Seeing With Your Other Eyes

My younger son has a part-time job as a movie critic.  It amazes me how one could get such a gig, where you can sit down for two hours in a theater with a big bucket of popcorn, write about the show, and get paid.  Because he often sees movies before they are out, he can tell me what is good or bad when the show is released.  Because of that, we often don’t go to the movies together. 

Last weekend, when  all of the women in our family were on a trip, and my oldest is away at college, Josh and I found some time to see a show that he did not have to review which allowed us to spend some rare “movie theater time” together.  We chose to see the film “Little Boy”. 

The movie is set in the early 1940s at the time of World War II in a small town in California.  It focuses on a family and especially the relationship between a father and a young boy who had his dad as his best friend.  The dad is drafted into the war and the boy is heartbroken.  The lad is determined he will do whatever he has to do to bring his father home safely, which involves believing and acting out on that faith with the guidance of a local priest.  It is a heartwarming and heroic story that I recommend.

I bring up the story in this blog, because it struck me how much of a role that faith plays in building a company, a credit union, or even a life.  Look at your business clients who started from nothing.  Consider the small, local credit union that grows to be the biggest financial institution in the area.  Think about every important relationship that you have, whether it be with God, family members, friends, or business clients.  What is a common denominator among all of these?  They all require faith.

The writer of Hebrews tells us that faith “is substance of things hoped for and the evidence of things unseen”.  You may know of people who have ancestors who came to America with a few dollars in their pocket, clothes on their back, and the belief they can make a successful life in this country.  You have also heard of successful businesses that have started out with smart people, a dream, and faith.  In each case, despite overwhelming odds, these folks saw something that did not exist—a successful company, a growing community, or a profitable ranch—to name a few.  These items did not exist, but they could clearly see them with their eyes of faith. 

This issue hits home with me.  Every day, I see our company as it will be and not as it is.  I then have to see where we are presently.  The path between the two requires faith to clearly see.  This faith is the starting place to turn dreams into attainable goals and steps where everyone can see what you already know. 

This principle applies to whatever you are doing in life or relationships.  The important thing here to remember are words that my Aunt Lil used to say, “Both the person who thinks he can’t and the fellow who thinks he can, are both right.  Which one will you be?”

Increasing the Regulatory Burden

The other day I was reading a study commissioned by the SBA and completed by Nichole and Mark Crain of Lafayette College in 2010.  The executive summary begins with stating that the annual cost of complying with federal regulations in the United States totaled $1.75 trillion in 2008.  If this were to be divided up evenly among households, it would total $15,586.  Compare that to the average household cost for health care in that year of $10,500.  It is interesting how there has been an uprising about the high costs of healthcare, yet you do not hear the same clamor over regulatory costs!

To give you the idea of the enormous size of this, in 2014, according to the International Monetary Fund, the entire GDP of Canada, the 11th largest on the planet, was only $1.788 trillion.  So, if we could take the regulatory costs in 2008 and make it a national economy to itself, it would be the 12th largest in the world.

To depress you even further, the cost of regulatory compliance has definitely not slowed down since 2008.  We still have not even scratched the surface with items such as Obamacare or government agencies like the EPA.  So where do most of these rules come from?  They come from a new 4th branch of government called the bureaucracy.  In 2011, federal agencies issued 3,807 final rules, yet Congress passed and the president signed only 81 laws.  In 2012, federal bureaucrats issued 212 federal rules which each were projected to cost more than $100 million. 

Another problem here is these rules are not passed as a laws are as outlined by our Constitution.  These rules, which often impose monetary or criminal penalties, are created as explanations of laws or enforcement actions of various agencies.  Consider one of the favorite laws in the financial realm, the Dodd-Frank Act.  This was supposed to protect the consumer from risky decisions of financial institutions.  The law is an offense to the Constitution.  An example here is the establishment of the Consumer Financial Protection Bureau (CFPB).  This agency has far reaching power from preventing financial transactions that are considered “unfair,” “deceptive,” or “abusive” in regarding a consumer financial product or service.  The statute has no definition of what these acts are, so the CFPB has exclusive authority to create rules with little recourse by those impacted by its decisions.

No doubt, if you are in a financial institution, you are feeling the impact of these dictates today.  What makes matters direr is that the CFPB was set up by Congress for Congress to have no appropriating authority over the CFPB, as the law allows the CFPB to claim funding directly from the Federal Reserve.  So this would appear to violate the Constitution’s establishment of how funding for the federal government agencies is handled. 

The head of the CFPB is given a five year term and can only be removed “for inefficiency, neglect of duty, or malfeasance in office” by the president.  Congress gave up even more of its authority by establishing a 15 member oversight council and granted it broad executive powers.  The council has open-ended discretion to designate nonbank financial institutions as systemically important, which should have a wide range of regulatory authority over these businesses.  I recently ran into this from some of my real estate friends in Colorado who were putting on classes for other realtors dealing with the new impact of the CFPB to their firms.  But these items cannot be challenged as the law prohibits aggrieved parties from challenging the legal status of the council’s actions in court.

So we are left with a Congress that has surrendered its own power to the executive branch entities, and the president to grant his power to an administrative state.  Statists have, for the past century, contended that these agencies are necessary to provide a progressive government required by a modern society.  Yet, delegating power to an administrative state is a violation of the separation of powers doctrine of the Constitution where the authority is granted to the three branches of the government.  The ceding of such power would seem an illogical act that is completed over and over again by each branch of government, yet it make perfect sense when elected officials and appointed judges share the view of an ever-expansive administrative state that runs the lives of the people of our country.

There is a saying that power corrupts and absolute power corrupts absolutely.  The consolidating and granting of such power to a group of people places us on a fast track to totalitarianism.  It is important that brakes be placed on our journey as I doubt the American people are intending to sign up for this trip in the first place.  We need elected officials and appointed judges who operate from the standpoint of limited government.  We may even need safeguards in our Constitution that would force significant federal agency rules that would impact the economy by $100 million or more to be forced to a congressional vote or some provision that would create sunsets for all federal agencies that are not outlined in the Constitution. 

There is an old story about the producers in a society being the ones that are pulling the cart while there are some who cannot produce, for no fault on their own, and thus sit inside the cart.  Today we find many more in the cart who choose to be there.  We also find another group in the cart, telling the pullers of the cart how to do their job.  One wonders when the pullers will just give up.

Member Business Loans and Government Programs

Credit unions occupy a unique space in the world of finance. CUs exist to help their members when banks ordinarily wouldn’t provide services or will be a more expensive option, because they must generate a return for the bank owners.  Credit unions can also provide member business loans to small business owners who are typically overlooked, because they are not seen as a source of enough business. However, CUs need to be careful to not provide an MBL to a member, simply because they aren’t ordinarily credit worthy. But, there are various programs that exist, which help members with limited resources or those that find themselves in unique situations.

The Small Business Administration (SBA) is probably the most well-known government program that exists to help small business owners. There are two major products the SBA offers, which are known as the SBA 7(a) program and the SBA 504 program.

