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Last Friday the FDIC seized First Midwest Bank in Waukegan, Illinois making it the 40th FDIC takeover in 2012. The state of Georgia alone has seen nine bank closures this year. This post will address the reason for the continued pace of failures and why some additional consolidation may be healthy for the banking system.
Roughly 500 U.S. banks have failed since 2007, the majority of which were relatively new banks — many less than five years old. These younger banks were often started to serve the housing boom which created enormous lending opportunities in the areas of development, construction, and mortgage. As the housing boom ended, most of the housing-oriented lenders started failing.
There are still over 7,000 individual banks in the U.S. — not branch locations but separately branded banks — many of which have a multi-state presence. Before the credit crisis, 340 separately-chartered banks were operating in Georgia and after 90 failures since 2007, that number is now around 250. That means that Georgia has accounted for nearly 20% of all bank failures in the U.S. since 2007.
However, the following should make you feel better (or at least less bad) if you are a Georgian — The largest* Georgia retail bank failure in the past 5 years was Georgian Bank with assets of $2 Billion, placing it 50th on the list of largest bank failures in the U.S. Additionally, the total of all Georgia bank failures since 2007 is less than any one of the largest eight U.S. banks that have failed over that period. It is still difficult to see another bank fail every few weeks in Georgia but it helps to understand that Georgia has fared much better than many states. [*This does not include the Bankers Bank, a/k/a Silverton, which was not a retail bank).]
So, why are there so many small banks in Georgia? First, through the 90’s and early 2000’s Georgia was a magnet for retirees and job seekers and these new entrants to the state drove significant demand for new housing. Second, Georgia had a Banking Commission that was willing to grant new bank charters relatively liberally. Finally, large banks were actively buying smaller banks in order to expand their market presence. The combination of all of these factors created an environment with very high incentives for new bank formation.
It has been argued by some that the banking consolidation in Georgia is healthy for the system as quality leaders and bankers are concentrated in the remaining banks. Some experts estimate that Georgia will lose another +/- 30 banks by the time everything settles out but that will still leave the state with over 200 GA-based banks plus all of the banks from outside of the state with a presence in Georgia.
The health of Georgia’s banks should not be judged solely by the number of closures which is only one indication of the strength of the system. Overall, Georgia’s banking system has fared better than those of many states and Georgia’s banks are well positioned to provide capital for the state’s economic recovery.
During a recent breakfast with a good friend the topic of wealth creation came up. Knowing that I work with many affluent individuals, my friend asked a simple question — What is it that the affluent and super-affluent do that others don’t?
The answer is extremely simple — since there is no limit to the amount of money you can spend (no matter how much you earn), the key lies in frugality. In pursuing this worthy goal, a key barrier that many of the highest earners face is the pressure to impress their peers. Whether you call it the ‘rat race’ or ‘keeping up with the Joneses’, the pressure to look the part can be a significant drag on wealth creation.
Below are two encouraging stories of actual clients as well as a few thoughts on things you can do to improve your financial condition by leaving the rat race behind.
Bob (not his real name) came from modest means. He started a company and, after owning it for 15 years, sold it for more money than most people make in 10 lifetimes but he still leads a very low-key life. He could own his own plane but flies commercial. He could belong to several private clubs but after making his millions dropped the only club membership he had. Bob’s top priorities are taking care of his family and supporting the causes & organizations he feels strongly about.
Sam and Ashley also both came from modest means but over the course of their 20-year marriage, they have worked hard and spent wisely, building an investment portfolio of over $1 million (not including their retirement funds). They also have no debt of any kind. They live in a reasonably nice neighborhood in a relatively modest home and drive modest cars. Their children attend a private school because education is one of their top priorities but otherwise they live a modest lifestyle. Early in their marriage they decided to stay out of the rat race and they would tell you that this made all the difference.
What do Bob and Sam & Ashley have in common? First, they made a deliberate decision to leave the rat race behind. They can also clearly explain their top priorities and they are not overly concerned about other people’s opinion of them. Their friends are the people who appreciate them for who they are and not for the extravagance of their lifestyle.
On the other hand, there are many people struggling just to keep up. Their debt continues to pile up because they are hesitant to cut their lifestyle and this ultimately places a strain on their personal relationships. No matter how high or low your income, there is always something you can eliminate that will help you enhance your financial condition. Making these choices is hard but I hope this post will give you the impetus you need to begin thinking in that direction.
The title may sound confusing because if businesses don’t pay taxes then why do they file tax returns and employ all of those accountants? What I’m really talking about is where the burden of the taxation rests and the point is that individuals, not corporations, ultimately pay all taxes.
