Title: Enterprise Bank's Leader, Chuck Leyh: Accountant, Banker and Deal Maker, Part 1
Subtitle: A two-part discussion with a successful banker fulfilling a COMMON BANKING need with an UNCOMMON BUSINESS solution.
“Being a banker is like being the pilot of an aircraft. It is years of boredom and seconds of terror.”
Kelly Coughlin is CEO of BankBosun, a management consulting firm, helping bank C-Level officers navigate risk and discover rewards. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank and Merrill Lynch. On the podcast, Kelly interviews key executives in the banking ecosystem, provide bank C-Suite officers, risk management, technology and investment ideas and solutions to help them navigate risk and discover rewards, and now your host, Kelly Coughlin.
Greetings, this is Kelly Coughlin, CEO of BankBosun, helping bank C- suite execs navigate risks and discover reward in a sea of threats and opportunities. Being a banker today is an enormous challenge. I like to say the three “Rs” that are constantly threatening and challenging then are risks, regulation, and revenue creation. And within each of the three “Rs” you have varying layers of threats.
In the risk bucket you have cyber risk, operational risks, compliant risk, market risk, interest rate risk and, of course, credit risk. That is the risk that in your core business, lending, you make a bad loan and it doesn’t get paid back. There are some great quotes on banking in the lending business. Warren Buffet says, “Banking is very good business if you don’t do anything dumb.” Carl Webb, Co-Manager of Ford Financial Fund said, “Banks get in trouble for one reason, they make bad loans.” And now you have an ironic quote from another now infamous banker, “Irrational lenders come and go, but mostly they go.” That’s from John Stumpf, former chairman and former CEO of Wells Fargo. And, of course, Stumpf was the banker who appeared in front of Congress a while back and got completely hammered, rightly or wrongly, and now he, just like other irrational lenders, is of course gone.
And then you have one of my favorite quotes from Fred Schwed, author of Where are the Customers Yachts. He writes, the conservative banker is an impressive specimen. He spends his day saying, no. He says yes only a few times a year. His rule is that he reserves his yeses for organizations so wealthy that if he says no some other banker would quickly said yes. His business might be defined as the lending of money exclusively to people who have no pressing need of it.
In summary, he affirms what Bob Hope, one of my favorite comedians of all time, said, A bank is a place that will lend you money if you can prove that you don’t need it. Consequently, because of these dynamics banks typically are not the place one goes to get early stage or startup or venture or distressed or risk capital for a number of practical reasons. Regulators don’t like it. The revenue could be tricky to accrue, especially when collectability is either not assured or perhaps uncertain.
Bank auditors are frequently stuck in an audit review model that challenges their ability to think outside the box on revenue recognition collectability. The end result is only a few banks step into this world of lending to companies who truly need it. I came across a bank, a while back, that breaks the mold on this. I was frankly looking at some historical financial data on banks.
As most of you know, I spend a significant amount of my time helping community and regional banks improve their revenue growth rate by improving their ability to compete with big banks, brokers and advisors. So, in doing that research I came across a very unique bank located in Allegheny County in a suburb near Pittsburgh PA. The bank is fairly traditional in a few areas. They accept deposits. They make personal loans. They make business loans and they sell some insurance products. I don’t believe they provide wealth management or trust services but it’s where they are unique that really got my attention.
Number one, they offer consulting services. Number two, they offer book-keeping services. Number three, they offer marketing services, and number four, they offer temporary services, primarily, temporary short-term CFO type services. Number five, they lend to the small business, the startup and the small distressed business market. And most importantly, their uniqueness is most apparent in its five-year cumulative annual growth rate of approximately three times the industry average. They have a growth rate of 25 percent and the industry average is about 8 percent. And with that type of uniqueness, I decided I need to talk to this company.
So, with that in mind, I hopefully have the CEO and chairman of the Board of Enterprise Financial Services group, Chuck Leyh, located in Allison Park, Pennsylvania. Chuck is a CPA with more than 30 years of experience in public accounting with an emphasis on tax and business consulting and he has experience in business analysis and business valuations and he is a member of the AICPA and a member of the Pennsylvania Institute of Certified Public Accountants.