The SBA 7(a) program typically provides a 70% guarantee on all existing debt. A credit union which partners with the SBA to obtain this guarantee will find it is really more of a loss share agreement. The SBA doesn’t guarantee a fixed amount for repayment, they promise to take 70% of the loss if losses occur. This program is especially helpful when a business has acceptable income and cash flow, but an unacceptable collateral situation.

The SBA 504 program provides an extra loan to help business owners buy their owner-occupied real estate. Say a dentist wants to buy his office for $1 million. The credit union could make him a loan for $500,000 and then the SBA would give him a loan for up to $400,000, which would be secured with a second mortgage. This means the dentist would only need to provide a $100,000 down payment; whereas, ordinarily he would have been required to have a $250,000 down payment.

With respect to agriculture, CUs can obtain guarantees from the Farm Service Agency (FSA). In this case, the FSA has guarantees up to 90% of outstanding principal. Like the SBA, the FSA guarantee is really a loss share agreement. FSA programs also can help subsidize interest payments. The FSA programs tend to be helpful with ag members who have accidently gotten themselves overly leveraged, or are young producers that are starting out with limited resources.

Other great programs exist which may not be as well known. USDA Rural Development may guarantee loans up to 80% for commercial projects in rural areas. The Bureau of Indian Affairs (BIA) may provide a 90% guarantee on loans to businesses that are 51% owned by Native Americans. Also, many states provide their own economic development programs, where the State government may provide a guarantee, subordinated financing or interest subsidy for various situations.

By being knowledgeable in these programs, a credit union can give its members a great advantage. Members who have a strong business plan that would ordinarily be credit worthy, but are lacking some type of key credit enhancement, are those that benefit the most from programs like these. And, when a CU takes the time to learn these programs, they can carry out their mission of better serving the member and help them in situations where banks might ordinarily pass over them.

What is Solvency?

You may have heard the word “solvency,” but never given much consideration to what it means. While sometimes it is associated with liquidity, it can mean different things.

One idea of solvency has to do specifically with a business’s ability to pay its short-term obligations. In other words, a business has short-term liabilities on its balance sheet that need to be paid within 12 months, and so long as current assets and cash flow meet or exceed the amount of current liabilities over the same period, the company can remain solvent.

Another way insolvency is interpreted is when total liabilities exceed total assets, leaving the company with no net worth or negative net worth. The company may have liquidity to operate, but due to a lack of net worth, it may be more desirable to declare bankruptcy. Insolvency, due to a lack of net worth, can happen instantaneously. Say a company has $100,000 in assets, and $50,000 in liabilities. A company in this situation is relatively okay. Now say that same company has an unfavorable legal ruling, and now they have a $200,000 lawsuit they must pay. Now total liabilities are $250,000. The company actually has a negative net worth of -$150,000. The owner may find it easier to declare bankruptcy than try to satisfy the lawsuit. This single action leads to company insolvency.

If a business can remain solvent and is expected to remain operational for the next 12 months, it is referred to as a “going concern.” If a business has circumstances that call into question the ability of it to remain operational in the next 12 months, it is not a going concern. This comes from an older usage of the word “concern” which meant “business.” If you receive an audit or information that says the business you are financing is not a going concern, you should be very concerned!

If a business fails to remain solvent, then bankruptcy may be inevitable. Bankruptcy is when the justice system intervenes to provide an orderly way to repay creditors or discharge debts. There are different types of bankruptcies for individuals and businesses. Chapter 13 is when an individual tries to restructure their debts in a way where they can better repay them. Chapter 11 allows a similar situation, except it applies mostly to businesses. Chapter 12 is similar to 11 and 13, except it applies more specifically to families engaged in agriculture. And then there is Chapter 7, which is best described as liquidating all assets to satisfy debtors, with the intention of discharging most debts.

Part of business lending is to assure we only lend to businesses that can remain a going concern, which typically means they show the strong ability to remain solvent. Events that can lead to insolvency can be quick and unpredictable, so it is important the business is well capitalized and carries the appropriate insurance. Insolvency can lead to bankruptcy, in which it will be challenging to be repaid timely, if at all.

What to do when a Loan Covenant is Broken

Spring is here, the time when a many commercial and agriculture loans have current financials turned in from borrowers.  Oh, what wonders await the lender who has to gather all this information, carefully inspect all the data, and make judgements on the current risk inherent in the credit! 

At the same time annual information is required, often loan covenants need to be tested.  This is assuming that you have put financial performance covenants in your loan agreement, which is the subject of another blog.  So the question is what do you do when your customer has broken a loan covenant?

Loan agreements usually spell out a variety of remedies that are at the lender’s disposal when a covenant is broken.  Some of these options may be to assess a default interest rate, charge additional fees for breaking the covenant, or even accelerating the remaining principal balance of the note.  Sometimes, any of these remedies are available, but the lender will choose to use none of them.  What actions should the lender take regarding loan covenant violations?

One course of action that is often done by lenders is to just ignore the covenant with no notification to the customer.  This can create a problem since courts have determined that a lender ignoring loan covenants may cause him to forfeit possible remedies that he has since he is establishing a precedent on how violations are handled.  In other words, if you decide to ignore your customer failing to meet his debt service covenant several years in a row, you may give up your ability to enforce it when you need to.

So, what is the proper actions when covenants are broken but the lender decides to not enforce a remedy?  A covenant violation letter should be drafted and sent to the borrower.  The letter should state what the loan covenant standard is, when the covenant was tested, how the covenant was calculated, and the result of the calculation.  The letter should outline any remedies that are being taken. 

If no remedy actions are being taken, the letter should also outline what possible actions the loan agreement places at the lender’s disposal and that the lender not electing to utilize a particular remedy today, does not set any precedent wherein the lender cannot select that remedy that is outlined in the loan agreement in the future. 

Another benefit of utilizing covenant violation letters is that it proves to the customer that you are indeed paying attention to his performance.  It opens up discussions to help deal with possible greater problems before they become terminal to the borrower.  A covenant violation letter can provide good grounds to allow the customer to see what problems you see in the company.

It also is a good tool to show your examiner or auditor that you indeed are looking at the credit and properly monitoring it.  What better way to show that you are properly monitoring the credit, than to have both your calculations and also correspondence with the borrower in the file when it is inspected? 

Covenant violation letters are an essential tool in properly managing a credit when the financial performance has failed to meet expectations, but is not troublesome enough yet to require utilizing more severe remedies. 

What is Liquidity?

We all have a sense of what liquidity is, which relates to how easily something can be sold or converted to cash. When evaluating a business loan request, we look at liquidity in a slightly different context. For the purpose of underwriting and analysis, we consider liquidity the ability to satisfy current obligations. Of course, those current obligations will need to be paid for with cash!

Consider the following example: Is $10 million in cash a lot of liquidity? We want to say “yes” because $10 million can purchase a lot of things! However, what if the same business with this cash has $20 million in bills to pay? Clearly, that $10 million in cash is not enough, and we may argue the company actually lacks adequate liquidity.