Increasing taxes on corporations means decreasing net income which means that either 1) shareholders (individuals) earn less on their investment, 2) employees earn less, 3) some employees lose their jobs, 4) consumers pay more for products or services, or 5) the company cuts costs and reduces the value to the consumer — or some combination of these. All of these options harm individuals not corporations. In fact there is no way to harm a corporation because a corporation is just the people who own it, work for it, buy from it, sell to it or are otherwise impacted in some way — all are individuals. In other words, punishing corporations is really punishing individuals.
Of the five options above it sounds easiest to choose #1 which is to let shareholders earn less. The problem is that these shareholders are mostly regular people, not Gordon Gecko or Thurston Howell III. Most “investors” are employees and small business owners with investments in 401-Ks and other retirement plans.
The bottom line is that raising corporate taxes hurts the American worker and takes money out of the pockets of regular people. None of the five options listed above enhances anyone’s job security or helps anyone get a raise. In fact, the opposite is true.
So the next time you are listening to or participating in a debate about the level of corporate taxes you will be equipped to share the truth that taxes are really only paid by people and not companies.
A client recently asked if I would share a few thoughts on what a bank really looks for in approving loans and determining rates & terms. Those of us in banking often assume that everyone knows these things and we need to do a better job as an industry of helping our clients in this area. Here are THE top factors, which are collectively known as the 5 C’s of Credit (because they all start with “C”):
Character – Self explanatory. If you have trouble maintaining strength of character none of the other factors matter. We were considering a loan in the summer of 2011 that was very strong from every angle, except one — character of the borrower. This was someone used to getting their way and responded very poorly (threatening, yelling) to one of the terms we requested. The borrower tested the market and realized that this request was standard across all banks. They came back to us offering a sincere apology after realizing our overall terms were very reasonable compared with other bank’s offers but we were chose not move forward with the loan. If this borrower made threats early in the process what could we expect after the loan was extended?
Capacity – This is excess cash flow after expenses. The better the cash flow, the better the chance the loan will be approved. Cash flow is different from profit. Profit is an accounting concept and doesn’t have much influence on a loan approval. One simple way to think of profit vs. cash flow is this — you can’t take profit to the store to buy milk & bread but they do accept cash. Going more deeply into profit vs. cash flow is beyond the scope of this post but I’ll provide one VERY simplified example that may shed some light. A company that has low profitability may still be a good borrowing candidate if they have significant non-cash items on the income statement such as depreciation. If the company shows a net-loss (negative profit) of $100,000 but has $1 million of depreciation then they have $900,000 of positive cash flow. This example assumes depreciation is the only non-cash item for this company but there are many other factors besides depreciation that can negatively or positively affect cash flow.
Capital – This is another term for Net Worth, which is determined by subtracting liabilities from assets. Assets are what you own and liabilities are what you owe. The more capital a company has, the more evidence that there is a commitment to the business. Lower capital indicates that the owners have taken too much out of the company leaving it without a firm financial foundation.
Collateral – Collateral represents one or more assets offered as security for a loan. If a loan is not handled as agreed, the bank will convert these assets to cash to pay off the loan. The more easily the collateral is convertible into cash, the more value it has as collateral. Two examples:
- “Liquid” assets such as a publicly-traded stock portfolio can be quickly converted to cash to repay the loan.
- An art collection is not as attractive as collateral because the bank has to find & take ownership of the art first and then find buyers. Certain items of art are only valuable to certain individuals so selling art may not be an expedient process.
Conditions – Conditions represent the overall environment in which the borrower is operating. If the company recently lost their top three sales people, there may be questions about the future viability of revenues. Conversely, the bank may be comforted if it sees evidence of employee stability, strong demand for the company’s products/services, and recent successful cost-cutting measures.
In addition to the thoughts offered above, it is also a good idea to communicate frequently with your banker instead of waiting until the annual renewal of your line of credit. Here are some ideas:
- Include the bank on periodic press releases
- Ask you banker to lunch every few months. They should ask you but take the lead if they don’t.
- Send quarterly financial statements even if not required in the loan agreement
- Proactively communicate material events in the life of your company — especially negative events. It is better to mange those communications than have the issues discovered in the loan renewal process.
- Send your banker quality referrals from time to time (you should expect the same from them). This is a factor that is definitely considered in a favorable light. The bank is in business to make a profit and if your referrals help the bank then your loan request may be considered more favorably. The difference will not likely be seen in the approval of the loan (a bad loan request will not be approved no matter how many referrals the bank receives) but instead in more favorable terms.
