The Changing Face of Retail Employment

This weekend, my wife and I made a trip to Sam’s Club for some supplies.  The place was a mad house with every cash register line backed up at least 5 people deep.  Shoppers were at a crawling pace through the store as it was packed with people.  I suppose the weekend before Thanksgiving was bringing out everyone.  Once we saw the crowd, we immediately were tempted to just turn around and leave.

But my wife, in her brilliance, suggested I pull out my smartphone and set up the Sam’s Club Scan & Go app.  So I found a quiet spot near the jewelry counter and loaded all my info into the app.  As we travelled through the rows, we scanned each item that we put into the cart.   So it was finally time to check out and I loaded in my payment information into the app in the chip aisle.  A clerk scanned my smartphone on the way out and we were on our way.  The entire trip took 20 minutes and I could have knocked off another 5 minutes if I had already set up the app before we went.

A story on the CBS local news in the San Francisco Bay area reports that Lowe’s is introducing 22 Lo Bots, a robot that roams the aisles and will show customers where items are located.  The Lo Bot is bilingual and communicates with the store’s central computer to locate items.  It then uses a series of lasers and cameras to navigate and then takes you right up to the item.  

A really neat item that comes with Amazon Prime is the Amazon Dash Button.  This is a little 1”x3” device that can be adhered to an object and pushed when you want to order a frequently used domestic product like laundry soap or paper towels.  We have one for Izzies, a sparkling juice drink that my family enjoys.  You push the button and two days later a box shows up on the front porch with Izzies!  I can see how this one can be very dangerous to shows with small kids in the household!

All three of these are examples of how retail is changing before our eyes.  We will see this in the next week as more people shop on Cyber Monday than Black Friday.  Personally, I rather enjoy any method that allows me to complete the shopping errand quicker, giving me more time for other things.  

There is also quite a benefit of savings to the retailers.  Dr. Bill Hardgrave, dean of Auburn University’s business school, says the RFID technology--the tagging of products so they can be tracked, and the most well-known example of the new “Internet of Things” technology—is a huge benefit for retailers.  With RFID tags, retailers can expect 99% inventory accuracy, a 70% reduction in shrinkage, and a 2% to 7% increase in sales.  Self-service checkout machines, automated stacking of shelves, and changing of price tags are also on the rise.  

In each case here, technology is changing the retail landscape.  We see that every day when you go to the store.  The checkouts at the grocery store we usually frequent shrank from 12 checkout lanes down to 8 that are manned and another 9 that are self-service with a station for one employee to oversee.  So this allows the store to hire 3 less clerks and they can check out more people quicker as they now have 17 lanes.  

In each case listed above, technology is making it easier and quicker to purchase items.  It is also providing savings for the store owner.  But one factor to consider is how these changes, which no one will be able to slow down, will continue to impact employment.  Technology is allowing for changes in buying habits which will lessen the need for employees and make those who remain in retail more efficient.  I thought that the employees who wore the t-shirts touting the Sam’s Scan & Go may not be realizing they are advertising for customers to not use them and thus may be working their way out of a job.

So the question is how will the employment landscape change over the next decade?  What jobs do we have now that will become as rare as a blacksmith or a buggy whip manufacturer?  How will this impact people both on the consuming side and also the workers in this industry?  What jobs will open up in the future that are not prevalent now which people will gravitate to?

I sure don’t have any answers here, I am just pointing out the questions.

This week also marks Thanksgiving, a special holiday in our country that was originally set aside to be thankful to God in remembering our blessings.  We, at Pactola, are humbly thankful for the relationships we have with each of you.  We are thankful for the businesses we have been allowed to help fund that have helped better your communities with more jobs and economic activity.   We are also thankful that you have allowed us to help make you better.  Best wishes for a new year filled with warm and cherished memories.

The Impact of Uncertainty

My job, as an analyst, is try and construct a reasonable projection of the future. I do this by looking at historical events and by looking at prevailing market conditions. One thing I cannot effectively model is uncertainty. I can create space for uncertainty through “sensitivity testing,” but it is a fool’s errand to try and predict when and how uncertainty will happen. Uncertainty naturally worries people who need to lock in decisions now regardless of what the future holds, so any change from the expected leads to a new set of winners and losers. 

The result of the last presidential election introduced and enormous amount of uncertainty in the business community, and the results have been fascinating. The recent election will be studied heavily for decades to come because of the large difference between what polling was suggesting and what actually occurred. Nearly all polling organizations predicted Clinton would win the election, and thus many organizations planned accordingly. Clinton, who seemed to bill herself mostly as the continuation of the Obama administration, would have likely resulted in more of the same things we’ve experienced in the past 7 years. Most of this time could be described as steady, yet subdued growth, resulting from gridlock in Congress and the Fed having no more policy tools. Compare this to Trump, which nobody was really sure what to expect. 

Then, on election night, shock rang through markets when it was becoming increasingly clear that Trump could, and would, win the election. At one point, the Dow Jones Index experienced a drop in the futures markets by over 750 points, which is over 4% of the total market value. This drop wasn’t because of fear of what Trump would do as president, but rather because nobody had expected him to become president, and so nobody had time to process what this could mean. As it turns out, over a week after the election, the stock market experienced an enormous rally, with the Dow Jones now only a hair below its record high. Interest rates are also seeing a significant jump as well. The 5-year US Treasury rate was 1.34% when Clinton was expected to win the election, and as of 11/17 the rate closed at 1.73%, which represents a 30% increase! 

There is definitely a lot of uncertainty out there. The increases in the stock market may suggest that business conditions may be improving. But, the wide swing in interest rates could indicate growth, yet fears of inflation too. Another interesting aspect of this election is that the Republican party gained majorities in both houses of Congress as well. This was also unexpected from polling before the election, and it is too early to predict what changes this will bring in fiscal policy. 

Personally, I think this only reflects what will become a growing trend in uncertainty going forward. In 2013, the number of registered American voters who consider themselves as independent reached a record high of 42%. One can assume that Democrats and Republicans very roughly split the remainder, giving each party roughly 29%. This means when either party controls both Congress and the Presidency, then 29% of the population is calling the shots for the other 71%. And as control switches back and forth, there will be inevitable turmoil from swinging from one extreme to the other. The American electorate may not be as divided the media portrays, but those who control the levers of power are probably more widely divided than what we actually see. I would interpret this as a lot of uncertainty that does not lend itself to many predictions.

Budgeting : A Failure to Plan is a Plan to Fail

This weekend, I had the wonderful task of creating the budget for our company.  I must admit, this is not a task I enjoy, especially after I missed the mark so bad when I created the budget for last year.  Sometimes, I think this task is best accomplished by a lot of blind guessing.  There are so many variables one cannot foresee when creating projections. 

But there is certainly value in the budgeting exercise.  Comparison actual numbers with the projection helps to see where there are areas of missed opportunities, and also those where you exceeded your best expectations.  This may help to see where resources may be best deployed for optimal performance. 

Budgeting involves more than just the financials, it also involves calendar planning.  One of our missions is to make as many friends with CUs as we can.  The more CUs we work with, the more buyers there are for loans participations, the more opportunities we have for new loans, and the more opportunities we have to serve the industry.  For us, meeting CUs means planned visits to a lot of national and state league meetings.  It also means personal visits with various CUs around the country.  This all involves a bit of calendar planning. 

Budgeting also involves planning resource needs.  This can include any fixed asset purchases and capital expenditures that are required for the continued needs and growth of the business.  Everything from equipment, furniture, office space, technological resources, and real estate should be reviewed as a budget is created. 

Budgeting requires a review of outside resources that are required for the company.  One item I realized when creating this year’s budget was the need to have our logo trademarked and the legal fees that would be required to do that.  I have been on the other end of accidentally using a log that was too close to one that was trademarked.  So, obtaining a trademark which required costs for a patent and trademark attorney and fees to the US Patent and Trademark Office was required.  Other outside resources you will encounter other than legal fees may be accounting and auditing fees, costs for strategic planning, and educational expenses for your staff.