A common way we assess liquidity is by dividing “current assets” by “current liabilities” to produce a “current ratio.” Current assets are assets we expect to convert to cash within 12 months, and current liabilities are obligations which must be paid within 12 months. Ideally, we would like to see a current ratio greater than 1.00x, which indicates there are enough current assets to produce the cash needed to pay all current liabilities. In our example above, $10 million in cash divided by $20 million in bills gives a current ratio of 0.50x.

Part of the credit analysis process is determining whether current assets are truly expected to convert to cash in the short-term. For example, inventory assets do not come with a guarantee that they will be used or sold within 12 months, so they must be given special consideration. However, accounts receivable are generally paid within 30-90 days, but there may be a need to do some analysis to assess their collectability. Several different assets can be classified as current assets, and it is the analyst’s job to convey how they think any of these significant items may ultimately affect liquidity or the current ratio.

Different industries may have different standards for current ratios. Generally speaking, we like to see a current ratio of at least 1.25x. Some businesses can function with a current ratio of less than 1.00x, if they have an especially high and consistent cash flow. A good example of this is fast-food operators, who can fund most of their working capital directly from their strong predictable cash flows from month to month. But, this is only acceptable in select situations like fast-food.

The main point we need to consider when evaluating a business’s liquidity is, liquidity does not exist in a vacuum.  Even though a large amount of cash or receivables may appear to be an ample amount of resources, we have to consider what bills need to be paid too.  $10 million may be a lot of money, but when compared to $20 million in bills, it is much less significant!

The Right People in the Right Places on Your Team

Frequently, writings about business and leadership deal with making sure you can attract the right people for your team and get them in the right position where they can maximize effectiveness.  I have heard many analogies comparing a company to a sports team, a bus, or a military squadron.  Any one of these can apply.  The ultimate goal is to win.  If you have your star lineman playing quarterback, you will have some problems with peak efficiencies.  If you have a wide receiver blocking at left tackle, you also open up your backfield to all sorts of heck from very large defensive linemen bent on destruction.

Often, the leader can get so involved in the day-to-day operations of an organization that he misses gaining an insightful overview of his staff and potential players.  This will lead to mediocre performance as players are overlooked because of what is perceived as their talents or placed in positions that they are not very effective in.  This blog will look at some of the common mistakes.

The first is when people in leadership positions are there just because of their longevity in the organization or in the industry.  Yes, I do believe that the gray-haired of us can coach excellence in those younger on the team.  But, sometimes, one has achieved longevity because all the talented people above him/her have left.  Companies that have these people in leadership may also be dominated by strategies that resulted in successes in the middle of the last century, but are completely irrelevant today.  This requires the leader to evaluate their contribution.

The converse of the first mistake is to grossly underestimate people who have not been in the company or industry for a long time, but who have good leadership skills, other business experience, or education.  These folks catch on to the corporate systems like a fish to water.  They also bring a wealth of knowledge to the company with a different perspective than those who are already entrenched.  These new ideas can be used to help the company grow.  Without those with an outside view, you may get the same results as we do with government, when we only elect career politicians with no outside real world experiences. 

A problem with those who enter the organization with little experience is that there is a tendency to look at those people as if they are still in that beginning place, even after years have passed with the company.  Leaders can fall into the trap of looking at how people were, not how they are today, or most importantly, where they can be in the future.  Vision is essential for good leadership and people development.

The majority of our staff had no experience in commercial lending before joining our team.  The technical knowledge only accounts for 10-20% of their success.  The rest comes from a constant thirst for learning, attitude, and critical thinking skills.  I would select someone who can think well with no technical knowledge over someone with all the industry knowledge, but who cannot go outside of their limited experience.  Our firm is better because of the varied background of the high thinking people on our team.

Another issue is when you have a right team member in the wrong position.  One bank I worked at had a gentlemen who led commercial construction management.  He had little construction knowledge and managed projects from an excel spreadsheet.  When something went outside of the boundaries of his sheet, he drove the customers and commercial lenders crazy.  The bank’s leadership was able to assess his talents and moved him to a position managing commercial collections, where he excelled. 

Certainly, a leader is required to challenge traditional methods of thinking when assessing the talents and abilities of his team.  But, ignoring some of the folks who on the surface may not have the typical characteristics that is considered necessary by conventional wisdom, is the same as missing the hall of famer who was drafted in the late rounds or the star who was not drafted as all.  Sometimes, these people, can make the largest difference in your company. 

Selling from the Front Porch : Persistence

Every time we would go down to Uncle Allen and Aunt Barbara's house, it would mean one thing to me--a chance to fish!  Allen had two farm ponds that were stocked with fish.  One had a nice dock and you could throw fish food over the water and watch swarms of fish come to the surface.  Yet another learning experience popped up one night on the porch when I looked up from a pile of beans that seemed higher than how tall I was on tip toes.  I did not have time to snap beans, I wanted to fish! 

So I dutifully snapped and threw beans into the buckets all the while glancing at the water from the pond down the hill.  I felt trapped and knew at the rate I was going, we may be there all night and halfway through the next day before the pile was gone.  To make matters worse, Allen had gone back to another few rows of the garden that we did not pick and piled yet more unprocessed beans into the pile.  Fishing would never happen this day!

Aunt B asked me, "Phil, do you want to go fishing?" 

"Yeah, I would rather do that than working on the mountain of beans we have here," I replied. 

Barbara's response made me almost fall out of my chair.  "You will never get to the pond if you continue to mope at the task at hand instead of just getting in there to conquer it!"  I had never thought of beans as something to conquer, but at that time, I did consider them my personal enemy. 

And so, I began to dutifully snap beans and engage in the conversation of the evening.  It did not take long before the bean snapping mission was accomplished and it was then time to grab a pole and some worms and head to the pond.  It happened the summer heat had cooled down enough to allow for the fish to become more active.  I was not as thankful for all the hard work at that moment, but I did learn in the winter how good a pot of home canned green beans and bacon were!

The lesson here was in persistence.  Good sales and leadership require it.  You can be snapping beans or building a relationship with your biggest commercial prospect; either of these requires you to press on and complete the task.

At my last banking job, I spent five years calling on a large contracting business before I won their accounts.  Many times I would respond to more retail-minded, transaction-oriented, what-have-you-done-for-me-lately bosses who questioned why I would periodically visit the company and its key leaders.  It proved they were focused only on the small business today, instead of working to build larger business tomorrow.  Yet to be successful, both now and future time-frames must be worked.  After five years, I won a solid customer and a relationship of tens of millions of dollars. 

Persistence is what keeps you pressing on when times get tough.  It follows a discipline of what needs to be done each day and every hour.  It drives the actions that need to be done in private times when nobody sees in order to have the excellent performance in public.  It is what forces the football player to get up in the wee hours of the morning in order to workout.  It is what makes the professional golfer hit ball after ball on the driving range to perfect his swing. 