Hopefully Chuck is on the line. Chuck, are you there?
Chuck: I am here.
Kelly: Chuck, how are you doing today?
Chuck: Very good.
Kelly: Well, did I make any mistakes in my introduction there?
Chuck: No, I think you kind of covered it. I’m not sure the growth rates are quite what you have stated but certainly over a long haul they have been very significant.
Kelly: I just took some summary financial data prior to today, you are substantially higher than the industry average?
Chuck: Yes, yes, we do a lot of, as you stated, startup businesses, businesses in distress, means we do a lot of risk mitigation with SBA, real estate, and what traditionally happens is in more challenging economic times we have more loans than we know what to do with. And in the competitive times is when it becomes more challenging for us to grow, because the economy is strong and a lot of business are healthy and banks are out lending and there is a lot more competition and there are not as many people, believe it or not, starting businesses or going through distresses when times are strong, and when times are weak those trends go up and that’s when we typically grow a great deal.
Kelly: Chuck, I have a lot of questions here but before we kind of get into the guts of this let me ask you this, are you fundamentally an accountant or are you fundamentally a banker?
Chuck: I am fundamentally an accountant. I still am a partner in a CPA firm and that’s what my chosen profession was. Twenty years or so I got this bright idea with some friends to start a bank and after a few years it wasn’t doing what it was supposed to. So, when you usually start something with your friends and clients they look at it and say, yeah, this isn’t working out here, well, you got us here, you better go fix it. And so that’s kind of how I got into banking.
Kelly: Alright, let’s talk about the history of enterprise. Is this first-generation enterprise or does what we see now kind of the second generation after you have fixed this version?
Chuck: So, this is the same business concept. Basically, this business concept grew out of me having a friendship with a banker and looking at modeling out a business plan. The way I kind of created the business plan to model out was to go to my accounting firm clients and get a list of the things they did not like about banking and see if I could draft a business plan that address those issues, and that’s kind of how this whole system grew. It wasn’t run quite the way it was intentioned and it struggled for a few years and, like I said, that’s been how I got into it on a day to day basis. And I have continued for the last 18 years to oversee day to day operations and turn things around and put it on the right foot.
Kelly: The version of enterprise that we see now, what was the market and was the opportunity? What void did you fill?
Chuck: I think, when you go back to when we started the bank, that list of things that my clients didn’t like about banking, there was basically a few premises and we kind of built a plan along that line. The lack of continuity in relationships, probably a lack of business empathy, and almost, what I term, the phase banker’s arrogance, where bankers felt that they know how to run a business better than the business person. So, that was kind of one issue and, obviously, the other was continuity where things get in our relationship, those people get promoted, move on and you start all over again trying to educate your bankers as to how your business run. And probably the unique focus of Enterprise Banking structure was to address those two issues.
And one of the ways that we did that was to create a relationship manager concept where, that’s not unique, every bank has what they term relationship managers, but in this situation a relationship manager functions as a small business inside the bank. Basically, it’s treated as the branch gets its percentage of revenue based on the bank’s net interest income, monies to bad debt reserve, which we build and allocate on a per loan basis. So basically, they get a percentage of that and out of that you hire their staff, have fringe benefits, expenses, whatever it is that all run through that little business unit.
By them running their own business inside the bank, it kind of address the empathy and the continuity because they don’t get promoted or anything else. The stronger, the larger the branch gets, the more money they make so they get empathy and get rid of that banker arrogance by running the business themselves. So, they experience the same problems their clients and borrowers are experiencing. The continuity issue is addressed because they are in that position and that’s a lifetime relationship type position like a CPA would have with their clients.
So, that’s a kind of a unique situation in the bank and a lot of it is quality assurances and checks and balances and everything that revolve around that structure and that structure was created to address those two basic issues.
Kelly: At the parent bank level, is there a credit committee that approves any sort of investment that the bank would make then?