I hope that helps and would be glad to answer any clarifying questions. Happy borrowing!
Around 11 months ago I boldly predicted we would see imminent inflation which would lead to rising interest rates and I was wrong. I was partially right about the inflation. Food and commodity prices rose significantly over the past year and then moderated somewhat recently. But no increase in rates. In fact, we have record low rates. So what’s the story?
I had lunch recently with a guy who advises mega-investment funds on Wall St. We discussed inflation in relation to money supply and he almost sheepishly said his research didn’t reveal much of a correlation. He said the only consistent correlative factor he could find was the percentage change in the labor force — not the unemployment rate but the number of people in the workforce. As more and more baby boomers are retiring, the pool of workers continues to decline. He even had a chart going back to 1930. Two statistics that travel together are not necessarily correlated but his argument was quite compelling.
His basic contention is that when you are working you are spending; when you retire and leave the workforce you stop spending because you don’t know how long you’ll live and don’t want to run out of money. After hearing his argument I started looking around while at places people spend money like restaurants and malls and there really aren’t very many people 70 or over frequenting these venues. So the logic goes like this — more boomers retiring = less spending. Less spending = less incentive for businesses to start or expand = fewer borrowing needs. Fewer borrowing needs = less demand for loans = lower rates.
There are a thousand other factors that influence rates to varying degrees but that was one I really hadn’t thought about. If he is right and if changes in the pool of workers is THE major factor then we’ll see low rates for at least another few years.
Assuming the above is true, here are some practical issues to consider:
– If you are counting on higher bank deposit rates to supplement your income, look elsewhere because money market and savings rates will be minuscule for some time to come. Check out safe, conservative options like whole life insurance with a reputable company like Northwestern Mutual or Guardian. Ask your agent about over-funding the policy.
– Business and personal loan rates will stay low for at least another 18 months and maybe much longer. No need to rush to refinance your mortgage but if your rate is in the high 4% range or higher look into refinancing now. Rates can’t go much lower.
– Residential real estate prices will remain low for years to come. Don’t look for your home to produce equity from appreciation and don’t think of retirement properties as investments.
– Think “niche” — every major market change creates opportunities for those who can see the big picture and have the willingness & ability to make an investment of time and money.
– If you would like to borrow personally or to invest in your business, interview several bankers. Banks are hungry to make loans right now.
I would enjoy hearing and unique thought on rates or the economy in general so please comment below or send me a note if you have any.
A very real post from a real banker (not a Wall Street bank) who serves very real clients including many business owners that have very real and very hard choices to make every day…………
The idea that you can raise taxes on the rich without hurting the employees that work for them is the product of a simple-minded theory-based group of people that in my experience and with few exceptions have never owned a business and never had to make payroll. This is how a real business owner thinks with regard to hiring: “If we’re making a profit we’ll try to hire another person to extend that profit further and we’ll keep hiring until it doesn’t make sense from a profitability standpoint to hire any longer.” As with many of my examples, that is a bit of an oversimplification and there are certainly exceptions but think about it for a minute and you’ll realize how true it is.
On the other hand, if they are not making a profit they’ll start cutting expenses until they have an economically viable model. For almost every one of my clients, payroll is the biggest expense which means layoffs are almost always a consideration when expenses need to be cut. I hope everyone can agree on at least this much.
Here is a fictional example to show how it works in more detail — Take a small business that employs 10 people and for the purpose of the example assume they all do the same thing at this business. Obviously this is not realistic since responsibilities are spread among sales, administration, finance, etc. but just suspend that knowledge for this simplified example.
Every business owner or team/division manager knows the value each of their employees brings to the company. In the case of our fictional, simplified company, employee #1 brings the most value and employees #9 and #10 bring the least. Value may be defined in terms of revenue enhancement or expense reduction but there really is no other way for an employee to bring value in an economic sense.
Before I get to the tax issue, I’ll touch briefly on why those who employ others are justified in expecting to make more than their employees. It really boils down very simply to risk & reward. Business owners take risks every day in many forms including taking on personal responsibility for company debt, the personal liability (primarily civil) that comes with running a company, and the fact that they are typically “all in” with the business. An employee can often simply change jobs (obviously more difficult in a tight labor market) if they don’t like their current role but a business owner doesn’t have the same luxury. They invest years of their lives in making an enterprise work and if it is not working out for them they can’t just switch to a new company without nearly certain economic loss. All of that to say that those that take the risk can reasonably expect more of the reward (how much more is up to each individual to decide).