One of my favorite persistence quotes came from President Calvin Coolidge.  I have the saying posted by my desk.  “Nothing in the world will take the place of persistence.  Talent will not; noting is more common than an unsuccessful men with talent.  Genius will not; unrewarded genius is almost a proverb.  Education will not; the world is full of educated derelicts.  Persistence and determination alone are omnipotent.  The slogan ‘Press on’ has solved and always will solve the problems of the human race.”

So no matter if the task in front of you is a big pile of beans, the largest customer you have landed to date, or reaching the top in your field, persistence is necessary to ultimately succeed. 

The Treadmill Desk

I couldn’t believe my ears this morning when I heard NPR report the successes and failures of the treadmill desk. If you are like me, you probably first thought of a metaphorical conveyer belt that keeps dropping piles of paper on your lap that you struggle to keep up with. But, it turns out there is an actual treadmill desk, which seeks to combine the need to exercise with the need to work!

The treadmill desk is available at Wal-Mart.com for a starting price of $619.99. As you can imagine, the price only goes up from there, depending on the quality and features you desire. Most standard models have a treadmill below to walk on, and a desk at chest level with enough space for a monitor, keyboard and mouse. The most common complaint is sweating while working and coworkers complaining about heavy breathing.

Workers’ health has long been known to have an impact on productivity, and the treadmill desk is just one of the latest attempts to encourage workers to stay healthy. The State of South Dakota encourages its employees to take two fifteen-minute breaks throughout the day, and to use the time to take a leisurely walk outside. Some places pay for or subsidize a gym membership for their workers. These strategies may have just as good of results as the treadmill desk, without some of the craziness the invention will likely introduce.

For those of us that work in cubicles, I think mental health is also important. Working in a cubicle means being confined to a drab space without natural light and with limited privacy. I like to think I have a colorful personality, and I like to surround myself with pictures of landscapes and my family. That way my cubicle doesn’t depress me, but feels more like a place I hang out to get some work done.

When starting in a new office, I am always surprised to see how little cubicles are decorated. I usually decorate my space, and afterwards, I find many of my coworkers start to bring in pictures of their family or other decorations as well. It’s nice to see a good trend catch on!

When working in a cubicle, I think it is important to get out and get some natural light at least once a day. I have always found my lunch break works well for this. It feels good to go outside, no matter the weather, to have a break in the feel of the office environment. Even sitting down for a cheap lunch away from the office feels like a nice way to step away from everything momentarily and collect your thoughts.

While the treadmill desk may seem like a clever solution to improving office health, it is reported to have a mixed success rate. I would be surprised if it were any more successful than conventional ways employers encourage better physical health. Although less discussed, employees need to make an effort to keep their mental health in good standing too. Taking regular breaks and finding time to clear your mind can do a lot to increase both your physical and mental health, which in turn should improve your work performance all around.

What is Leverage?

We often hear the term “leverage” in finance, but what is exactly meant by it? Generally speaking, it means to multiply your results by using a limited amount of capital. For example, say you want to purchase an office building for $1 million, but you only have $250,000. You can leverage your $250,000 by obtaining a $750,000 loan, therefore, having enough money to buy the building. Thus, in finance, leverage typically means assuming some amount of debt!

How we assess leverage is different depending on the situation. In business lending, typically loans are either commercial real estate (like an office building), or something unrelated to real estate (like a line of credit). With real estate, we measure leverage with a loan-to-value (LTV) ratio. For example, many home loans are done with 20% to 5% down payments, resulting in 80%-95% LTV.  Now that is high leverage! In commercial real estate, we try to cap most projects at an LTV of 75%.

For non-real estate transactions, we focus more on the business’s balance sheet. We like to compare the net worth of the company to the total amount of loans and bills due; or in other words, their total liabilities. We again look at this as a ratio of debt-to-net worth. This tells us how much capital is funding the company compared to how much comes from borrowings. Say a company has $5 in net worth and $2 in debt. Their total assets will equal $7, most of which is funded by the company’s own capital. The debt-to-net worth ratio is 2/5 = 0.40x.  We consider that low leverage. Now assume that same company goes out and borrows $8 to buy new equipment, and net worth stays the same. Now the combined debt comes to $10, and the debt-to-net worth ratio is 10/5 = 2.00x. We consider that high leverage, since they have to virtually borrow $2 for every $1 in capital!

How much leverage real estate or a company can assume largely depends on details. Like we saw, residential real estate can have higher leverage than commercial real estate. Companies that require a lot of equipment and fixed assets generally do better with low leverage; whereas, contractors and service providers can operate more successfully with higher leverage.

You might be surprised to find that banks and credit unions are very highly leveraged companies. Most of them have roughly $10 in liabilities for every $1 in capital. That is a debt-to-net worth ratio of 10.00x. This is why failing to get paid on loans quickly leads to failure. Consider capital of $1 and liabilities of $10 equals $11 in assets, and if only $1 in loan assets goes bad, then the institution has run out of capital and the regulators will shut it down!

Hopefully, you understand by now that leverage is a double-edged sword. It helps people and businesses do more with limited capital, but assuming that leverage makes problems more serious if they occur. Where regulators and the government feel they should draw the line on the maximum acceptable leverage for everyone is a matter of constant debate, as well as whether they should have the right to make that decision at all.

Structuring a Winning Bonus Program

My position allows me the opportunity to interact with many different credit unions throughout multiple states.  On several occasions, I have been asked my thoughts about how to structure a bonus or incentive plan for front-line staff and lenders.  I also have been able to learn which bonus programs work well and which have characteristics that are absolute failures.  It is valuable to identify those failures first in order to avoid those errors when creating a successful bonus program.

If you have a plan that totally changes every couple of months, you may end up with a bonus program failure.  One bank where I worked would literally changed the entire program every quarter, yet they based bonuses on annual measurements.  The program became a joke as none of the front line people took it seriously and it caused some to go to a place that was not so volatile in its decisions.

If you have a program that is more complicated than a Rube Goldberg machine, you may have a bonus program failure.  I have seen CUs that have spent incredible amounts of HR time to track and manage bonus programs that are more complex than most Federal regulations.  I have also seen management spend hours on end every month to explain to front line staff how their performance is or is not measuring up.  If you cannot explain how your employee is performing compared to the program thresholds within 10 minutes, your program is too complex.

If you have a program based upon what everyone else in your market does, you may have a bonus program failure.  Any bonus program needs to start with a definition of your sales culture, your institutions goals, and your CUs current position.  The bank or CU down the street is different than you, so the plans should be different.  One way this principal is handled correctly was at a bank I worked for that determined they needed more deposits to eliminate the higher cost of borrowing funds from the bank holding company.  So, one year, they actually gave bonuses on increases in deposit accounts.  One place it is not working is with an institution that desperately wants good loans to increase the yield over alternative investments.  Yet, they have no program in place to reward good lenders.

