Title: Out of the Box Banker; Inside the Box Regulators, Chuck Leyh, Enterprise Bank, Part 2
Subtitle: A two-part discussion with a successful banker fulfilling a COMMON BANKING need with an UNCOMMON BUSINESS solution.
Date: July 25, 2017
Attendee and Guest: Kelly Coughlin, CEO, BankBosun; Enterprise Bank Chuck Leyh
This is part two of my interview with Chuck Leyh, CEO of Enterprise Financial Services in northwestern Pennsylvania.
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. Today is part two of my interview with Chuck Leyh, the CEO of Enterprise Financial Services in Allegheny County, Pennsylvania. For those of you who do not know your geography, Allegheny County is in western Pennsylvania.
By the way, the history of Allegheny County is fascinating, especially the period during the 1750s and 1760s, before the revolutionary war. During this time, the French and British were jockeying for position, power and control of the inter area of the U.S. and primarily the Ohio River Valley. In the U.S. we call this the French and Indian war but the Europeans call it the Seven Years War, and it was really the world’s first World War. And at the center of the Ohio River Valley was a small fort first established by the French at the spot where three rivers came together, the Allegheny, the Monongahela and the Ohio rivers. This spot was titled Fort Duquesne by the French but after they lost it to the Brits, it was renamed after the British prime minister at the time, William Pitt, of course, we all know it as Pittsburgh.
And at the center of Pittsburgh and Allegheny today is Enterprise Financial Services led by Chuck Leyh and his team. And they are doing some really really interesting and fascinating debt funding deals with companies who most likely would receive a big “no” from traditional bankers. But because Chuck’s team has included a number of due diligence, risk mitigation and value-added consulting services to their business model, he has created a very good business and a company with excellent financial results. In part one we talked about his unique business model and how it evolved and some of the critical value-add components. In part two we are going to talk about how this uniqueness presents challenges in dealing with regulators and his auditors.
Kelly: Okay, just briefly, you are dealing with regulators and auditors, I imagine those guys give you a bit of a hard time over your business model. Is that a fair statement?
Chuck: I would say that is an extremely fair statement. I would say that if I had known the way the regulatory environment was going to be migrate after the recession I would have never started the bank in the first place. I am a CPA by trade and whether you are a regulator or you are a banker, the generally accepted accounting principles govern the way we operate and the financial information that we put out and I have a very very strong belief that regulators do not follow generally accepted accounting principles and as a result makes it very challenging for banks to deal with startup businesses or businesses in distress.
Kelly: Is it mainly the revenue recognition challenge?
Chuck: Yeah, I think that’s a big big part of it. I’ll give you an example, if you look at GAAP There is terminology when it comes to revenue recognition and it’s basically, more likely than not probable. If it’s probable you are going to recognize the revenue you should and if it’s not, you shouldn’t. When you look at the way the regulators interpret things of that nature it goes beyond what the intent of generally accepted accounting principles, say, for instance, when we accrue revenue and a loan that may have a challenge associated with it, the regulations for the regulators that are interpreting that probability threshold, say that if you haven’t gotten a payment in 90 days you stop accruing revenue unless you are well secured and in the process of collection.
And that interpretation makes a lot of sense to me. If you haven’t got a payment in three months, clearly this loan’s cash flow is challenged and it’s affecting your probability of collection, unless you have a lot of collateral and you should start recognizing income. But the key comes into the way regulators interpret and their own regulation because when they say, stop recognizing income if you have a delinquency greater than 90 days, unless its well secured and in the process of collection, they interpret the term, “process of collection”, meaning that I have to show I’ll have my money in 30 days.
Well, you tell me in the legal world how you can go through a foreclosure and get your money in 30 days. Even if you are at 25, 30, 50 percent loan to value. It’s not possible and yet it is extremely probable that you are going to get all your money back. This is why you have small business people that they build up a lot of equity and say, okay, it’s time for me to try to start my business. I have spent years saving for it. I have got all this equity saved up, now I need a loan for cash to buy some things and have working capital and the banks will say no. And people look at us and say, what are you talking about? I am asking for $100,000 loan and I have got $250,000 equity in my house, how can you not do this? And the common sense approach is, I should be doing this I don’t have a risk of loss.
Except when a regulator tells you, well you can’t recognize any of the income and you know it might take two or three years to work out this loan. You have now put this capital out there and you can’t recognize income for two or three years until you have finished your collection. Well, you can’t wait for two or three years to show income. Now, that drives banks away from helping small businesses. It drives them away from helping businesses in distress and it does not follow generally accepting accounting principles. And you will not get a regulator that will back off of that issue. It’s just very bad for the economy, it’s very bad for the country and it’s a challenging environment to be in.
Kelly: I then asked Chuck about an interesting disclosure in his management discussion and analysis for the fiscal year ending September 30, 2016. The difference between management’s application of GAAP and the regulator’s application of the regs is evidenced most clearly in a year when the regulators require that all prior payments received as a result of collections from nonaccrual loans that had been recorded as interest income should now be reversed and recorded as principal even though the banks position was well secured.
The result was a big material difference in the financial statements reported in the bank’s call report versus the financial statements reported to the shareholders. Enterprise presented a very transparent description of the differences and the methods that triggered this, but I think you will hear Chuck talk about his ongoing frustration in having to deal with this. Let’s listen.
Chuck: No question about it, I’ll give you an example, we made a loan to a group who started up in business. They didn’t have enough to make the full down-payment of the GAAP required to put something down on full accrual but they did make a significant down-payment so that we were sure to get our principal back based on the property that served as collateral and other assets, and at least that was our opinion. The regulator’s opinion was, no, you are not assured so you should be on cost recovery.