The budget process will also require a look at your team and assess where additional staff or development for existing staff are needed.  This requires more than just money; it also will require time.  Finding options to develop your team individually and also as a group is essential. 

You may have head that a failure to plan is a plan to fail.  I believe that is true.  Planning requires not only the large budgetary process, but also smaller plans that cover various tasks that may take a few weeks of months to complete.  Planning may involve longer terms than the budgetary year.  I once worked with a large construction company that worked on projects that were to begin 5-10 years in the future.  This required a rather long term view of planning that then drilled down to the annual numbers. 

Another saying is that if you do not set a target and then just shoot, you will always hit your goal each time.  That is true if you have nothing to aim at.   Budgeting begins with your goals and then finding what resources you have and need to accomplish those.

Once you have budgeted several times, you realize that when you really nail it on the head, there is still quite a bit of other factors that had to go right that were outside your control.  There is no sense to become over-confident.  If you miss the mark by a wide margin, you need to have the ability to assess where things went awry and how to create the next budget, keeping in mind your present condition and reality.  Overall, I find this process to be humbling.

Keys to SBA Prospecting

So you have decided to add U.S. Small Business Administration (SBA) loans to your financial institution’s loan portfolio.  The SBA program provides a nice way to help mitigate some of the risk that is found in some commercial loans.  The risk is lowered with the guarantee provided by the federal government.  So this should allow you to become involved in more loans and expand your loan portfolio.

But how do you go about finding good SBA prospects?  There are several strategies you should follow to avoid the bad loans and find the good opportunities.  We will first focus on what to not do.

Thou shalt not chase after every business start-up.  An article in Forbes in January 2015 claims that 9 out of 10 business start-ups fail.  An article in Inc. later that year cites that 96% of new businesses fail within 10 years.  So new start-ups have between a 4-10% chance of still being around in ten years depending upon which article you believe.  Most business loans are amortized over a longer period than 10 years so be aware of the very slim success ratio which will mean to be prepared to take losses.  All start-ups should have strong capitalization and management experience.

Thou shalt not lend to a borrower that is not willing to put equity into a project.  The SBA is not to alleviate prudent equity injections required for a business lending project.  In fact, equity is a requirement.  If you cannot trace the equity to hard cash or true equity in assets, and the borrower is not willing to put his stake into the project, walk away.

Thou shalt not just focus on the small deal.  The average SBA loan in 2015 was $371,628.  Many institutions turn their SBA ammo on only the smaller deal.  But with the ceiling of a 7a SBA loan at $5,000,000, it makes sense to look at larger financing opportunities to use for the program.

Thou shalt avoid refinance opportunities.  Refinancing under SBA has quite a few additional rules that must be followed.  SBA is not a solution for refinancing debt for companies with bad operating performance.  It can be used to help refinance debt that has an upcoming balloon, or can provide a payment savings of 10% or more. 

Thou shalt avoid borrowers with prior losses to the U.S. Government, poor personal credit, and poor personal character.  SBA is never to be used for a mitigant for these situations.  You still need to maintain your standards for a SBA loan as you would on a non-SBA loan. 

Thou shalt not attempt to use SBA for non-owner occupied real estate, non-profit, SBA restricted industries, or credit card refinance. 

Thou shalt focus on good, well-run, small- to medium-sized businesses. Just because a business is a good performer does not mean that it is too good for the SBA.  Many times these well-run companies are perfect for a SBA as they grow and need to take their company to the next level.  Don’t just focus on the high-risk company that is a marginal player.  Remember, the SBA provides a guarantee on a portion of the note, so you will have to accept a loss as well. 

Thou shalt focus on business expansions, real estate, and equipment.  SBA is not just for the unsecured operating line.  It works best when there is an existing, well-run business, that is seeking to rise to the next level.  This expansion may require a new facility, equipment purchase, or building expansion. 

Thou shalt look for buyouts that make sense.  SBA is a good tool for a business buyout financing, as it helps lower the risk to you.  Good areas to focus on are professional companies that have an ongoing client list such as a doctor, dentist, or veterinarian.  In many cases, the SBA provides a method that the young professional can take over an existing clinic as they build up their business.  Make sure there is adequate equity that the buyer is putting into the project and there also may be a requirement the seller carry back some of the goodwill in a subordinate financing. 

Thou shalt consider SBA when looking at restricted industries to your loan policy.  If you have restrictions on hotels, restaurants, or contractors, using the SBA guarantee may help you provide financing to a good lending opportunity within those industries. 

Thou shalt contact Pactola for help.  When you have a SBA opportunity, contact us.  We have several credit unions that use us as a Lender Service Provider with the SBA.  We can help walk you through the process.

Yield Curve 101

Working at a credit union, you are well aware of how an interest rate can be different for each person based on their credit score. A person with a bad credit score will be expected to pay higher interest rates to try and compensate for the risk of lending to them. And of course, people with the best credit scores get the lowest rates. But have you ever thought that there are other factors that can impact the interest rate?

You know that home loan rates differ from auto rates. And, unsecured loans or personal loans can have very high rates. That is because the type of underlying collateral (or lack thereof) drives the risk of lending too. Another thing you may have not considered is the term of a loan also affects whether a rate will be higher or lower. This is because of uncertainty. If we make a loan for 15 years, we don’t know if someone will continue to have the same ability to pay for all of those 15 years into the future. So, the longer we make a loan for, the more risk we need to price into the interest rate, and generally the interest rate will be higher.

Long-term loans also present a unique risk to the credit union in terms of interest rate risk. If a credit union makes a loan for 15 years, and then interest rates move up, the money in that 15-year loan will be stuck receiving a lower interest rate until the loan pays off.  The credit union then loses out on the chase to make money at a higher interest rate.

This opportunity cost of being stuck with a lower interest rate into the future is something studied heavily in finance. We can actually map out what interest rates look like from today, if we make a short-term loan or a long-term loan. This graph is typically referred to as the Yield Curve. And as you might expect, the longer the interest is fixed for, the higher the rate usually is. Below, you will see a graph I have made using interest rates from 2005, 2007 and 2016.

As you can see, the interest rates for all of 2016 have pretty much followed a similar pattern. The line on the very top of the 2016 bundle is actually our current yield curve for the end of October 2016. The yield curve for May 2005 (when I graduated college) has a similar shape, but is notably adjusted considerably higher than current rates. So overall, in the past 11 years, rates have come down considerably. And lastly, the 2007 yield curve actually slopes downwards. Why is that?!

What is particularly fascinating about the yield curve is that it can be a predictor for the economy too. If investors suspect a recession is about to occur, they expect the Fed will lower rates, thus we will see lower rates in the future. This will cause the yield curve to actually slope downwards or flatten out. Clearly, in 2007, investors expected a recession, which surely followed in 2008.

You can likely assume the opposite is true, which is when the yield curve slopes upwards, investors are more optimistic about the future and are expecting the Fed to potentially raise rates in the future. And what is notable about October 2016 is the yield curve has a stronger upward slope than the immediately preceding months in 2016. Perhaps this is because the economy is showing more strength, and a Fed rate hike is becoming more likely.

Buying a Business

If you have been in commercial lending or finance for any period of time, you probably have fielded a question regarding how to buy an existing business.  Now if you have not had this question, some day you will.   This is a common request as there are many reasons for business owners to sell and for future business owners to buy a firm.  Typically, the second question after they ask if you can help finance a business purchase is how much they should pay for the business.

There are several methods in determining the value of a business.  The easiest way occurs if you have a business that derives all of its income from a single tangible asset.  Examples here are an apartment building, office park, or a hotel.  In each of these cases, one tangible asset provides the revenue stream for the business.  In these cases, revenue comes from apartment rents, office tenant leases, or hotel guests.  Value can be determined by utilizing some method like a market cap rate or discounted cash flow analysis. 