Chuck: Yes, there is actually in this bank, one of the problems that we created to address was the timely decision on credit. More than, if there was a “no”, setting goals for people so that they can address those goals and perhaps come back and then have a different answer if they have taken time to prepare themselves better for the lending relationship. And so, because there is a senior loan committee that’s actually made up of board members that meets weekly and it addresses all the credit requests.
So, the relationship managers have a financial stake in what happens with the loan. And, obviously, that is something in their minds and it has to pass their comfort level before they will introduce it to senior loan committee. But the senior loan committee then is the ultimate approval source so, pretty much, every relationship and loan, so that there is a strong checks and balance in the system.
Kelly: So, in terms of the types of deals that you guys do, let’s just talk about the nuances of the start-up business. Are you looking for deals, whether it be a startup and that their cash flow is limited but there is some sort of a asset protection there that you have got some collateral protection?
Chuck: Yes, as I am sure you are aware, most banks emphasize historical consist in cash flow as the basic foundation for assessing risk for making a loan.
If you have a start-up business or a business that’s gone going through distress where it has lost money for a period of time, you don’t have that cash flow continuity and strength to support the lending relationship. This is still a bank. It still takes bank risks so it reverts back to looking for an underwriting that’s almost a worst-case scenario. It almost assumes that the business will go under then it looks at it and says, can we assess the risks and protect ourselves? And that typically then leans towards collateral of some sort or government guarantees that mitigate the risks if there is not enough collateral so that the elevated risk of failure is offset by this collateral that mitigates the amount of the losses potential.
Kelly: Your success in the distressed business vertical, if you will, versus the startup.
Chuck: I don’t know that there is a whole lot of difference between the two. Actually, the distressed area is a different type of thought process and underwriting. You know, when you have a startup, business projections are never what reality ever is in either business. So, you are kind of looking at the management background, the experience level, the concept and, is it a well thought out program? That’s what you are sort of looking at for the startup program.
But, it’s a little different with the distressed business because in there, typically you come in and they have been successful for a period of time, now they are going through a problem and you have to assess that problem. Is that the real problem? Do they have the fix identified? And you believe that fix is the only thing that’s necessary. And so there is a little bit of an analytical difference between the two. Both, you have to have a good sense that management has a hand to hand, either in the start-up situation or the distressed situation but the validation is a little different in the two different scenarios
Kelly: I don’t need to tell you that management is first and foremost a factor to be evaluated, how are you doing in that area, and especially in the stress mode where you have management that kind of attribute their distressed situation to market factors as opposed to themselves and their own management decisions?
Chuck: I have been in the marketplace for 40 years and you have kind of seen a lot of examples of good and bad management, you’ve seen a lot of examples of mistakes and people learning from their mistakes or basically saying it’s somebody else’s fault. And so you kind of go through the situation and you see how people analyze the situation, how they take responsibility for it and what their game plan is, moving forward.
And that is the intangible analysis you go through to try to assess your probabilities for success, but, ultimately, in this type of lending you are going to have a lot more failures than you will in a traditional bank environment. And so you have got to stress the collateral practical liquidation analysis and assess the risks a little differently based on collateral. Because until you experience somebody first hand going through distress and pressure and how they react to it, you actually don’t know for sure how an individual’s character will hold up to pressure.
Kelly: The team you have that help you in the due diligence and acceptance of a deal, I suppose you are looking at their market plan, certainly their internal control systems, their accounting systems, all those core things to run the business but, in my opinion, businesses typically fail on the revenue side, not so much on the back-office side. How do you guys go about really evaluating the revenue projections and their ability to get their first customers, if they are a startup; or to substantially increase their ability to get customers, if it’s a turnaround?
Chuck: There are obviously, based on the pedigree of management, the experiences they have, the type of idea, the amount of competition, all of those things, that are into a risk analysis and then you look at that perceived risks and then you mitigate it with either collateral or guarantees or something else.
As a CPA and as a banker, the one thing I disliked with when bankers would tell my clients that that business plan doesn’t have a prior, it will never generate to revenue, and then five years later those people are multimillionaires because they really did know what they are doing. And, you know, that banker arrogance is again the thing that you watch because just because a revenue is planned doesn’t seem to make sense to you, it doesn’t mean it doesn’t have the chance of success.