If you have a plan based upon activity rather than real accomplishment, you may have a bonus program failure.  Another program I took part in had a sales call threshold component.  And, yet another one had a threshold of a certain number of loans, not dollar volume, but number.  Neither of these are beneficial as they encourage behaviors to gain bonuses that may not be in the best interest of the CU.  If you have to incent front line people to make calls when their position inherently requires them to do so, you have the wrong people.  If you reward someone who makes twenty $10K loans for cars and avoid giving a bonus to the employee who does a single $1MM loan with a higher margin, there is a problem.

If you have a program where either the employer or employee thinks they are getting screwed, you may have a bonus program failure.  If management thinks they are not getting more out of the employees’ accomplishments from the bonus program than they are paying out, that could be the sign of a problem.  On the other hand, if you have high employee turnover due to the bonus program, and if you have an attitude of leaders of “how much more can we get out of them and not have to pay them,” you have a problem.  Leaders who have that attitude and distrust for their people are manipulators.  Any great accomplishments of their CU will be reached in spite of them, instead of because of them.

If you have a program for one department that is in opposition to the overall goals of the CUs or negative impacts another department, you may have a bonus program failure.  One bank had a big push for treasury management services and decided to incent front line staff for setting up TM appointments.  This resulted the TM department seeing a lot of people, with over 90% not being a good fit for their products.  The additional work also prohibited TM from taking care of their existing customer base adequately. 

If you have a program that the front line has figured out how to “game the system”, you may have a bonus program failure.  One bank had a program to pay commission on sales of credit life and GAP coverage.  The payment was made early after month end, while customers had a 60 day window to cancel coverage if they wanted and receive a full refund.  Some front line people would add on the product to get the commission, only to have the customer cancel it after the commission was paid. 

So if these are signs of problems, what factors are indications of successful programs?  One CU started with defining their desired relationship-based sales culture, complete with goals of what they wanted to accomplish.  They created a two tier bonus system with incentives split between individual and team performance.  They took out any minimum thresholds on any categories which showed the employees, “If we win as an institution, we want you to win a little as well.”  They reduced bonuses for poor loans and sloppy work. 

The results? Staff turnover dropped down substantially.  The CU also became one of the fastest growing institutions in the entire state.  Members noticed the new attitude among the employees and encouraged their friends to join.

A good bonus program can help identify and reward the actions and results you want for your shop.  Poor ones will lead a company to grind through employees, encourage strife between departments, and cause a company to preform beneath its potential.  Where is your CU at?

Rules of Thumb

While generally, I’m skeptical of “rules of thumb,” sometimes they do bear out as reasonable. Notably, most of the “rules of thumb” I use show the assumptions are generally correct after ample research and publications show a regression to a mean, or after years of work experience seem to also show a regression to a mean.

Real estate operating expenses tend to be an area where rules of thumb are particularly useful. You may have noticed or read that the operating expense for multifamily housing tends to start out at 30%-35% of gross revenue, and over time migrate to 40%-45%. For midscale hotels, that operating expense tends to be 70%. For full service hotels, the operating expense is generally 75%. If borrowers are using lower operating expenses, then in all likelihood they are underestimating the cost of operating the property.

Another interesting heuristic that comes to bear in the underwriting world is the debt-to-net worth ratio in Commercial/Industrial loans. Generally speaking, we don’t like to see debt-to-net worth greater than 3.00x for contractors or service providers, and we like to see the same ratio remain less than 1.50x for capital intensive industries.  Why do contractors differ from a capital intensive operation? A contractor’s balance sheet will be primarily receivables and payables, most of which will be satisfied within 30-90 days. Therefore, they can deleverage rapidly. However, when net worth is tied up in capital expenditures like equipment and machinery, those assets do not readily convert to cash to satisfy liabilities on the other side of the balance sheet. Therefore, their leverage is more permanent, suggesting we want to see less leverage from them overall.

Another rule of thumb in Commercial Real Estate lending has to do with leverage and collateral values. The less marketable real estate may be, the lower loan-to-value (LTV) you will find. For example, there is always a need for multifamily housing in a healthy community, so the property will always have interested investors. The LTV of these properties might be as acceptably high as 80%. Office and retail properties may be a bit less marketable, so we ratchet our LTV back to 75%. Perhaps industrial properties are even a little less marketable, because they come in an odd variety of shapes and inconsistent build-outs, so we take the LTV back to 70%. Then we have “special purpose properties,” which can only be used for narrowly specified purposes without significant investment to change those characteristics, like a medical office, private school, or restaurant. We may bring our LTV back to 65% in those cases.

Having these industry benchmarks in your back pocket makes you more powerful in the business lending world, because you can more quickly identify potential problems or get a grasp of the proper credit structure immediately. And of course, if a proposed loan does not conform rigidly to these rules, there may be a good reason to make an exception. However, there should be a strong mitigating reason to make an exception, as exceptions should not be granted simply to provide a reason to book the loan!

Selling From the Front Porch : When a Low Price is Scary

This is another part from a series of stories from my childhood that in reflecting back, formed most of my foundation for sales and leadership.  Most of these occurred on the front porch of the back deck of the houses of my relatives.  Today was a little different as we are in my uncle’s garage.

A severe Missouri thunderstorm spanned the sky.  Since my uncle’s porch was not covered, we moved into the cover of his garage.  I always enjoyed the garage with all the various tools and machinery.  He also had a large mounted caribou over the deep freeze. 

Lightning bolts were thrown from the sky to the ground, followed by cannon-like thunder.  Sheets of rain poured as we watched a funnel cloud in the distance.  If you have ever experienced seeing a tornado, it is mesmerizing.  The discussion this day revolved around the weather and tractors.

My uncle Allen had just purchased a 2240 John Deere tractor.  It was a beauty with a raw 55 horsepower of power that can handle any kind of work around a small farm.  My dad asked about the price and how it compared to other tractors he shopped for.  We were surprised to learn it was one of the more expensive of the ones on his short list and was several thousand more than the cheapest one, a Ford.

Now don’t get me wrong, anyone in my family enjoys a bargain more than most people you will find.  Whenever I go visit my dad, who does not drive, one of the activities he always wants me to do for him is to take him to the Wal-Mart.  My family is also a regular at auctions and flea markets.

So my next lesson in sales began when Allen said, “Yeah, the Ford was the cheapest.  But I just don’t believe their tractor is reliable.” 

Allen went on to explain the problems his dad had with an old Ford tractor and all the various repair work he had to do on it.  When he told the sales person at the local Ford implement dealer the problems he saw in the past, the first response the salesman had was to gloss over his concerns and offer a lower price.  The salesman committed a cardinal sin of not listening to the client and expecting that a lower price would win him the sale. 

Years later, when I was running a branch of a Savings and Loan in my hometown, a local Realtor told me he had great success in selling property after he had raised the price of the house.  “Sometimes, when something appears too cheap, it won’t sell.  A higher price helps to create excitement for the property,” he said. 

Now don’t get me wrong.  Price is a huge issue.  But the larger issue revolves around a sale being an emotional transaction as much as a mental one.  The buyer needs to feel he is receiving more in value than what he is giving in payment.  That is the definition of a bargain.  Everyone likes bargains.