But what do you do if there is a mixture of tangible capital assets and also non-tangible assets?  One method would be to assign values to both the tangible and intangible assets in figuring value.  If a manufacturer has real estate and heavy equipment, part of the purchase price can be comprised of the market value of these assets.  The remaining value can take into account intangible assets such as the business name, client list, or goodwill. 

A second method looks at the tangible net worth of the business and figures a value based upon the owner’s equity in the business.  This method may be applicable if the buyer is assuming the existing debts of the company in a stock or ownership purchase.  Most business buyouts I have seen, tend to be a bulk asset purchase of all the assets of the company and assuming none of the existing debts of the selling owner. 

Typically, with the tangible net worth method, the seller still will want some amount of goodwill for the intrinsic value of the business that is provided to the buyer over and above the market value of the tangible assets. 

Another method, the capitalized earnings approach, looks at the value of an investment that is expected by an investor.  This strategy seems to be geared more toward buyer than the seller.  An example here would be if a buyer of an ice cream shop would expect a rate of return, or cap rate, of 12% on his investment.  The overall net operating income, or stabilized version thereof, would be divided by the rate of return to create a price for the business.  A variation of this method is the excess earnings method, where a return on assets is separated from other earnings. 

A gross income multiple may be used to figure value by using some multiple or fraction of the top line revenue the company produces in a given year.  I have seen this done with some medical practices, where this factor is used in determining a portion or all of the price. 

Financing a business with large amounts of intangibles can be challenging.  Any financing of goodwill would not be able to be collateralized.  Some options would be to have the buyer provide additional tangible collateral, allow the seller to carry back junior debt that would carry the intangible value, or utilize some guarantee program like the SBA to help lessen the risk of the collateral shortfall. 

A seller carry may be used without or with a guarantee program.  The carry must be in a junior position to your loan and may have to satisfy some requirements of the lender or government guarantee.  Typically, the business would need to be able to cash flow all the debts.  Repayment of the seller carry in some cases may be required to be on some form of standby to the lender debt and may also be required to amortize at a slower pace than the senior lender debt. 

We can help you when the business buyout question comes across your desk.  We also work with different government guaranteed programs to help better manage the risk in the business purchase.  These loan requests can open up new doors of wonderful business for your credit union.  

The Cost of Doing Nothing

Doing nothing is doing something. When faced with a hard or complicated decision, some people feel it is better not to make decision or wait until the facts become more clear. However, waiting can cost you.

In the broadest sense, we call this cost an opportunity cost. If you are putting off the decision to build a new branch, then you are forgoing any future income you could earn from the new location until you finally go through with the project. If you are waiting to move the credit union’s excess cash into investments, your opportunity cost is the interest income you could have earned on those investments in the meantime.

In a more direct sense, we call the cost of waiting a holding cost. This is the cost you incur waiting to achieve your objective. An example of this can be seen with the Deepwater Horizon drilling platform that blew up in 2010, which resulted from BP pressuring its workers to take safety short cuts. Every day the platform wasn’t producing money came at an extraordinary cost to the company, so they wanted the well drilled as fast as possible. Drilling platforms can cost over $500,000 a day to operate. That is a serious holding cost if you are not producing anything!

 For a credit union, a holding cost could be the money you are losing after you opened your new branch while waiting for it to generate enough income to break-even. If that branch will never be profitable, then you need to consider if that loss justifies furthering your mission.

There is another way doing nothing can cost you by failing to fix problems. By allowing a problem to persist, your decision to do nothing has measurable costs as well. If you have bad computer systems or slow computer systems, doing nothing about it has an increased labor cost since your employees can’t work as fast. Not having enough computerized systems is an even better example of this.

I also often see the costs of doing nothing manifested as a desire not to know. Some businesses or operations lack good reporting or proper reporting. If you are a business with poor bookkeeping, then you wouldn’t even know if you are losing money. If a company produces multiple goods or services but doesn’t track each activity individually, how would they know the profitability of one isn’t masking the poor performance of another?

If you are a credit union, and if you don’t track the profit and loss of each branch individually, how else would you know if some of your branches are unprofitable? And even if you believe your mission doesn’t mean every location must be profitable, it would still behoove you to know how much any location loses so you can properly tailor services and costs. In this sense, there is a cost to not knowing your true cost.

Doing nothing is a real business decision with costs if you are a manager or executive. Doing nothing because of ignorance is truly equivalent to burying your head in the sand. Of course, doing nothing could make sense, when you know it costs less than doing something. But, that argument only makes sense when you perfectly understand both the cost of doing something and nothing.

Could Automation Lead to More Job Opportunities in the Future?

This last weekend I wasn’t able to catch much of the Sunday political talk shows, and maybe that is because I’m beginning to tune out further election coverage to save my sanity. But I briefly caught a blurb on one show about universal basic income, which is something I had wrote about before in a previous post I made here: http://pactola.com/blog/2016/7/1/how-many-jobs-will-be-lost-to-automation

The idea behind universal basic income is that it provides guaranteed payments to everyone, to protect against large-scale social strife that may result from people losing their jobs to automation. I feel this is a grandiose idea that could have only been hatched in the 21st century, and in way it is socialism reinvented. I can say that, because I spent time in the former Soviet Union and I’m not casting political aspersions.

I understand the intentions are well meant, but does the mere fact you exist entitle you to a basic level of income, for not even working?! I strongly believe in assisting those who have lost their jobs, but I’m not sure handing everyone a free paycheck is the best way to wash our hands of the problem of a changing job market. I wonder what our ancestors would say. Imagine the immigrants that poured through Ellis Island, the homesteaders who constructed sod houses on the barren prairie, or the families who built businesses from the ground-up. None of these people felt they were owed a paycheck just for existing, and all they wanted was a chance. What happened to that sense of seeking out opportunity?

It’s not that we shouldn’t dream about a more comfortable and easier future, but the idea of universal basic income makes the assumption that people aren’t seeking opportunity or they simply can’t. It also seems to make the assumption that people cannot adapt. It basically assumes that if someone is a teller at a credit union or bank, that they will be fired if their job is automated. And worse, they will no longer be able to do anything else, because all they have come to know is life as a teller.

We can already see how these assumptions will not hold true. I think it is unlikely institutions would fire tellers, but rather move them to other tasks that need done, and even finding more valuable tasks the institution wants to address. And even if larger, less caring institutions did layoff tellers, surely they will be able to find other jobs that may or may not be related to banking. This is what automation has always effectively done in society; free up people from less productive activities so they can occupy themselves with more productive actives for society.

This talk show had someone providing an astute counterargument to universal basic income. When we were an agrarian society, we had over 60% of our workforce devoted to agriculture. Now, we have 2% or less. Talk about massive job losses, right? And yet, that isn’t what happened at all. All of these people who were engaged in farming had their time freed up to find different jobs. And the same technologies that improved agriculture also created additional jobs for those people.

In the long-run, I don’t think automation will lead to any serious shift in unemployment, but rather continue to contribute to “natural unemployment.” This is a phenomenon largely attributed to the disappearance of old jobs that are no longer needed, and we believe it holds relatively steady around 3-4%. Of course nobody likes to see job losses in the short-run, but holding onto the old way of doing this is not healthy for the economy in long run. Should we really have fought to keep manufacturers of buggies and buggy whips? The workers today who will have their jobs automated will be working in positions that don’t even exist yet, but I think ingenuity will likely give them something even better to do.

Getting Up After Being Knocked Down

One of the movies I loved growing up was Chariots of Fire.  It is the story of two athletes in the 1924 Olympics: Eric Liddell, a devout Scottish Christian who runs for the glory of God, and Harold Abrahams, an English Jew who runs to overcome prejudice. 

A scene in the movie reveals a lot about grit, determination, and never giving up in the face of adversity.  Liddell is in a race and he is pushed to the infield and off the track.  It would have been quite easy to just wallow around in the cool grass, but that was not what Liddell did.  He sprung to his feet and sped through the track like a man possessed.  Soon he caught up with the last runner in the pack and then began one by one to pass each of them on his way to the finish.  He wins the race after unbelievable odds stacked against him. 

