Category Archives: Guest Blog

CBA 124th Annual Convention The Economic Outlook: Key Takeaways

Screen Shot 2015-06-05 at 2.24.22 PMBy Christopher Thornberg, Founding Partner
Beacon Economics, LLC

Dr. Christopher Thornberg of Beacon Economics recently presented the firm’s economic outlook for California at the California Bankers Association annual convention. Business owners and managers of all types are wise to keep abreast of economic trends that may affect their industries and customers. As such, we are grateful that Beacon Economics has allowed us to share this summary with our clients and readers.

National Economy: What, Me Worry?

Eerily similar to 2014, growth in the first quarter of 2015 was much weaker than most analysts had expected, largely due to a sharp widening in the U.S. trade deficit and a slowdown in domestic consumption. But also similar to last year Beacon Economics believes this blip is largely transitory. Consumer spending, for example, seemed to be impacted by weather issues. With a still hot labor market, worker wages starting to rise, and a boost from lower energy costs, consumer spending is poised for growth. This view is supported by the savings rate, which rose by a full percentage point in the first quarter. Expect these savings to boost spending in the latter part of the year.

The weather also accounted for the slowing in construction—but not all of it. One big hit came from reduced spending on new oil wells, driven by lower oil prices. This will likely continue for a couple more quarters but will be offset, in part, by increases in spending on other types of structures. New home sales have picked up, as have permits for new non-residential structures, in many parts of the nation. Gains here should be more than enough to offset the slowing from oil exploration.

Trade continues to be a drag on the economy. The strong pace of U.S. growth has caused a sharp appreciation of the U.S. dollar. That will weigh on growth this year, but not as heavily as in the first quarter. The global economy appears to be stabilizing slowly, and with stimulus programs being put into place in China and the European Union, we see better numbers by the end of the year. Add it up and Beacon Economics expects the nation to get close to 3% growth this year, still better than last year but not by as much as initially hoped.

California: Go West Young Man!

Our ongoing optimism about the Golden State’s prospects bore fruit again this year. California is growing at well over a 3% pace. This translates into 500,000 jobs created in the state in the last 6 months, accounting for almost 1 out of 6 jobs created nationally and totaling 100,000 more jobs than created in Texas. While some of these jobs are in the red-hot San Jose and San Francisco economies (ranked 1 and 3, respectively, for growth in major U.S. economies) they aren’t carrying the state on their own. Los Angeles, for example, grew at half the pace of the West Bay—but that still implies that L.A. added more jobs in absolute terms than San Jose and San Francisco combined. And growth isn’t limited to the coasts—Fresno, the Inland Empire, and Sacramento all posted growth numbers well above the national average.

The biggest problem the state faces currently is its lack of housing and rapidly declining levels of housing affordability. California can grow more rapidly as long as there is slack in the workforce. But at the current rate of job growth that slack will run out in the next 18 months. After that, growth can only continue on the basis of net migration—not easy when there isn’t even enough housing construction to supply the needs of natural increase (births minus deaths). Unless something dramatic is done to deal with this chronic problem, expect growth to slow in a couple years.

Credit Environments

The credit environment is still improving. Delinquencies and charge-offs continue to decline for all classes of loans. Banks have similarly been reducing their loan-loss reserves in response. Despite this, however, the pace of bank lending remains subdued. Growth in direct loans has been running in the 6% to 7% annual range, lower than the typical 10%. C&I and Commercial Real Estate continue to run hotter than normal, consumer loans cooler, and residential loans are still in decline. The slow recovery in housing as well as the ongoing struggle with new financial rules and regulations has limited the available supply of credit to potential borrowers.

California based banks continue to buck the trend on this front. Outstanding loans grew at a 16% rate through the final quarter of last year, driven largely by C&I, construction, multifamily, and commercial real estate loans. Even housing has changed course in the state. Loans tied to residential properties grew by 12% over the course of 2014.

So far there are few signs of problems in the credit markets. Auto loans being made by non-financial institutions did show some increase in delinquencies at the end of 2014—likely due to the aggressive push in sub-prime auto loans by these entities. And valuations for tech firms seem aggressively high relative to profits. But a true financial crisis is not caused by modest front line trends. Rather the issues have to be much more broad based, and equivalently, have to be accompanied by an expansive increase in overall credit. Today, credit is flowing at a pace that matches economic growth, or in other words, the debt to GDP ratio is at a reasonable level. No worries—at least not yet.