The most successful people are the people who does something unique and outside the box. Because you haven’t seen it succeed you feel there is a greater risk. You want to try to balance that mind set so that you don’t turn down a deal because the revenue is not apparent. But you do look at the deals where you are more skeptical of the revenue and you say I want more protection with collateral or more of a government guarantee or more some risk mitigation when I don’t feel real comfortable or think this revenue stream is going to happen soon. And every situation is done on a case by case basis, and that is the key.
In a small bank like this where everything is customized to the specific circumstances you don’t have prepackaged products. You try to design something just for that particular client. For instance, somebody starts up a driving range and they come in and say, you know, I have a better idea and I can do a better job running the driving range, my people skills, my networking, my background. Well, you look at those kind of things and you know it’s going to take time for reputation to grow, you know things are going to have to work out in a certain way and you know there is going to be curves and steps backwards, you know, the best of us, hopefully, take two steps forward and then one backward. It’s inevitable to happen.
So, you start to look at the design, for instance, you might go say, okay, clearly these people don’t have any revenue from say, November through April, well, then you may design a loan structure that it goes interest only in the off season and then it kicks up to a greater than normal principal and interest payment on the in season so you kind of help them budget themselves and help them structure things. And you advise them in that relationship as to how you are going to mitigate your risk in the off season in the business plan.
If you have a facility where you can conduct parties or do something in the off season or some other revenue that complements the off season to get rid of some of the cyclical nature of the business. And then you start to look and see how does that perspective borrower react to your advice and your thought process. And all those things come together to determine whether it’s a relationship you want to work with or not.
Kelly: Let’s say, a term of the compensation on these deals, are you taking any warrants, options, any sort of equity or is it straight interest rate?
Chuck: We haven’t done that up to this point in time. It has been a straight interest rate. I will say that up through the recession, the spread for taking this kind of risk when you are using the SPA, for instance, they will have a maximum rate that you can charge and have a guarantee.
The spread that you got from your cost of funds to the rate that you would get for doing this type of lending was significant, the money was very good. I will say that since the recession, flattening of the interest rate curve here, recently, but really since the recession that margin shrunk a lot and so we are looking at different ways to perhaps supplement revenue to get the margin back to where it was say 10 years ago versus where it is today.
Kelly: Right. Like any bank, your core source of funds are going to be customer deposits and you always have some assets to liability risk management you have to do there, are you able to get sufficient deposits from your customer base, knowing that this is your business model, so are they fearful of that?
Chuck: Actually, when we work with a client obviously we are showing a loyalty towards them that the other banks aren’t showing because we are doing a loan that others won’t do. We kind of expect that loyalty to come back so we’re kind of writing things upfront that says if we are going to take this risk loaning you this money. You have got to have your operating accounts with the bank. Everybody is pretty good about that and obviously when the businesses become successful and strong and get out of their start up period then deposits can become very significant.
And that funds a big portion of the bank but we are not a retail consumer oriented group so that’s our sole client base and small business deposits is not sufficient to fully fund the operations. So, we will go in and do borrowings from federal loan banks, we will do self CDs, you know, and then use even a broker CD market, as long as the funds are reasonably priced, and competitive with home loan bank borrowings. We actually push our class of funds higher than most banks because while we are taking what most would deem to be more credit risk than most financial institutions, we take extremely low credit risks and interest rate risks.
So, what we are giving away on the credit risk part we are taking back on the interest rate risk part so that we have pretty much a neutral situation for our funding and our asset to liability management so that drives our cost of funds up also by having a lot longer term borrowings than a lot of institutions.
Kelly: Let’s talk about your consulting services that are packaged into your offerings. I see that you have got marketing, bookkeeping and temporary services and I believe that there are primarily CFO services, what purpose do they fill and are they important to your overall offering?
Chuck: Well, they are very important, especially to the start-up businesses. And the original premise of forming the bank was to make banking into a service value oriented proposition versus a purveyor of money. The concept here with a relationship manager is to be a consultant, a financial consultant similar to a CPA. But CPAs are typically more in a tax oriented consulting approach and then some general business consulting, and these people are a more general business consulting, finance consulting. That’s the training they get, to be a relationship manager.