History is full of stories of those overcome their odds, those who fail and continue to move forward.  They are in inspiration to each of us when we experience our own failures.  It allows us to move forward and make progress when the everything else around us seems to tell us to stop, that we have made a good effort and no one would fault us from quitting.  In the spirit of growing after failure, I have compiled some quotes on the subject which are as follows.  I hope you enjoy.

1. “If you’re not prepared to be wrong, you’ll never come up with anything original.” – Ken Robinson

2. “Do one thing every day that scares you.” – Eleanor Roosevelt

3. “Everything you want is on the other side of fear.” – Jack Canfield

4. “Failure should be our teacher, not our undertaker. Failure is delay, not defeat. It is a temporary detour, not a dead end. Failure is something we can avoid only by saying nothing, doing nothing, and being nothing.” – Denis Waitley

5. “Forget about the consequences of failure. Failure is only a temporary change in direction to set you straight for your next success.” – Denis Waitley

6. “I have not failed. I’ve just found 10,000 ways that won’t work.” – Thomas A. Edison

7. “When we give ourselves permission to fail, we, at the same time, give ourselves permission to excel.” – Eloise Ristad

8. “What is the point of being alive if you don’t at least try to do something remarkable?” – John Green

9. Failure is part of the process of success. People who avoid failure also avoid success.” – Robert T. Kiyosaki

10. “Giving up is the only sure way to fail.” – Gena Showalter

11. “Everything you want is on the other side of fear.”  – Jack Canfield

12. “There is only one thing that makes a dream impossible to achieve: the fear of failure.” – Paulo Coelho

13. “Develop success from failures. Discouragement and failure are two of the surest stepping stones to success.” – Dale Carnegie

14. “Success is stumbling from failure to failure with no loss of enthusiasm.” – Winston Churchill

15. “Don’t be afraid to fail. Don’t waste energy trying to cover up failure. Learn from your failures and go on to the next challenge. It’s ok to fail. If you’re not failing, you’re not growing.” – H. Stanley Judd

16. “We are all failures – at least the best of us are.” – J.M. Barrie

17. “You’ll always miss 100% of the shots you don’t take.” –  Wayne Gretzky

18. “Only those who dare to fail greatly can ever achieve greatly.” – Robert F. Kennedy

19. “Failure is the key to success; each mistake teaches us something.” – Morihei Ueshiba

20. “Never let the fear of striking out get in your way.” George Herman “- Babe” Ruth

21. “If you want to conquer fear, do not sit home and think about it. Go out and get busy.” – Dale Carnegie

22. “There are no secrets to success. It is the result of preparation, hard work and learning from failure.” – Colin Powel

Ethics in Business Lending

In the past year, I’ve made several trips across North Dakota on I-94. I usually drive past a particular interstate exit to a small town on the western side of the state. There are no businesses on this exit. This exit, in this small town, was a proposed location for a hotel. At the time this hotel was proposed, it only made sense to do because of the oil boom in western North Dakota. While I didn’t question that the hotel could be profitable in the short-run, I seriously questioned the continued feasibility in a downturn. At this time, the price of oil still remained above $80 a barrel, but this town played no central role in providing oil related services. Any demand for a hotel would only come fromthe overflow of the housing shortage.

The proposed hotel project had an adequate down payment. The guarantor had ample financial strength to make the loan payments if the hotel project flopped. Yet, I declined to pursue the loan, because the hotel was sure to flop in the long-run. Hotels were being used as temporary housing, and it would only be a matter of time before permanent housing caught up to demand. And in the short-run, the project was still susceptible to any downturn in oil prices.

An aggressive lender could have argued that this was a bankable loan. If the guarantor could make the payments regardless of what happened to the hotel, why not give it the green light? In this situation, we would just be giving the borrower a rope to hang himself with. While our focus as lenders is rightly squared on getting repaid, there is clearly more that should be considered than just repayment. Is it wrong to give someone a loan if they will use it to fund a project that we know will be a failure? I would argue there is an ethical problem with this. In a fairly clear way, you are helping this borrower lose money. And while it may be in our best business interest to do the loan to earn interest income and fees, it is clearly not in the borrower’s best interest that the loan be made. 

I know we wade into murky waters when we start talking about what are right and wrong loans to do ethically. But, I feel when the facts are relatively straightforward, it is appropriate to throw up the ethics flag. It is like when an alcoholic is hitting you up for spare change in front of the liquor store. Sure, there is an outside chance he isn’t going to buy a drink, but we can reasonably assume we are fueling his destructive habit. 

It feels strange to feel good when I drive by this interstate exit and see there is nothing there. It makes me feel good that nobody else gave the borrower the loan to do this project. It makes me feel especially good this late in 2016 that the hotel doesn’t exist, because it would surely be losing money, and causing stress and heartache for the owner. Luckily, it never got built and the interstate exit remains barren and boring.

Create Your Own Member Destiny

Our team always enjoys teaching our fall classes with lenders.  It is also a good time to learn more of what is happening in various markets.  This helps us to be more relevant in the various areas where we help credit unions.

One theme I have noticed, is that there are many new projects and growth in the communities that are served by the CUs that we serve.  Now some CUs are involved in many new projects that create economic growth, jobs, and wealth for their area.  Sometimes, the CUs we work with seem to be content to sit on the sidelines and allow the economic growth to be funded by other institutions.  They are happy to received whatever person comes in to their office and works to serve that member well.

A lender who follows this strategy will usually be provided the leftovers as other banks will get the main business opportunities for their market.  But that is not what CUs are created for.  We are not built to be on the sidelines, we are built to serve our membership and grow our membership in ways that help our community grow. 

Successful lenders will not only work on the member in front of them, but they will have a strategy to build future business by developing long-term relationships.  Eventually, these will result in new members and new business opportunities for your CU.

Patience is a key virtue to have here.  One of the largest relationships I built took five years of calling and relationship building before I was able to land the client.   Now every lender does need the shorter term customers who will come to you in the near future.  But it is also important to have a strategic calling plan to develop relationships that may not bear fruit for one, three, or even five years or longer. 

Developing an expertise is also key to your business strategy.  One CU that I have worked with has a focus on medical professionals.  They want to not only have the personal accounts, but also retirement funds and business lending needs as well.  Another one, has a focus on small manufacturing firms and serving needs they have.  Within your market area, there are smaller sub-markets that you can gain an expertise in and become known for.

This strategy may require that you develop friendships with your target audience and may need to even hit some networking events that center around the target group.  Some of these groups may also become good pipelines of business for you.  In my career, I have built deep relationships with commercial Realtors, medical professionals in the town I was located, and land Realtors.  These have provided large amounts of loans and deposits over the year.

Some CUs will also shy away from projects because they are too large and complicated.  That is what we are here for.  We help with the complicated and as long as you can keep only 10% of the loan on your balance sheet, it is not too large.

My encouragement here is that you begin to create your own destiny in your CU.  Work on identifying the businesses in your community and determine what is your target audience.  Network with various industry or trade groups that can introduce you to other new sources of desirable business members.  Create your own “hunting list” of those in your communities that you want to bring in your membership.  Be patient in building the relationships with them.  You can build your destiny, or just take what comes to you.  

Is Your Credit Union Banking Non-Profits?

I recently read a newspaper article about a local non-profit that is undertaking a $14 million project to redevelop a 100,000 square foot facility to carry out their mission of helping children and families in the area. It is an impressive project and will make the community a better place. Surprisingly, they are doing it all with special grants, donations and funding from the city. No banks or credit unions loaned money to the project. Could it have commenced sooner if that funding source was available? For me, this reinforces something I have explained to business lenders several times: non-profits are a good source of business loans too.

 When we think of a non-profit, you might have an archaic vision in your head of what sustains these organizations. You may think of them as small operations heavily dependent on the charity of others. You may also think they are run by poorly paid people, who chose to take up that work because they are extremely mission-oriented. I would say that is hardly typical of a non-profit in the twenty-first century, and we all need to open our minds a bit more.

