and understand the importance of cobbling together a strong local network of capital for small businesses in our community.

In addition to helping the CUSO fulfill its unique role in the community, it is a dream job to provide custom solutions for local institutions and local entrepreneurs. I enjoy the kind of job where I never know what to expect next. Here at the CUSO, each day throws a new interesting problem at me to solve and I don’t see myself getting bored here any time soon.  Trevor