So in the garage that stormy day, Allen described the reliability of the John Deere and how this would save him repair and down time in the long run.  This would allow him to finish jobs on the farm quicker and get to his occupation as a carpenter.  The biggest cost to Allen was time.  “God only gives you so much time on this earth.  You better use it wisely,” he would say.

He also went on to describe how the John Deere salesman listened to his concerns and suggested a different model that had more horsepower than the original one he wanted.  Allen trusted in the salesman and that is why he got the sale over the other implement dealers in the area.  Jeffrey Gitomer writes, “Being the least expensive won’t get you anywhere if the prospect has no confidence to buy.  Many times, low price actually scares the buyer.”

Yet it surprises me how many times a salesman will respond to the initial objection with a lowering of their price.  This communicates a message that your services or product is of lower value than the price you put on it.  If your strategy is to be a Wal-Mart, the low price leader in your area, you still need to have your customers feel as though they receive more value than what they give their hard earned money for.  Most of our companies do not desire to be the low price leader, so providing value is the key. 

The next time you are confronted with a price objection, find out what the true problem is and speak to that problem. Counter with value. People will pay a little more if they believe they are better being with you than with your competition.

Why People Don't Make Optimal Decisions

I recently read a book by the Nobel Prize winner Daniel Kahneman. He won the Noble Prize in Economics, although he is a psychologist. Kahneman pointed out that economic theories often assume people act rationally and make the most optimal decisions to benefit themselves. However, Kahneman showed through several psychological examples that people often do not make these rational decisions. Why is that?

Kahneman explains people have the capacity to think in two primary ways. People have an automatic, intuitive way of thinking which immediately processes the world around us. Examples of this include your ability to walk, avoid simple objects, or complete any task with minimal mental effort.

The second way in which people think is more what we consider “deep thought.” Examples of this type of thinking might include solving challenging math problems, examining statistics, or really any task that will require your undivided attention.

This is important to know, because Kahneman shows people don’t typically engage their “deep thought” process when making decisions, which is necessary for people to make rational optimal decisions. Rather, people often use their intuitive thinking process, which is wired to help us with basic survival but not designed to help us balance complicated decisions that involve weighing several facts and statistics.

The importance of this is astounding, and it leads to another interesting fact about the human condition. Because people tend to make decisions using their intuitive thought instead of their deep thought, peoples’ decisions tend to have a lot of bias.  The intuitive way of thinking is easily influenced, or “primed” by the environment surrounding it, often without calling on the deep thought process to check facts and verify preconceived notions.

Understanding this is how people are naturally wired can help us make better decisions. When we are ready to make quick decisions at work, we should be reminded how biased those decisions can actually be if we aren’t willing to slow down and engage a deeper thought process. After all, this is the only way the most optimal result will be found.

This knowledge can also be used to improve public policy. Kahneman noted a study that showed organ donation rates are much higher in countries that require people to opt-out of the process, instead of opt-in. Kahneman believes that people have to engage their deep through process to determine whether or not they truly want to be a donor. With people naturally wired to make quick intuitive decisions, they tend not to disagree much with the decision being presented, and don’t want to have to think about opting in or opting out.

Selling from the Front Porch : Listening

“The good Lord gave you two ears and only one mouth.  That should be a lesson for you to listen twice as much as you talk,” said my Aunt Lil after I had butted in and tried to butt into the conversation when I was on the front porch.  Strawberries were being passed around with the homemade vanilla ice cream.  I wanted to talk so much and was not concerned with what others were saying that evening.  My impatience was showing.

Aunt Barbara, the school teacher, commented, “You can never learn while you have your gums constantly flapping.  You have to listen.”  This began another leadership lesson from the front porch on listening.  Now you may think this is an easy one to master, but I still have the problem of using these skills from time to time.  Even earlier today, my wife commented that I was too interested in saying what I wanted to say than allowing her to articulate her thoughts.  I am ashamed to say that I do not have this lesson mastered, and I bet if you were honest, you would have the same failing from time to time.  Sometimes, I half-listen till the other person catches a breath and I can then speak my point that I have been dying to say.

In an earlier post I mentioned Jim, the travelling encyclopedia salesman, who took time to build a relationship with my family members before he was asked for information about his product.  He did not just ask questions to uncover the motivating factors, the hot buttons that would make the prospect buy.  In fact, he started by treating the prospect not as a prospect, but as a person, a friend.  He used his natural curiosity and care for others to guide him into getting to know me and my family.

So how do we go from listening to pick up the hot buttons to make the sale (which I would call “me-centered conversation”) to just listening?  I think you first have to move away from any focus on the sale and spend time hearing what the other person is saying.  Try to avoid the temptation to fix their problem right away; allow them to spend time sharing their life with you.  This is a huge temptation for most guys who seem to be wired to fix things quickly.  Eventually, the time will come when they want your help. 

Asking great questions, ones that bring out more of a response than just a yes or no, can also provide more opportunity for the other person to talk.  Many of these can lead to uncover the emotions and motives of the talker and can be worded in a way to appear that you are not putting the person on the psychiatrist’s couch.  An example is to take, “what scares you?” into “what keeps you awake at night?”  Another may be to turn “what makes you happy?” into “what are the greatest accomplishments in your business?”  These questions help uncover the deep motivating factors in a person’s life.

Eliminating preset agendas from your mind is essential.  One of these may be to sell your product or service or to convince someone of your position on a certain issue.  These all tend to make the listening focused on you, instead of focusing on the person you are listening to.  A preset agenda may also steer your listening to gain the opposite conclusions from what is being said.  One time, on the porch, a salesman came by to sell some cleaning products.  Buying the product would also buy some sort of automatic drop ship for more and a membership into a multi-leveled marketing company where the consumer could earn residuals on other people’s purchases. 

My Aunt Barbara asked, “Is this like Amway?” 

The salesman stiffened, “No, it is nothing like Amway,” he replied.  Clearly the company was set up like Amway and had similar products.  But Amway was getting a bad reputation at the time and was not as popular.

Barbara stated, “That’s too bad.  I like Amway and their products.”  The salesman had a preset agenda in his mind as to the response my aunt would have.  He listened to her through a filter and in doing so, lost a potential sale.

Listening requires a focused attention on the other person.  It requires that you are building a friendship rather than just making a sale.  It requires receiving their words and then serving up the conversation back to them.  It also requires remembering what they said and acting on it at a later date. 

In short, it may not get you the immediate sale, but it can help build the relationship for the long term business relationship.  In my field, sales cycles can extend for years from the time of the introduction to the closing of the first deal.  If the deal is delayed, listening will help make your life richer because of the friends you have made.

Now Interviewing : What Kind of Job Candidate Are You?

My wife and I recently had an interesting overlapping situation with our jobs. My company has been interviewing to fill a position, and my wife had to attend a career fair to represent her company. It probably isn’t surprising we had similar things to talk about, but what was surprising is that we both noticed that job candidates always seemed to fall into the same categories.