 Non-profits can largely do anything a for-profit business can do. Sure, just like some small businesses struggle and barely make it, that too can be the case with small non-profits. But other businesses flourish, scale-up and have billions of dollars at their disposal. There are non-profits like this too. The Bill and Melinda Gates Foundation has an endowment of $44 billion. The John D. and Catherine T. MacArthur Foundation has a $6 billion endowment. You are thinking these are exceptions, and local non-profits hardly have these resources, right? The John T. Vucurevich Foundation, based right here in Rapid City, has a net worth greater than $100 million and the South Dakota Wheat Growers Cooperative, based in Aberdeen, has $247 million in equity. Even local non-profits can be heavy hitters.

 Of course, you don’t need to look any further than your own credit union to make this very point. A credit union can provide banking services, and yet they do it all as a non-profit. And how big is your credit union? $25 million in total assets? $100 million? $1 billion in total assets? Non-profits like our credit unions have grown to become powerful organizations in our community. And that means they have large organizational needs too. They need to purchase capital assets, they need to buy buildings, and they need lines of credit. Just like any for-profit organization that would like to preserve their cash, non-profits may also prefer to borrow for some of their needs.

  I want to believe that credit unions should also have the inside track when it comes to lending to non-profits. When a credit union helps a non-profit, it is really a non-profit helping another non-profit. We know that successful lending sometimes means exploiting a niche or presenting a compelling story of why to work with you. I think credit unions providing MBLs to non-profits competes in both of these areas. Unless you have local banks trying to corner all the non-profit MBL transactions locally, I think credit unions could be doing much more to take advantage of these opportunities.

Where are Oil Prices Going?

In the upper Midwest and Plains States, oil plays a large role in the economy.  It certainly changed sleepy little towns in North Dakota that had not seen significant economic growth for decades into expanding communities with new businesses, houses, and public facilities.  And then, after several years of crazy expansion, growth slowed significantly with drops in oil prices that started in late 2015. 

The economy of the area has since then cooled from the red hot growth of the past few years and has struggled in some areas to find a new normal.  Not only has a decline in oil prices hit, but also lower commodity prices and a low Canadian Dollar has also impacted area demand.  These can mislead the analyst. 

Commodity driven markets can create struggles for the lender in trying to find what is normal.  Often, one who is looking at a company or an area, will attempt to think to the extremes.  When prices are high, there is a temptation to believe that the high prices will last forever.  We certainly saw this in the farm economy from 2010-2013 where producers added more debt with the assumption the high commodity prices would continue their contango.  On the other side, when prices are low, fear can make one believe that the area will only grow worse and worse.  The extremes can cause you to not understand where reality is. 

Now absent an accurate crystal ball, any explanation of future prices is merely a guess.  However, it is possible to look at the history and present factors in the market and find some facts.  The first is that oil prices have climbed nearly 80% since the low in February 2016.  What is also important is that the low dips in the market have consistently been higher than the earlier lows since this winter. 

The low prices have not only hurt U.S. producers, they have also cut deeply into the revenue of all OPEC producers and major non-OPEC producers.  Venezuela has been an abysmal failure with the low oil prices and the socialist government.  Saudi Arabia has sold nearly 30% of foreign assets in an attempt to try to balance its budget.  As a major producer, Russia has experienced severe headwinds to their economy from drops in oil.

OPEC announced this past week that they were going to begin to cap production.  Instantly, U.S. oil prices shot up 6%.  But as with all things, the devil is in the details.  OPEC had to move to change from increasing market share to capping production to halt an increasing financial mess.    Increasing prices indicate the market thinks there will be a balance between expected supply and demand.  This happens even though there has been a current glut in oil supply worldwide. 

The projected cap for OPEC will limit production between 32-33 million barrels a day.  This would put OPEN production at a level that cannot be sustained over any moderate period of time without significantly damaging oil fields and future revenue flow in many companies.  The first challenge to the cap is dividing it among the member countries. 

This will be a problem with Iran and Iraq, who have not had a monthly production quote for years.  In the OPEC meeting in early April, Iran did not even attend the meeting.  Last week they did, indicating they are moving toward agreeing to production limits.

Once the OPEC countries are all on board with production caps, a group of non-OPEC producers, led by Russia, would have to curb their output to do their part to stabilize oil prices.  Russia is producing around 11.5 million barrels a day.  But most of Russia’s fields are mature and are questionable if this level of output can be sustained far into the future.  Moscow has indicated they would support the proposed OPEC caps as proposed in the last two cartel meetings.  At this time, it is hard to tell if Russia will decide to limit production or just pay lip service to OPEC’s attempt to curb production.  So watch for strong negotiations between Russian and OPEC this fall.

The next hurdle that OPEC has in raising oil prices is the volume from U.S. producers.  The bulk of shale and tight oil reserves are right here in the U.S., but, unlike other major oil countries, the U.S. has no national oil company or centrally controlled oil production.  So, the U.S. government cannot commit to a national position on oil production.  The impact the U.S. has on global oil prices is primarily on crude import levels.  It is only recently, that American drillers have been allowed to export oil.  Any supply of American oil on the world market will take time before it is felt.  OPEC wants to raise prices to a level that keeps American shale producers sitting on the sidelines. 

The election could play a role here as there is one of the presidential candidates has indicated a commitment to U.S. energy independence.  This would use whatever resources we have here in the U.S. to keep us from imports.  Also, some local oil regions have recently experienced more opposition to fracking.  Oklahoma has seen a rise in earthquakes that some believe is a direct result from fracking.

The other factor is that innovations in technology have driven down the up-front cost of shale wells.  So now these producers can be profitable at lower levels of oil prices.  There are also large numbers of partially completed wells that are not producing.  Completion of those wells will be at an even still lower cost.  In North Dakota alone, there are over 1,900 partially completed wells. 

So take all these factors together, thrown in a wild card of any major political instability in oil producing countries like Venezuela or Nigeria, add some overall growth headwinds to global economic growth, and the crystal ball begins to get pretty murky.  Overall my guess is we will see prices continue to rise gradually but not reach the high levels we saw a few years ago.  This will bring production back to U.S. shale producer, but not at the same torrid pace we saw a few years ago.  

Assessing a Business Construction Budget: How Much Construction Experience is Needed?

As someone engaged in business lending, I must be an armchair expert on a wide array of topics. How can someone like myself feel comfortable reviewing loans related to agriculture, hotels and cinderblock manufacturing when I’ve never farmed, made a bed, or operated any heavy machinery in my life? It takes years of experience, but a solid knowledge of economics and finance can help you predict how these operations should behave, and then astute observation of past performance can help you corroborate those expectations.

Construction projects can be especially risky, because of the prospect of cost overruns and the fact we have no initial collateral in place. So, if you have never swung a hammer on a job site, how do you know if the construction request in front of you has any merit? Some common sense details can help us cut through most of the uncertainty.

First, you need a project budget, which we refer to as a “sources and uses” budget. In other words, we want a budget that shows all the project related expenses, and then a list of all resources provided to pay those expenses, such as personal cash, loans, etc. Sources must equal uses.  And there are some common expenses we know to check for on the “uses” side that are often overlooked and can materially affect the lender.

I particularly check for whether interest expense is budgeted to pay for the subject construction loan. The longer construction takes, the bigger this will be and more burdensome to boot. So, we need to make sure there is enough interest to pay for the loan until the project begins to produce cash flow.

Another item we need to check for is “contingency.” This is a catchall for unforeseen expenses. If it is small relative to the entire budget, it means there is little room for error. If it is particularly large, it may be treated as a slush fund for nonessential items. Generally, contingency should be between 5-15% of the construction budget. It may be okay if there is little or no contingency, so long as your guarantors have substantial personal liquidity reserves that can easily meet the same 5-15% test.

How do you know if everything in the construction budget has been estimated correctly and captures all necessary items? We will require a bid from the contractor(s) to corroborate the actual cost. If our sponsor is the GC, we may have a third party contractor or engineer evaluate the budget provided to get an expert opinion regarding the accuracy of all the expenses. A good appraisal should help corroborate this information as well.