Back to the tax issue……….assume for this discussion that the employer in our fictional example decides that a fair amount to expect in after-tax profit for taking on the risks and hard work is $300,000. Otherwise, they will shut down the company, give up all of the risks & hard work, and get a job working for someone else even if for a lower amount. It doesn’t matter if you or I or anyone else thinks this number is fair because this is a decision reserved solely for each individual business owner.
Assume the business owner is earning an after-tax profit of $300,000 which is her minimum requirement. Now assume her business’ tax rate increases from the current 35% to 39.6% as will occur if the Bush tax cuts are allowed to expire. Further assume that this will reduce her after-tax profit to $285,000, below her minimum requirement. Her first move will not be shut the company down but to determine how to cut expenses. Again, since payroll is typically the largest expense, employee #10 is at risk of receiving a pink slip.
If on top of higher taxes you add dramatically higher health insurance expenses or other factors that further strain profitability, then employee #9 will likely be laid off too. The other 8 employees that remain, including the owner, will have to work harder to make up for the lost productivity.
This really is the way that real business owners who are facing real economic challenges think and make decisions. You can argue whether or not any given level of profit is fair* or that employers shouldn’t fire employees but instead personally take a pay cut but in reality the example above is very common. And in reality, there are tens of thousands of business owners that aren’t making a decision to cut their compensation from $300,000 to $285,000 but instead are running businesses that are making far less. Many of these individuals are facing very difficult decisions and will have to lay off employees (irrespective of whether taxes increase or not). Increased taxes will only damage these companies further.
Repeating a sentiment from my last post, this is not a political commentary but instead a simple issue of mathematics. Like everything else in life, businesses are distributed along a bell curve of profitability. Many employees of companies in the tail of the wrong end of that bell curve will (not “may” but “will”) lose their jobs if taxes on businesses increase. The search for the elusive concept of fairness* will harm many of those it is most intended to benefit.
*Life is not fair. It never has been and never will be. This part probably belongs in a personal blog and not one for business but, in my opinion, over-emphasizing fairness can be a distraction from the more noble pursuit of simply doing the best possible every day with what we have been given.
Recently the Fed announced it would buy $600 Billion of Treasury securities and called the measure “quantitative easing”. There are plenty of articles out there that can explain this but here it is in a nutshell…………The federal government is printing new money and using it to buy Treasury debt. That’s right; our gov’t is printing money to buy securities from itself. Sounds great — just print more money and we’ll never have a problem again!
Here’s the problem — printing new money ultimately will cause inflation which is most harmful to the poor and those on a fixed income. Inflation has been held at bay for several key reasons including 1) an enormous amount of cash is sitting on the sidelines waiting for positive economic signs and 2) since people are not spending money, the “multiplier effect” is currently very low. The multiplier effect occurs when the baker sells a pie and uses the money to buy shoes which allows the cobbler to buy a shirt from the tailor and so on. When the baker isn’t selling as many pies, the rest of the system slows down too.
When economic activity picks back up it will do so in a relatively short period of time. People will reinvest their money and the unemployment rate will decline significantly causing the multiplier effect to improve………and the newly printed dollars will still be out there. The combined effect will result in inflation and some say extreme inflation. Those who would argue that the Fed can just as easily sell Treasuries as it can buy them (and in the process slow inflation) are missing the point that the Fed and the White House are not opposed to the idea of inflation.
Devaluing the currency (allowing inflation) is, in effect, a method paying down national debt. If inflation increases by 10%, we will have essentially repaid 10% of our debt. This is a slight oversimplification but it is a long-standing strategy used by governments with overwhelming debt burdens………just print more money to pay the debt and kick the can down the street by signing the country up for future inflation.
Again, those hurt most by inflation are the poor and elderly who are on a fixed income. A family that has $2,000 in monthly expenses will now have to pay an extra $200/month for those same expenses. $200 is a lot for a low income family and can be the difference between eating two vs. three meals a day or deciding they can’t take their sick child to the doctor.
The answer is NOT more government programs or higher taxes. The answer is for us all as a nation to collectively decide to live below our means. Unfortunately, since we are already in difficult economic times that will hurt a lot more for some. For the family that decides to drive an 8 year old car for another three years vs. getting a new car, there might not be too much pain. For the family that has to decide whether or not to take their child to the doctor, the pain is much higher.
“Austerity” will be a word commonly used over the next few years and for good reason. There really is a limit to the benefits governments can provide as we’ve seen from Greece and now from Ireland & Portugal. It is not a political issue but a math formula………too many people draining too much too much from the system + not enough people contributing to the system = insolvency as a nation.
By printing another $600 Billion, the Fed has effectively kicked the can down the street but time marches on and there will be a price to pay eventually in the form of inflation.