Money Talk

Episode 35

What Makes a Bank a Good (or Bad) Investment with Gordon Honegger

Our guest for today is Gordon D. Honegger, co-Chairman of the Board of Directors of Hometown Community Bancorp, which owns a corporation called the Morton Community Bank.

 

Welcome to our listener-supported podcast, Money Talk, uncompromised absolute financial truths behind financial perceptions with host, Ed Sutkowski and Chuck LeFebvre. Let’s listen in.

Chuck LeFebvre: I’m Chuck.

Ed Sutkowski: I’m Ed. Our guest for today is Gordon D. Honegger, co-Chairman of the Board of Directors of Hometown Community Bancorp, which owns a corporation called the Morton Community Bank. Gordon, welcome.

Gordon D. Honegger: Well, good to be here.

Ed: Gordon, we would like to focus today on why would Pete with X dollars buy stock in a bank rather than a firm, rather than in a listed New York Stock Exchange company? What is it about a bank as an investment that makes it a good investment? If indeed, it does qualify as a good investment? Your thoughts, please?

Gordon: I think one reason is transparency. By law, banks have to file a call report quarterly, and they divulge a lot of information. It’s unbelievable what you can get off a call report, which runs about 80 pages. Totally public. You can set home and analyze your investment because if you just use the– I just got a prospectus on a big company and it’s eight months old. With a bank, at the end of the quarter, 30 days after the end of the quarter a bank by law, you’ll go to jail if you don’t do it right. Perfect information. Well, what do you look for? You’ve got this data, that’s great. You’ve got all this information. As an investor, what do I look for in analyzing this data? There are 12 statistics, profit, loan due, percentage loan to assets, growth of assets, delinquencies, charge offs, margin, and so forth. There are 12 statistics that every bank has to put out quarterly, and you can just– a statistician will go crazy comparing all the different banks. Now, whether you should be in the banking industry or not is a different question, but within the banking industry, you can identify the winners and the losers and the mediocres very, very quickly and very accurately.

Ed: Gordon, I look at the 80/20 rule. Chuck, I think we may both share that, that you should spend 80% of your time on 20% of the issues. Now, we have 12 statistics, of those 12, what’s 20% of the critical ones? I don’t have all the time in the world. I’m this “egocentric” busy guy. I don’t have time to mess around with this $10 million investment. What are the 2 of the 12, or 3 of the 12 I should look at?

Gordon: One interesting one is called the Texas ratio. I don’t know why it’s called the Texas ratio, but it’s all the loans that are nonperforming and all the ORE. In other words, all of the repossessed assets that the bank has as a percentage of the total assets of the bank. That is the key ratio. If you have a 25% Texas ratio, I don’t think you should probably invest in that bank. If you have a 5%, maybe you should. Look at the statistics.

Chuck: You would rank that as a higher or more important measure of the banks’ soundness in investment than, for instance, its margin or its loan to asset ratio or any of these other things? That’s your number one.

Gordon: I would say that’s the one that can really sink a bank’s value. Margin is another good one as you mentioned, Chuck, you’re right on.

Ed: What do you mean by margin?

Gordon: Margin is the difference between what you’re buying and what you’re selling. Right now, what we’re buying is really cheap. I had a guy walk in yesterday with $2 million; you know what I paid him for a nine-month CD? 0.02%. What? Less than 1%. Oh, 25 basis points. I have $100 million in Chicago with a bank and they’re paying me 0.01%. Money right now is like water.

Chuck: I think getting back to your original question that is, why would someone buy stock in a bank? My answer on that question has always been that, for instance, if you’re that guy and you’re plunking $2 million down into a bank and you’re going to get point 0.02%, and it’s not FDIC insured because it’s $2 million, then why don’t you just buy the stock instead? You’re going to get a higher yield on that investment. It’s not quite as liquid, especially if it’s not a publicly traded bank, but if the bank fails, you’re going to lose all your money if it’s not an FDIC insured deposit, and you’re going to lose all your money if you’re a shareholder, but the stock is going to perform better. It just seems like that was what I observed in my years in the banking industry, was that you had all the shareholders of the bank also were all the people who had the large deposits at the bank and they kind of had figured out that, well, G, after I’ve gotten above a certain level of deposits, why am I collecting interest when I could be collecting dividends instead?

Gordon: A couple of things. I want to make sure that I understand margin, I’m going to get back to your background talk as it relates to Gordon’s margin. I understand it’s not costing the bank very much in terms of interest to this $2 million individual. An individual with $2 million, what are you going to loan that out at? The margin is different than what you paid this $2 million guy. What rate are you going to charge me for a $2 million loan? Well, you hit the nail on the head about why you should not buy banks and why bank stocks are in the tank right now, because the margin can’t get any less because we can’t pay negative interest. On the other hand, what we charge for loans has gotten down into the 3% category, and on some loans, even in the 2% category. Normally, we try to get a 3.5% margin to cover expenses, and we can’t go any lower. That’s why there’s a really, really good community bank, just like ours, that went public. It could have sold out before the pandemic to a larger bank for like 1 3/4 book.

Ed: Book, you mean the difference of the assets and liabilities?

Gordon: Yes, the net worth of the bank. 1 3/4. Instead, it chose to go public. Again, this was before the pandemic, the stock is now selling at book. The family could have gotten 1 3/4 book one day, and the next day — this actually happened before the pandemic — they’re getting book.

Ed: So they lost a couple of bucks.