The category, which should probably be dreaded the most, is the “I just need a job” category. They really aren’t sure what you do, or what they are even doing there. Really, they are just looking for a way to get paid 9 to 5, and that is their only concern. The interview or conversation almost feels like a speed date. While there isn’t any hurry, it feels like the candidate is there to collect some basic info and is probably trying to weigh it apples to apples to other places they have interviewed or plan on talking to. Towards the end of the interview, they typically announce, “I think I can probably do that.” And, they probably can. But is the bare minimum all they would do?

The second category is the “dine and dash!” Admittedly, I was once in this category. These are typically (but not always) fresh graduates, who are smart and ready to work hard. What is wrong with these candidates? There is a concern that their “five year plan” may not exactly include your company. They are trying to build a skill set, which will give them greater career opportunities in the future. Hopefully, your company can provide those career opportunities, but we all know how the grass always seems greener on the other side. These people can provide years of meaningful contribution to your organization, but can they show enough long-term commitment if a big investment is made in them?

The last category is the “diamond in the rough.” The most rare of the candidates, they are the people you wouldn’t have normally considered for the job, but who surprised you with a set of skills and reasoning that could be retooled or polished up to fit well into your organization. Because you weren’t originally considering their skill set, you likely wanted to interview this person because their personality seemed like it could be a fit. The fact that they have skills that could also be used after a little orientation seems like the icing on the cake.

And lastly, regardless of what category you may find yourself, please keep in mind good manners. Treat your interviewer with respect. Come prepared with a desire to know more about the job, and some examples of how your last position might reflect your ability to do your new job. Wasting your interviewer’s time by not being prepared is not going to leave a good impression. And, follow up by thanking your interviewer for their time. Not only is this common courtesy, but it reminds them you exist and have a genuine interest in the job.

Selling from the Front Porch, an Introduction

“How do you do it?”  asked a branch manager of a regional bank I worked for.  As a commercial field lender, we were to make joint calls with business clients the managers had drummed up.  We had just finished visiting with a business owner who was planning to move his accounts to our bank. 

“Do what?” I asked.

“How do you talk so naturally to business people and get them to tell you everything you want and more?  You also get them to want to move their business,” she asked. 

My mind flashed back several years to my wife who made a comment that she sometimes will cringe at a social event because of the questions I was asking.  “They seem so personal, but for some reason, he gets answers and even more of what he has asked.  He is kind of like a financial priest.”

Now I am nowhere near that good, but I do have the ability to get folks to open up and talk about their business.  I began to wonder where I learned these skills.  It was not until a trip back to my home town in Missouri, that I realized where I began to learn sales skills and leadership.

It was on the front porch!

I had several relatives who had large front porches, back decks, or flat areas outside of their house where they would gather to visit.  My folks would often take me out in the country to one of my kinfolks’ houses in the summer.  We would pick beans or corn from the garden, go inside for supper, and retire outside to snap beans or shuck corn.  We would plop down in some of the finest metal and mesh lawn chairs known to man.  If you were lucky, you could get on the porch swing and play with the dogs.  Cold iced tea and homemade ice cream were usually present.  We would watch the lightening bugs come up and share life together.  As I grew older, I added fine BBQ and other beverages to these events. 

The lessons I learned on the front porch formed the basis for all my leadership training.  I just never realized it at the time. 

As we sat outside on the porch or the cool grass surrounding it, we would often have neighbors drive up and stop to visit.  In those days, we would also have traveling salesmen who would come over to sell gasoline for the tractors, crop insurance, cleaning products, Girl Scout cookies, and Boy Scout popcorn.  The majority of the time, with the exception of the kids, the salesmen walked away empty handed after they had used their entire lung capacity to fill our ears with the benefits of their product for a half hour or so. 

There was one salesman who stood out among the rest, Jim.  Jim sold encyclopedias.  This was a very expensive investment, but an important one to my aunt, the school teacher, who had a very smart son.  I remember the day he pulled up his car into Uncle Allen’s driveway and sauntered up to the porch where we were working through a big batch of peas and green beans.  Jim came up with nothing in his hands, something rare for a salesman.  “Mind if I help?” he asked. 

“Sure,” my aunt Barbara replied, “plop down in that chair.”  And from the rest of the afternoon till darkness set in he helped the rest of us with our vegetables, enjoyed some tea and ice cream, and listened.  We also learned that Jim was new to the area, what his family was like, and how he was out to meet folks and make some new friends.  It was a good hour or more into the conversation when Allen asked Jim what he did for a living and we learned Jim sold books and encyclopedias.  Jim gave enough information to answer the question and then skillfully served the discussion back up to the others on the porch.  After three hours or so, when it was getting dark, Jim excused himself and drove off.  He never once got out one of the volumes of the encyclopedias or discussed features and prices.  He just came up on the porch and shared life.

He continued to do that off and on.  It was not until the 3rd or 4th meeting that Aunt Barbara asked to see the encyclopedias.  Jim continued to stop by the porch and visit.  Eventually at the end of the summer, my cousin Ken had a big set of encyclopedias with a ten-year subscription to the annual update.  Not only that, but several other neighbors purchased sets for their kids as well.   These were other people who had dropped by the porch from time to time or people who my aunt and uncle had recommended their friend Jim to drop by and see. 

So what was Jim’s keys to success?  He took a genuine interest in people.  His questions were not just aimed at figuring out the hot button the prospect had and then just pushing it.  He asked questions and then listened.  My wife always tells our kids, “People don’t care how much you know, until they know how much you care.”

Jim also made friends and not just for the sake of the sale.  He continued to drop by occasionally and would receive introductions into other folks and recommendations for his product.  He built a network of friends over time.  Jeffrey Gitomer says, “Your ability to build a successful network is tied to your determination and dedication to take whatever time is necessary to build quality relationships.  And you’re lucky—the outcome of your success if totally self-determined.” 

Jim also followed the Golden Rule, “Treat others the way you want to be treated.”  One time, way after the initial sale was made, he was asked why he was different than the high pressured salesman we so typically saw.  “I just stopped and thought how I would want to be treated if I were the buyer.  Then I treat folks that way,” he replied.

This was one of the basis of leadership and sales, which involve the same skill of influencing someone.  So if you want to learn more, come up to the front porch with me.

Why We Don't Audit the Fed

For those who are not aware, we have a central bank in the US, which we call the Federal Reserve System. The central bank in any country is primarily charged with regulating currency, the money supply, and interest rates. Our Federal Reserve System (or simply known as “the Fed”) has the specific objective to carryout policies to promote maximum sustainable employment and price stability. That is fancy talk for keeping unemployment low and controlling inflation.

Libertarians like Rand Paul constantly call for auditing the Fed. While it sounds unbelievable that we don’t audit our central bank, you need to step back and consider what is meant by the word audit. First of all, the financial statements of the Fed are audited! An independent accounting firm does sample accounts, make sure the books balance, and make sure proper division of control is in place.