So, for three and a half to four years this loan never missed a payment, ever, for four years never missed a payment. We never recognized one penny of income. Then in year four when the minor payment were sufficient GAAP tells you, you can retroactively switch back to accrual and all the deferred income comes in, in one fell swoop. So here you have, in our case, this was a large credit, this is a $2M credit. We waited for three to four years. This client never missed a payment, always had profit, always looked good. We couldn’t recognize income until year four and then all the income comes in, in one fell swoop from three to four years for this loan. When you talk about distorting income and creating a problem for shareholders and interpreters of a financial statements to try to understand what was going on. You can’t create a better example than that.
There just seems to be no recognition from a regulatory body that that’s a bad thing. You know, they all sit there and say, oh we are glad to see how it worked out for you. And nobody looks back and says, maybe you should be concerned that you misrepresented the financial information for the last three or four years. That doesn’t seem to be an issue for them. They are just very conservative, and that’s just the way it is. You know, a lot of people sit out there and say, why are bankers so tough on small business and why won’t they make the small business loans, and you hear all your clients say, when I need the money they won’t give it to me and when I don’t need it they will. Well, this is in fact the driving reason why.
Bankers aren’t bad people, but they have regulators that they have to deal with and what people don’t understand is, there is no way for me to get to court to get an independent evaluation of this. When the regulator makes this important decision, your only appeal rights are to the same regulator that made the decision and the only way we can get to court is to refuse to do what the regulator says. Then when they assess the fines against you it can be up to $10,000 a day for each director and senior officer and then we have the option to go to the court.
Well, think about this issue I had with that one credit and how it misrepresented things, do you think my directors wanted to take the risk of a five to ten thousand dollars a day penalty and it takes two years or so to go to court on an issue like that. And that’s their personal assets that they have to worry about. So, it’s a practical matter. A bank can’t even get to court to get a judge to rule on the thing and to override what you are doing so it’s a very challenging environment to be in right now.
Kelly: Yes, what’s in store for you and Enterprise? Your secretary says you are 60 years old, you have got another 15, 20 years left in you. Organic growth, acquisition, what’s the future there?
Chuck: We pretty much have decided on organic growth. Actually, two and a half years ago, three years ago, stock growth for a few years because we made a decision to let capital grow to prepare for the adjustments for Basel III and now we are going to have to look at it again, watching what is going to go on with the new CECIL changes and how it is going to affect capital. And about the time that we were contemplating what was going to happen with Basel III, and at one point we thought it wouldn’t be effective to the banks, at that stage we decided to double our overhead and prepare to double the size of the bank.
So, we doubled building size, infrastructure and everything else. And as soon as we were done doing that and ready to start kicking in for growth and now that we have the infrastructure to grow safely and soundly then Basel III kicked in and we had to table the growth for a few years until we accumulated capital. And we kind of finish that up about a year ago and started to grow again and so now our key is to keep growing and balancing profits and growth because we elevated our overhead intentionally, our fixed over-head, and now we need to grow into it so that’s the bottom line, built to where we wanted to be.
Kelly: What opportunities do you see?
Chuck: As much as I can sit there and seem negative with regard to regulators, it’s a great business environment out there and people are always coming up with new ideas and it’s just a lot of fun to be out there helping people work with their dreams and build their businesses. I think the opportunities are endless and we are in an area around Pittsburgh, Pennsylvania, where it’s a very large market and I think our opportunities are whatever we want them to be.
Kelly: Great. And financial services or any service business, your key asset, go home every day, take the elevator home every day. How do you tie them up? How do you secure them and where are the biggest challenges you have in fulfilling?
Chuck: Well, as I said to you before, the relationship managers and that concept of running your own business inside the bank is certainly those risk parameters, risk reward parameters are very unique to the banking environment, most bankers are not entrepreneurs. It’ challenging to find people that fit in that consulting relationship manager role but we don’t really lose them if we don’t want to in this scenario because typically they get there and they have that entrepreneurial drive and it’s hard for them to find that in banking. So when they get here it’s like they’ve found a great place and they are happy based on the concept.
So, it’s pretty easy to satisfy that group. And the senior management group where we have our chief operating officer and operations people and accounting people?the assets here are the people, they are not the machines, they are not the equipment. So, you have got to take care of them, reward them, keep them competitive with the rest of the market place and that makes it a fun place to work. We have a campus type setting here, we have an auditorium here where we put on programs and I speak to small businesses and they are involved. We have a gymnasium here, day care center. We have soft-serve ice-cream and pop and popcorn and so we try to make it a fun environment for everybody that it is something where they look forward to coming to work.
And it work out well because to be quite honest, the senior management group that we have recruited and we have really worked at, especially the last two or three years, developing a transition group, as I have gotten older and some others and so, you know, we try to create an environment that’s fun for them and it seems to be working because we haven’t had any turnover in those areas for the last 10 years. We are pretty happy with the way things are working out that way and it’s basically just taking care of people and creating an environment that’s fun to work in.
Kelly: Terrific! Well Chuck, I bet you are an excellent executive. That’s all I have, is there anything else that you want to add?
Chuck: Life has always get you challenges and you always seem to take a step back but as long as you are routinely taking two forward that’s just the way life is and you have to enjoy it for what it is and it’s a lot of fun.
Kelly: Great. Alright Chuck, thank you very much for your time. I really enjoyed it. Best of success going forward.
Chuck: Very good. Take care Kelly.
Kelly: Thank you. Bye.
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.
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