If a third party contractor is utilized, it is also common to ask that the contractors be “bonded” or carry insurance to make sure their work is completed with an expected level of quality. Sometimes, general contractors are even expected to provide a “completion guarantee” to assure the project gets done.

There are additional underwriting details to evaluate when looking at a construction project, but look at how much risk we have already started to get our arms around. While we may have no personal experience at a construction site, we have already assessed what resources are available and where additional resources can come from. We can also make sure the contractor has the ability to deliver and verify their estimates and assumptions. In doing this, we show risk management isn’t about having deep knowledge about a specific topic, but rather having framework for dealing with unpredictable events and different kinds of uncertainty.

Three Failures in the Wells Fargo Fiasco

Wells Fargo was named by Global Finance and The Banker in 2016 as the best U.S. bank.  Brand Finance calls it the most valuable bank brand on earth.  CEO John Stumpf was named 2015 CEO of the year by Morningstar. 

Wells media accolades are known far and wide.  It was broadly admired by the American public even though this is a big bank.  Wells has $1.9 trillion in assets, 269,000 employees, 70 million customers in 8,800 locations.  Wells also has the highest cross selling ratio in the industry with an average customer using 6.15 different services. 

By now we all are aware of the fraudulent accounts at Wells that were made public recently.  Wells, once one of the most admired companies, now sits in the gutter with other entities that are known to milk revenues from the customer.  Fines from the Federal Government and testimony in front of Congress are now the headlines for the bank.

But there are three entities that have failed in this situation.  The first is the leadership at Wells, itself.  The records show that Wells was aware of the fraudulent accounts dating back to 2011.  In the five years since then, Wells has terminated 5,300 employees during this time, who were involved in this scheme to pad their own salaries, or in some cases, making goals just to save their jobs. 

Five years is a very long time for this to continue.

But this was not just a get rich quick scheme.  This lasted for years and probably even years prior to 2011.  This was ingrained in the culture of Wells and praised by the shareholders of the bank.  The head of retail banking at Wells was praised as one of the most powerful women in banking.  She oversaw the growth of Wells into a retail powerhouse.  She also left the bank in July with a $125MM bonus. 

Maybe this is the old bank culture that is rearing its ugly head again.  Maybe it is the same disease that brought us Enron, the subprime mortgage bubble, the financial crisis, and all angst associated with it.

The second failure is the media.  The Los Angeles Times reported in an article on December 21, 2013 titled “Wells Fargo’s Pressure-Cooker Culture Comes at a Cost.”  This outlined the aggressive tactics pushing banker sales teams and cross selling products.  In the article, the writer states, “The relentless pressure to sell has battered employee morale and led to ethical breeches, customer complaints, and labor lawsuits.”  Employees were forced to work after hours to make up for missed sales quotas.  The Times reported one branch manager was constantly told that she would “end up working for McDonald’s” during the hourly browbeatings, otherwise known as sales coaching calls. 

So the question to the media here is how does the Wells go from a pressure-cooker to the most respected bank brand in the U.S. when nothing changes with its sales culture?

The third entity who failed is the U.S. Government, specifically the Consumer Financial Protection Bureau (CFPB).  Many of you know that this agency was formed unconstitutionally with no congressional budgetary oversight.  Discussion of that is for another time.  This agency is supposed to protect the little consumer against the large corporation.  Now they hail this finding as a positive to their very existence.  But the question is, did they really do their job. 

The evidence will lie in two areas, time and money.  First is time.  The CFPB knew about these practices since 2011.  It was widely known in the industry.  Now in 2016, just before an election, the findings become public.  The long time this has taken also allowed Wells to continue to open bogus accounts, continue to make money, and even allow some of its key people who oversaw the fraud to retire wealthy. 

The second is the money.  The CFPB will assess a record $100 million fine.  Wells will pay another $35 million to the Comptroller of the Currency and $50 million in penalties to the Los Angeles city attorney’s office, for a grand total of $185 million.  To most of us, this seems like a lot of money.  But how does it look to Wells?

In 2015 Wells earned top line revenue of $86,057,000,000.  This comes down to $235.8 million in revenue a day or $9.82 million in revenue per hour.  So the fine of $185MM is less than a full day’s worth of top line revenue to Wells.  It comes down to only 18.8 hours of time.  Do you think that penalizing a company for 18.8 hours of earnings is enough to cause them to realize the gravity of the fine?  The next time some money making scam is created by the bank leadership that will generate billions in revenue but only cost a penalty of 18.8 hours’ worth of earnings, do you think that penalty will be severe enough to deter future wrongdoings?

It all points to governmental ineptness.   All I can say is time to move to another place to bank.  Credit unions are the place to be. 

By the time you are reading this, we will have finished our Agricultural Education Forum in Miles City.  We appreciate having the opportunity to visit with each student in the class.  Please take advantage of our Small Business Lending Class in Fargo on October 5-6 and our Intermediate Agricultural Finance Class in Fargo on October 6-7.  Come to the New Ideas Conference and stay for some good business lending education. 

We also have our Commercial Real Estate Lending class in Deadwood on October 17 and 18.  We have quite a bit of space available in that class.  We will be holding this at the Tin Lizzie Gaming Resort and will also have our first blackjack tournament during the social hour on the 17th.  We look forward to seeing you there! 

Skin in the Game

What is skin in the game? That sounds horrific, doesn’t it? It sounds like somebody lost skin doing something painful, like sliding into second base. Another way to phrase this is “to share in the risk.” Someone who has “skin in the game” is someone who is “sharing in the risk” of a transaction.

Why is it important that someone share in the risk? When making a business loan, we feel someone is more motivated to operate their business successfully, if they are exposed to the risk of losing their own money. That is why we want them to have some skin in the game. If the borrower does not have their own money at stake, they do not suffer if they give up and walk away, or they may not feel as motivated to turn things around when bad times hit.

Lately, I have had to explain to a handful of lenders (across several institutions) the issues related to financing 100% of a business borrower’s purchase. In other words, the borrower has no skin in the game. This presents a great risk in business lending, even though 100% financing is common in consumer lending. Consumer loans are relatively small in dollar amount, especially when they aren’t for a home. And it should not come as a surprise that buying a home requires a down payment since it is a big purchase, and we want to make sure the borrower has skin in the game.

Financing business loans at 100% carries considerably more risk, because of both the high dollar amounts and the nature of the collateral. There are less buyers in the market for an office building or stamping machine than there are for cars and RVs. That means if we foreclose on business assets, we may have to accept a much bigger discount on the value to sell the asset. An office building might sell for 80-90% of its appraised value. And then consider, we will have a lot of legal costs in foreclosing on something that big and have to pay a large commission to a real estate agent. When all is said and done, we might get proceeds equal to 75% or less of the appraised value of the building. Why then, would we ever want to finance more than 75% of the building? Usually, we don’t.

So by now, you can see there are actually two major issues that arise when someone has no skin in the game. First, the borrower has no exposure to losses, which could affect their motivations; and second, there are no ways to offset costs related to foreclosing and selling collateral. Therefore, sharing in the risk doesn’t just keep the borrower motivated to stick with business, but their equity in a project also helps absorb some of the losses the lender faces.

On the surface, these seem like tempting transactions to do when there is significant cash flow that can easily make the loan payments. But we have to bear in mind, we are observing the best-case scenario when everything is going right. We have to ask ourselves, what could transpire in a worst-case scenario? What could happen is cash flow could no longer service the debt. And if someone has not invested any of their own money, what incentive would they have to stick with the project then?

When Sales and Credit Management Do Not Mix

One bank I worked at had a division between management over sales and those over credit administration.  The bank had a strong credit culture, so, usually the will of the credit administration folks would shape any sort of program that those whose bonuses were tied directly to the growth of the bank’s branches they ruled over.