Now, the subsidiaries that we have, given to more of a specific and stronger expertise in certain disciplines, whether it is real estate, marketing, bookkeeping services, IT services, and then general business consulting with different specialties niches so that when, you know, a startup business has the idea, if you build it they will come. We all know it doesn’t work that way, people have to know about it and so our marketing people will take it to the next level. And what it does is, it improves the probability of success for the startup businesses, and obviously that has a strong synergy with the bank because it improves our success rate and reduces the bad debts.
And at the same time, we price the services that we are not making a big profit on it, we are making some money on it and then that synergy of making our underlining businesses get stronger. Those two things together create a strong value for the bank and for the client. When we have a new relationship come on board from a borrowing perspective we do analyze and have our consultant go out and look at their accounting system and make sure that they have the capabilities to report to us the way the loan documents require. And we have somebody from our IT subsidiary go out and review their computer systems to make sure that they have a security level that makes it safe to do business with us and them.
And so those two things are looked at and if they identify a problem then we go to the client and say, you need to beef up these areas and if you want we can help but you don’t have to work with us or you can find anybody but there is an issue here. So, those are the two areas we look at where we say there is a certain level we have to get to but we never go with our people and say you have to use them or something like that. If the client wishes to that’s great, if they don’t then so be it.
Kelly: Oh, that’s very smart, very smart.
Chuck: Most of the clients have assembled a team of people and we are more than happy to work with that team of people. Let’s say, if something doesn’t work and that team drops the ball somewhere that’s typically when our people starts to get involved. So, it’s more of helping a client and being there to pick them up when they stumble rather than try to push services and grow the service aspect of the business. This is a bank, we look at those services and seeing them being complementary to the bank, not so much as a huge profit center in and of themselves.
Kelly: Do the cost and the revenues from those services, do they run through the bank or do they go through a consulting subsidiary?
Chuck: They go through a subsidiary but they get consolidated but most of them are operated a little above break-even but not much. And that’s how the pricing is affected to keep it almost overly competitive so that people that are going through distress can actually afford to get the help.
Kelly: I love that business model. I really do. In terms of your footprint, where do you operate geographically?
Chuck: It’s pretty much Allegheny County and the bi-contiguous counties but what really drives it is not so much a geographic distance. That is something that with remote banking and all the electronic world, the way it is today, geography isn’t really an issue. What is important for us is the evaluation of collateral and the accretive evaluation, and if we get into a troubled loan, having it be within an area that we can dispose of assets to get our money back.
And this bank does some things pretty unique in that area and like, for instance, many times when you reap with us a piece of property and it’s in a distressed situation we can actually have a little subsidiary that comes in, repairs the facility, gets it ready for market and then our real estate group goes and sells it. And so in this particular bank we are not sitting there selling a distressed property at thirty cents on the dollar. We don’t do that. We go in, we make sure we fix it up so it’s presentable and it’s safe and then we’ll market it in a conventional sense and market for its fair market value. You have to be close enough to our Allegheny County location for us to efficiently carry out that aspect of the business plan. And so it pretty much runs in western Pennsylvania.
Kelly: That’s terrific. That concludes part one of my interview with Chuck Leyh, CEO of Enterprise Financial Services, in Allegheny County, Pennsylvania. In part two we are going to talk to Chuck about how his unique business model presents challenges in dealing with both regulators and the auditors.
Thanks for listening.
We want to thank you for listening to the syndicated audio program, BankBosun.com. The audio content is produced and syndicated by Seth Greene, Market Domination, with the help of Kevin Boyle. Video content is produced by the Guildmaster Studio, Keenan, Bobson Boyle. Voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin. If you like this program, please tell us. If you don’t please tell us how we can improve it. And now some disclaimers, Kelly is licensed with the Minnesota Board of Accountancy as a certified public accountant. The views expressed here are solely those of Kelly Coughlin and his guest in their private capacity and do not in any way represents the views of any other agent, principal, employee, vendor or supplier.