So what does Paul mean when he suggests the Fed isn’t being audited? An audit can be more than simply bookkeeping and internal controls. An audit can also be done on a bank or credit union’s policies. If you have a policy to limit loan-to-value to 75%, then that policy can be checked to make sure your loans are not exceeding 75% of appraised value. But what policies does Paul want to audit?

Paul is not quite clear on what he wants audited, but it is presumed to be the policies of controlling inflation and keeping unemployment low. The challenge is, who other than the Fed is in a position to say whether the Fed is doing a good job with this? The effectiveness of the policies are not clear cut, and they aren’t as easy to check as say, a loan-to-value policy.

The independence of the Fed is of far greater concern. Politicians will always want to see unemployment as low as possible at any cost. A principle you should understand in macroeconomics is unemployment and inflation are inversely related. In other words, it is tough to have very low unemployment without having high inflation. The Fed needs to balance the two opposing forces. If the Fed isn’t left alone to balance the scale, the fear is the politicians will always be pushing down too hard on unemployment, at the cost of hard-to-control inflation in the future.

Furthermore, our entire money supply and economy will then be at the mercy of whichever party is in power. The objective of the Fed would likely be different, depending on whether Democrats or Republicans control significant parts of government. Our fiscal policy is already a mess, because these two parties cannot effectively work together. Could you imagine if our monetary policy and money supply were subjected to the same gridlock and tampering?

While auditing the Fed sounds logical in theory, it is important to keep in mind that it already is audited! The financial statements and internal controls are audited! The suggestion that the Fed is not audited comes from the opinion that the Fed’s actions and behaviors should have greater government oversight. Presently, the Fed can make decisions about interest rates and controlling inflation without Congress looking over their shoulder, and many argue this independence is what makes the Fed a stable and trusted institution.

Preparing Future Leaders

I just finished a trip visiting several credit unions in western North Dakota and eastern Montana.  My travels had me in communities all the way north at the Canadian border and all the way south to the Montana-Wyoming state line.  All of these small towns are rural.  When you are in one town in particular, you are the farthest away from a Starbucks that you can get, but the local coffee shop was great! 

Most of the counties are experiencing a drop in population.  There are some larger communities and also some areas closer to the Bakken Oil Formation that do have more people.  But all institutions are challenged with attracting, training, and retaining good people.  This leads to yet another challenge, building good leaders for the future growth of the institution.

It was encouraging at one credit union in particular, to find a very capable CEO in her 30s.  Most did have other key people in leadership positions and some on their board who are younger.  But I could also see some who seem to be run almost entirely by those who are older.  Now don’t get me wrong here.  I think there is a wealth of learning that can be gained from those who are older and they must play an important role in the leadership of your CU.  At the same time, you must be developing young leaders who will lead your institution into the future. 

I am reminded of a call I received over two years ago from a board chair of a rural institution.  The gentleman was in a real pickle, the institution had relied upon one individual and now that person could not lead due to some sudden health complications.  The business had not trained up leaders to replace him.  Eventually, the CU merged with another one.  In order to avoid this at your business, it requires the constant development of new leaders.  This requires three things.

First, existing leaders need to identify future leaders and recognize leadership characteristics that they currently have and need to develop.  Leadership is not a destination, it is a daily journey.  Letting the younger folks know that you see them as leaders will go miles for their self-image and also begin to give them an attitude of ownership for your company.  I always say the best employees are those who do not really work for you, they work for themselves.  Those people will always carry out their duties with a higher standard of care as they have ownership of their work.

Next, invest constantly in future leaders.  Find out what qualities the young person needs to be able to sit in your chair in the future.  Some of this will involve technical knowledge.  In our field, this would involve everything from analyzing a loan request, preparing and closing a loan, and finally, servicing that credit through its life.  But technical items may only make up 15-20% at best of what needs to be taught.  Invest time in teaching leadership, attitude, sales skills, and working with people.  These skills are needed most to succeed.  They are also the most overlooked. 

Allow your future leader to influence your organization in areas.  Influence is leadership.  Let them begin to lead in smaller projects and tasks.  Also, if they have great ideas that will make your CU to grow positively, allow them to provide leadership for your culture.  As they see they are actually making a difference, it will prepare them for future leadership at your shop.

As a leader, are you showing them an example of the daily discipline necessary to develop your leadership?  Remember leadership is still a journey, never a destination.  You will always have to learn.  It’s like my Aunt Lil said, “Once you think you have ripened, the next step is you begin to rot!”  If you think you are sitting in the chair of leadership and have nothing else to learn, think again!

Carryover Debt in Agriculture

Business lending is an activity that requires thorough training and experience, and in this process, lenders will learn each lending type carries with it a different set of best practices. Simply put, you cannot hold a hotel operator to the same performance measures as say a farmer, rancher, or a car dealership.

Agricultural loans are probably some of the most complicated lending to take-up.  The asset conversion cycle for agriculture varies greatly, depending on the operation in question. Winter wheat is planted in the fall and harvested in the spring. Spring wheat is planted in the spring and harvested in the fall. A rancher will have calves birth in the spring and may sell them in the fall. He may not sell all those calves, keeping some back to feed until a heavier weight to sell at a later date, or he may keep some cattle to build his herd.

How are lenders supposed to get their arms around these requests? Communication is key. A good ag loan file will have detailed notes, explaining what each operating draw was for, and what each operator’s plan is going forward. The importance of this cannot be overstated, because an operator may see it in their best interest not to sell their harvest or cattle when you may expect. They may find it beneficial to wait until market conditions improve, or they may have other plans.

When a farmer or rancher has borrowed money to fund their operation, but they delay selling their crops or livestock, they will find themselves in a position of having carryover debt. Unlike other lending types, this is generally permissible. While this may seem unusual, we must consider the nature of the assets and credit administration in agriculture.

Crop inventory does not become obsolete. While its market value is constantly changing, it can be delivered to market years after it has been harvested. Cattle arguably have the same qualities if they are used for breeding, but must be delivered to market after a certain period if they will not be used for breeding. Still, cattle share another important quality with crops, which is they are a liquid asset. For these reasons, it is acceptable if carryover debt exists, so long as regular farm inspections are completed and communication is kept current, demonstrating the assets are still on hand and being appropriately managed.

While not desirable, a producer and his/her lender may find themselves in a position where they have carryover debt, but lack adequate amounts of crops and cattle to pay the debt off immediately. In this case, it is necessary to term out the debt. If fixed assets, like machinery and breeding livestock, are used as collateral, then the debt should probably be termed out between 3-7 years. If farm ground is used as collateral, then mortgage financing could justify terming the debt out 20 years like any mortgage debt.

The key idea is carryover debt should not immediately be classified as substandard credit. If collateral exists and leverage is not out of control, it is simply working capital that needs to be regularly inspected or termed out. Again, this is unique to agriculture. This is not like financing inventory and finding yourself in a situation where the inventory is useless, or like financing a contractor who manages to collect receivables but not payoff his line of credit. The financed assets are different and credit administration is different, indicating a different approach to risk management is necessary.