But this was not always the case.  One fine spring day, managers and lenders met with the senior vice presidents over the bank branches.  It was a typical meeting held in the spring or early summer when the bank’s upper leaders announced our goals for the year.  I always thought it kind of funny that in some cases half of the year had passed before you actually knew what the new “flavor of the year” was.

Something unique happened in this meeting.  It became evident that the SVPs of sales and SVPs of credit administration were not in the same universe, even though they sat in the same room!  Anyone who has been in lending long enough has experienced this.  Probably one of the most famous examples is the mortgage crisis.  I will digress a few minutes here to discuss that. 

When I started doing residential mortgages in my career, everything was underwritten by hand, verified, and presented to a loan committee that met daily for a loan approval.  This process was rather long (but not as long as some of the runaround a mortgage applicant gets today!  Anyway, to remedy the problem, folks at Freddie Mac and Fannie Mae whose bonuses were tied up to the production of mortgages, derived a system where everything was underwritten by computer algorithms.  The parameters of underwriting were stretched to a point where we began to see exotic products with no down payment, financing of closing costs, interest only, etc. 

This created a huge demand for housing and we saw house prices triple in the 1990s at a time when real wages increased around 3% annually.  Of course, the system crashed down and one of the biggest causes was the lax and insane underwriting standards.  The movie The Big Short does a wonderful job explaining the mortgage mess.

Anyway, back to my bank story.  A new product was announced for that year.  It was called the “Business Streamline Line of Credit.”  It was designed to be a small line of credit, usually no more than $50,000, that would be sold to business owners.  The line had no maturity; it was based on a demand note.  Payments were interest only, with no plan to amortize and retire the balance.  The loan was also unsecured.  The product would also be primarily administered by front line branch managers and consumer lenders, and not seasoned commercial lenders.

So after ten minutes into the presentation touting how great this product was, the time for questions from the audience began.  One of the first ones was what about underwriting?  All this was done on some business credit score system based entirely on a two-page application the borrower would fill out.  We were told that because these loans were so small, that the money spent on full underwriting would make them unprofitable. 

Next who was the target market?  Anyone, as this product was designed to be a gateway product into new clients we had not worked with, not existing companies that we had a relationship with already and also understood. 

Generous incentives were provided front line people who sold “Streamlines”.  Goals were established for each market.  For the next few months, anytime anyone opened a “Streamline” everyone received an email as to what a great job they had done.  It was not long that we had amassed over $50MM of these loans on our balance sheet.  What could possibly go wrong?

I have learned when that last question is asked, it usually is just before something bad hits.  The program began to unravel.  First, leaving this to people who had absolutely no business lending experience was a problem.  We began to attract the unbankable customer others had turned down.  And, we did it with an unsecured line of credit. 

Next, since all standard underwriting went out the window, since it was “too expensive”, proper due diligence was also ignored as many of these lines were closed with companies that did not actively operate or with individuals who were not authorized to act on behalf of the company. 

Most of these lines were maxed out quickly with no ability to repay the loan.  When the crash hit, most lines in those situations were frozen and some sort of repayment plan had to be worked out.   By the time I had left the bank. Nearly $10MM of the $50MM portfolio was charged off.  Imagine what a 20% charge off rate with no collateral to recover would do to your balance sheet.  Fortunately, they were large enough to weather it.

The geniuses who hatched the plan, left the bank for a new opportunity to screw up another financial institution, while credit administration stepped in to clean up the mess. 

The lesson here is in commercial lending, niche products need to be analyzed and implemented carefully.  If no one at all is doing this in your market area, you may become the lender of last resort, attracting relationships that will cost you a lot of money and staff time to manage. 

Next, you cannot abandon sound underwriting principles.  We come across that now with some CUs we work with who have such a product.  They become obsessed with selling the loan without any strong consideration if the product makes credit sense.  Less growth today with marginal clients will give you much more time with the good ones. 

I want to end with a plug for our fall classes.  Our annual Agricultural Education Forum in Miles City is on September 26 and 27th.  At the time I write, we have 23 students signed up for that one.  After going to the New Ideas Conference in Fargo, stay over later and attend our Small Business/Commercial & Industrial Lending all day October 5th and the morning of October 6th.  Intermediate Agriculture Finance will be held the rest of October 6 and all of October 7th in Fargo.  We have discounts for those who want to attend both of those classes.  We end our fall classes with a session on Commercial Real Estate Lending at the Tin Lizzie Gaming Resort in Deadwood, South Dakota on October 17 and 18th.  Come join us and you can participate in our first Blackjack Tournament. 

Every year we are humbled and honored to be able to help our CU family grow in their knowledge and skills in the area we live in each day.  We look forward to seeing people on your team this fall. 

Don't Wait Until Election Day!

You are likely reading this on a Friday morning and you may be somewhat preoccupied with what you are planning on doing this weekend, like have a cold beer after work or sleeping in on Saturday. I have small children, so neither of those things are likely to make my “to do” list, but best of luck to the rest of you.

But if you are taking a five-minute mental break from work right now, why not take this brief moment to become a more informed citizen? Oh no, I’m not going to rack your brain. I just want to take this time to remind you that November election is about so much more than candidates trying to become president. You will also have a chance to vote on some ballot “measures,” which are proposed laws or constitutional changes brought to the voters to decide!

In North Dakota, you will have 5 ballot measures this fall.

·         Measure 1 : Residency requirement for state legislators
·         Measure 2 : Allocation of some extraction tax revenue to schools
·         Measure 3 : Expand the rights of crime victims
·         Measure 4 : Increase the tax on tobacco products
·         Measure 5 : Allow individuals to use medical marijuana

You can find the details about these ballot measures at: https://ballotpedia.org/North_Dakota_2016_ballot_measures

In South Dakota, you will have 10 ballot measures this fall to consider.

·         Amendment R : Governance of post-secondary technical education institutes
·         Amendment S : Expands crime victims' rights
·         Amendment T : Redistricting commission created to make redistricting decisions
·         Amendment U : Statutory interest rates for loans
·         Amendment V : Establish nonpartisan elections
·         Referred Law 19 : Regulations on who may sign petitions for independent candidates
·         Referred Law 20 : Decrease the minimum wage for those under age 18
·         Measure 21 : Cap interest rates for short-term loans at 36 percent
·         Measure 22 : Revise campaign finance and lobbying laws
·         Measure 23 : Nonprofit organizations allowed to charge a fee for services

You can find more details about these ballot measures at: https://ballotpedia.org/South_Dakota_2016_ballot_measures and https://sdsos.gov/elections-voting/upcoming-elections/general-information/2016-ballot-questions.aspx

As far as the presidential election goes, the South Dakota ballot will have four candidate tickets:

·         Donald Trump/Mike Pence (Republican)
·         Gary Johnson/Bill Weld (Libertarian)
·         Hillary Clinton/Tim Kaine (Democratic)
·         Darrell Lane Castle/Scott Bradley (Constitution)

On the other hand, North Dakota will have the following presidential candidate tickets on their ballot:

·         Darrell Lane Castle/Scott Bradley (Constitution)
·         Hillary Clinton/Tim Kaine (Democratic)
·         Rocky De La Fuente/Michael Alan Steinberg (American Delta)
·         Gary Johnson/Bill Weld (Libertarian)
·         Jill Stein/Ajamu Baraka (Green)
·         Donald Trump/Mike Pence (Republican)

As you can see, North Dakota has two additional candidate tickets on their ballots from the Green Party and the American Delta party. South Dakota notoriously has more restrictions for getting on the ballot and voting than North Dakota does.

Speaking of access, South Dakotans need to be registered to vote by October 24th if they wish to vote in the election on November 8th.  Interestingly, North Dakota does not have voter registration on the state level for presidential candidates. But, cities may require a city level registration to vote in city elections. Although, without a state registration system, you will be required to provide a government issued ID showing you reside in North Dakota.

If you are looking for information about where to vote, what will be on your specific district ballots, etc., then try starting with http://www.vote411.org/enter-your-address#.V9lixSgrKUl or for South Dakota go to https://sdsos.gov/ , and for North Dakota go to http://sos.nd.gov/ .