As for rates, the 10-year bond remains steady at 200 bps, while the Federal Reserve has stayed the course. Estimates of Fed tightening actions keep getting pushed back largely on the basis of current economic conditions. We always expect very slow action on the part of the Federal Reserve. Forget equity prices; it is leverage that worries the Fed most—and leverage is not expanding in any troublesome way right now. Equivalently, the share of discouraged and underemployed workers, while falling, is still high from a long-term standpoint. There isn’t much of a punch bowl to take away.

Low interest rates, and high valuations on many assets, is a function of the wave of capital crashing onto U.S. shores without many places for it to be absorbed. Until the global economy returns to a sufficiently aggressive growth plane and can re-absorb some of the liquidity, Beacon Economics sees low rates, low returns, and high valuations as a part of the financial landscape for at least the next few years.

For additional information about Beacon Economics or Christopher Thornberg, please visit www.BeaconEcon.com.screen-shot-2016-09-13-at-11-07-51-am Dr. Thornberg’s complete PowerPoint Presentation is now available on the Beacon website.

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Is Exit Planning Worth the Time and Money?

By Keith Eck, Founder and Owner of Keith Eck Financialscreen-shot-2016-09-13-at-11-07-51-am

Keith Eck

When we talk to business owners about the value of Exit Planning, we are talking about orchestrating a business exit that fulfills their unique financial and personal goals. Since tackling a task of this magnitude can be daunting, owners sometime ask whether devoting the necessary time and money to this project is really worthwhile.

To answer that question, we’ve asked Kevin Short, an investment banker who works every day with owners of small and mid-sized companies, about the value of Exit Planning.

“Good exit planning can be the difference between a successful closing and a complete derailment of the sale process,” says Short.

When asked to explain, Short focuses on Steps 1, 2 and 3. “When an owner sets his objectives in an Exit Planning context (Step 1), he or she does so methodically and proactively. Owners who wait until entering the M&A arena to decide how much cash they want and need from their companies do so reactively and often are blinded by attractive bait held out by less-than scrupulous buyers.”

In Step 2 of the Exit Planning Process, owners and their advisors place a value on the owner’s company. “When an owner’s first valuation experience happens in my office, and that owner is primed and ready to sell last Friday, learning that the company is not worth what he or she had hoped is a painful experience. Even more painful is the subsequent re-dedication of effort to building the value of the company.”

In Short’s opinion, “The element of Exit Planning that gives an owner the biggest bang for the buck is, without a doubt, Step 3 of The Exit Planning Process (Build and Preserve Value).”

One technique that exit planners use to motivate managers to remain with a company post-closing (a vital Value Driver) is the Stay Bonus. An effective Stay Bonus accomplishes three tasks: 1) it gives the key managers a reason to stay; 2) it is structured so that it increases the value of the company, and 3) it includes a penalty (usually in the form of a covenant not to compete) that prevents key managers from taking key clients, vendors or trade secrets with them should they leave before or after the sale.

Short can rattle off far too many horror stories about owners who, believing that their loyal employees were happy and already well compensated, were held hostage by those same employees.

In one, Kevin describes an owner who was a week away from the sale of his company for $10 million. “At this very late stage of the game, the buyer met with each of the key managers to reassure them that they’d be retained by the new owners at their existing compensation levels. At its meeting with my client’s top salesperson, it was lavish in its praise about her performance and about how important her continued success was to the company’s future success. When the buyer asked her to sign a covenant not to compete before the closing date, the salesperson asked for a break and headed straight for my client’s office. She proceeded to remind my client that she’d helped build the company to its current value during her tenure, and ever-so-generously consented to wait until the closing date to collect her $1 million bonus.”

“My client paid the ransom. He understood that if the salesperson servicing his top four clients left the company, the buyer would likely scrap the deal. If the buyer did come to the closing table, it would reduce its purchase offer by far more than $1 million.”

As a result of this and many similar experiences, “We recommend that owners get very aggressive implementing Stay Bonuses with anyone who has a significant impact on a company’s performance.” Short elaborates, “The Stay Bonus should apply to anyone—and that might be the janitor—whose cousin is your biggest client—who has leverage against the company.” And, of course, tie the stay bonus to a covenant not to compete (or similar agreement), first checking with your attorney about how to best create enforceable agreements.

In Step 3, advisors also work with owners to protect business value. One method is to clean up shareholder agreements (again, well in advance of any contemplated sale or transfer). “If a shareholder agreement does not force a minority shareholder to sell when the majority shareholder does, majority owners can (and often do) find themselves unable to sell, or held hostage by minority shareholders.”

“By and large,” adds Short, “entrepreneurs ignore both Stay Bonus Plans and shareholder agreements because they believe that other shareholders or employees will ‘come along’ on closing day.” Short observes, “What owners forget is that every shareholder and every employee figures out leverage and most intend to use it.”

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