Please vote. If you don’t vote, your voice is literally not heard. But also, please read about what you are voting for too. Some measures may seem like a good idea on the surface, but can have greater negative consequences once enacted.

Incentive Programs Gone Awry

Last week, news broke of a large fine of $185 million assessed against Wells Fargo.  The bank’s employees had opened 1.5 million in bank accounts and applied for 565,000 in credit cards that were not authorized by customers.  This practice dates back to 2011.  Wells is refunding $2.6 million in illegal fees to customers and fired 5,300 employees over this incident.  Wells has 40 million retail customers. 

Richard Cordray, head of the Consumer Finance Protection Bureau, stated, “Unchecked incentives can lead to serious customer harm, and that is what happened here.”  For those who are familiar with Wells in the industry, what came out in the news this week has been going on for a long time.  This is no surprise to anyone. 

Wells is known as having a strong culture that promotes sales and cross-selling.  I have known many former Wells employees who are well trained and smart, but who left the bank because of the high pressure environment.  I know of bankers who would get multiple calls from supervisors during the day to track sales efforts and results.  The sales culture went into overdrive here and it makes me wonder how many phony accounts were done from greed and how many from an attempt just to keep one’s job. 

Clearly, this also shows a banking culture that is not serving its customer base and is only concerned for profits.  It also shows a lack of commitment to the communities they are in and an attempt to pad the pockets of the shareholders and leaders of the company.  I am a little happier every time I drive by the vacant Wells building in my rural South Dakota community.

The real issue here is not just with the employees who opened the accounts, it is the actual system, the sales culture, that was set up and firmly established at the bank that encouraged and rewarded these actions.  In many positions at Wells, if you wanted to get your boss off your back, get promoted, and also receive bonuses, finding ways to open new accounts is the key.  The other issue with Wells is that many of these accounts remained open when a cursory review of the activity in the account, would indicate that something is wrong. 

A much more dangerous threat to the US economy than the fraudulent customer accounts, is the huge amount of derivative holdings by the largest banks in the country.  Derivatives played a big part of the financial meltdown in 2007-08 and subsequent freezing of the credit market.  As long as we have a stable market, derivative holdings should not be a concern.  But the real concern is when there is mass instability, when the counter party risk holders cannot fulfill their role, that derivatives become a “weapon of financial mass destruction” as Warren Buffet puts it.

So why should banks traffic in this?  The simple answer is money.  According to the Office of the Comptroller of the Currency’s 1st Quarter 2016 report on derivative holdings of banks, banks made nearly $5.8 billion in revenue just in the first quarter in their derivative trading.  Wells clocks in at the 5th largest derivative holding bank with just under $6 trillion of contracts held by a bank with total assets of $1.7 trillion.  The other four largest bank derivative holdings are with JP Morgan Chase, Citibank, Goldman Sacs, and Bank of America.  The top five banks hold a tidy $182 trillion in derivatives while they have total assets of $6.8 trillion.  In this quarter Goldman Sacs earned over 33% of its gross revenue from derivative trading.  The total credit exposure of the derivative holdings of the top four banks in the first quarter 2016, is listed at 482% of their total risk based capital.

To put some of these numbers in perspective, the Gross Domestic Product of the U.S. economy last year was $17.9 trillion.  The entire world GDP is estimated to be $73 to $78 trillion in 2016.  So the holdings of the just the top five U.S. banks is over 2.3x the entire world economy?  At what point does “too big to fail” become “too big to bail?”  The next major bailout will not only come from the government, but also from bank depositors. 

It is sad to say, but we have learned no lessons in the financial crisis as shown with the derivative holdings to be higher now than it was at that time.  There seems to have been no concerted effort to stem this tide.  In fact, it seems there is an effort among some of our politicians to cozy up to the big banks by receiving millions of dollars to give short speeches to banking officials. 

So large banks and their trade associations will point the flaw in the system at the credit unions who do not pay taxes.  But of the $16.122 trillion of assets held at financial institutions, only 7.5% of that is held at banks.  17% at banks other than the largest 100, while the top 100 hold over 75% of the banking system assets.  The total $1.2 trillion in credit union holdings is less than the $1.7 trillion asset size of Wells Fargo! 

Clearly the “credit unions are the problem with the banking system” argument is the magician’s sleight of hand, designed to take your focus off real systemic risks in the financial system.    Real solutions need to be put in place to prevent another meltdown.  At the rate we are going, I would expect another one to occur that will make the last financial crisis appear to be a walk in the park.

Real reform needs to be accomplished.  Perhaps issuing a tax on speculative derivative trading with portfolios that have over $1 million could be implemented.  New rules that prohibit financial institutions, that are under the government’s insurance funds, limitations to the size of their derivative holdings may help. 

With the election coming up this fall, it is important for the voter to understand who owns the ear of the candidates.  Who or what industry group has given the most money in contributions or paid for speeches?  It is most likely that they will control the agenda of any candidate from the highest office in the land all the way down to the local level.  

Credit Scores: Do They Matter in Business Lending?

Business lending covers a pretty large gambit. It encompasses a small business that may need some credit to purchase a vehicle or equipment, up to large private companies who manage vast portfolios of commercial real estate. When I am looking at a multimillion dollar request, I sometimes crack a smile when someone asks about the credit score of one of the project owners. Could a credit score really make or break the success of an office building, hotel, or manufacturing facility?

I don’t see this question as purely rhetorical, and there may be instances when it is arguably important. But first, we need to understand what a credit score is before we speculate how it affects business lending. A credit score is an attempt to understand the risk of lending to you by using standardized information about you, and comparing it to the same set of information that can be applied to everyone else. When we say everyone else, we should pay special attention to what that indicates.

Everyone, in an American sense, means most of us who probably own a car, probably have a credit card, usually have a job that pays us twice a month, and have likely graduated high school. Most of us share these common characteristics, so it is easy to anticipate the likelihood of a loan getting repaid when we look at how everyone else might have fared in the same situation. But, people borrowing for business purposes are different, and that fact alone distinguishes them. How many people do you know own a restaurant? How many people do you know own an apartment building? You might know one or two people like that, but they are not representative of everyone.

So, a credit score generally assesses the likelihood of a loan getting repaid, if the loan is for a standard reason we all borrow. In other words, it is a measure of our ability to repay consumer credit. But for people who are not borrowing for an ordinary consumer purpose, it doesn’t factor in other valuable information. The credit score cannot give us an idea of how much equity someone has in a real estate investment, or how much cash savings someone has to fall back on in hard times. Rather, a credit score is a narrow assessment of how many people can do one thing, which is repay a consumer loan.

Then if a credit score is consumer measurement, how relevant is a credit score in business lending? For small business owners who need credit for purchases like vehicles and equipment, a credit score might actually be a reasonable indicator of repayment, because small business purchases are more akin to consumer credit needs. But the larger the request becomes, and the more removed from consumer credit the request becomes, and then the score itself may have little importance on its own. But, there might be a reason to have concern if someone has a poor credit score and he/she wants to borrow millions.

If someone has a poor credit score, it might give us some insight into their character. No matter how large their borrowing need is, it is a bit concerning that someone may not be paying their small bills. It may be the case they really don’t have the extra money, or they simply don’t care to. Sometimes, the score is low because of a tax lien or judgement, which is a serious concern. However, sometimes there isn’t much cause for concern. Even I irrationally had a lower credit score once, simply because I had medical bill fall into collection, because they never sent the bill to my address so I knew to pay it! Borrowers might have a low score, but for explainable or immaterial reasons.

So, is a credit score relevant in business lending? For small businesses, yes, it tells us something about repaying small loans. For large business loans, the score alone is much less significant. But if there is an adverse score, generally a reason should be provided as to why this is the case. But ultimately, a credit score cannot give me meaningful feedback about whether an apartment building will lease up, whether the demand for widgets will go up or down, or whether 2016 will be a good year for crops. To determine these things, we need a more detailed underwriting process, and a credit score is a small item to consider in a much greater picture.