Chuck: Now, what I was always told was the banks, the way you create that margin is you’re borrowing money at short-term interest rates and you’re loaning it out at long-term interest rates. When you think about the yield curve, is essentially the difference between short-term and long-term interest rates when you have that flattening of the yield curve that really creates this type of crunch that you’re seeing right now. What’s the key, Gordon, when you have a flattened or even an inverted yield curve, which I guess we’re not inverted now?

Gordon: What do you mean by inverted?

Chuck: When the long-term interest rates actually drop below short-term interest rates, they call it an inverted yield curve. Typically, when people refer to the yield curve, they’re talking about the difference between the 2-year and the 10-year treasury, but really, there’s an entire curve going from the overnight rate, all the way up to a 30-year treasury rate. You can graph that on a chart, and it looks like a curve that typically slopes upward if the left side of the chart is the short-term interest rate and the right side is the long-term interest rate, but there are times when you’ll see higher short-term interest rates than long-term interest rates. They refer to that as being an inverted yield curve. It seems like that’s when banks have their biggest challenge in terms of how to manage your balance sheet when the yield curve is either flat or close to flat, which is what it is now, or even inverted. Is there any strategy that works or you just–

Gordon: Well, there’s no strategy, and you got all these investment houses that have podcasts. [laughs] I get three a day from some very high-powered people, it’s free, and they just go on and on about nothing because, guess what, our ALCO committee, which is the Asset Liability Committee tries to balance and figure all this out. We bought some longer-term, like six or seven-year term, really strong bonds or treasury bill-type things at 1 1/8%. We’re paying people an 1/8 of a percent and we’re getting 1 1/8 on that part of the portfolio that is our liquid part, which is about usually 25% a year. The whole bank is in investments, not loans. The loans are bad enough at 3.5% or 3% or whatever, but the investment part is even worse. They adjusted because of the flat yield curve that Chuck mentioned.

Ed: Well, in full disclosure, Chuck, you have a little bit of banking background also in addition to being a math major, which most people will hold against you.

Chuck: They are going to hold the banking part against me.

Ed: Yes, that’s right. You were associated with a bank for about seven years.

Chuck: Yes. I was in charge of the trust department of a bank, which typically would be a position that would not involve anything other than just managing the fiduciary side of the operation. I also sat on the bank’s asset liability committee that Gordon just mentioned for his bank and the senior loan committee and attended the board meetings. I was really involved in a lot of that balance sheet stuff, even though it was outside my “job description.” It’s fascinating stuff, and it’s very different than– Gordon is right, by the way. I agree with what he said about these call reports creating a type of transparency in the banking industry that you don’t see everywhere. I think the caveat there is that for somebody who is not familiar with banking balance sheets and banking financial statements; they don’t make any sense. You don’t look at it the same way you would– You only get the information on those call reports the same way you would look at a prospectus from a different type of investment. It’s such a highly leveraged industry, where the entire balance sheet and cash flow works very, very differently than it does for most other businesses and so it’s very easy to get lost in these numbers. It’s also very confusing for people who are just unfamiliar with the banking industry too. You look at assets and liabilities, and to a layperson, they have the opposite meaning for a bank as what they do to you or me. I think of an asset as the bank deposit. Well, the bank thinks of that as a liability. You’ve got to know how to read the thing.

Ed: What you’re saying, you lie two ways. You lie or you used numbers. It seems to be you’re not lying, it’s just that this configuration is not quite the same as the ordinary apple. It’s a very contorted form of business reporting.

Chuck: It is. It takes a little bit of an education to understand how the numbers work. For instance, we were just talking about the margin, which is sometimes referred to as the net interest margin in these bank reports. For example, most people think of that as, “Okay, I deposit money in the bank and that’s what the bank’s interest expense is, is what they’re paying me. Then the loans that they’re collecting, that’s the interest that they’re earning.” Most of these banks have an enormous portion of their balance sheet that’s in an investment portfolio other than loans. That loan rate is not really reflective of what you’re getting for your net interest margin. You have to look at what these other investments are. Sometimes they can contribute a significant amount-

Ed: Both ways.

Chuck: -to what’s occurring there. Yes.

Ed: A little bit of background, Chuck, you were with a bank seven years. Gordon started– from what I understand, your involvement with banking is in 1972, that’s about the year in which Godfather, the picture, was released. Then we went to Apollo 17. From that point, given your background, which I find to be kind of interesting, a PhD in Ag Econ, what was your dissertation about?

Gordon: Well, my dad was in the poultry breeding business and I did a simulation. I wrote a program called A Competitive Game. It was the first one in the country, where I took real data. I took real competitors. My dad had seven competitors, and I gathered all of the information on those competitors and wrote an interactive business game. I had all my dad’s key employees come to Purdue, and we operated in our lab like we’re here, except we had a balcony and we had windows and we recorded the game, so to speak, that these Kimber, Hy-Line, all these different competitors had management teams and they would make executive decisions, get results. I ran them over to the computer at Purdue. Back then we had cards, and I only had one chance to get it done or I had to go back to the end of the line, and then I’d get the results and everybody would see how much money they made or lost. Then they made executive decisions again. We did that for about five years into the future. That was my dissertation, a study of competition in that particular industry.

Ed: Numbers. It sounds to me that’s numbers also. You also taught at Purdue and Southern Illinois, and your undergrad degree was in Ag Econ but you come from a relatively small community called Forrest, Illinois, original population of 1,000. You started from let’s say something less than Wall Street background but with an emphasis on numbers. We’re talking numbers here. Chuck, I’m missing something, it is almost always a numbers game but the whole card is what? Loan selection? Who do you loan money to? What is the killer for the bank other than what you’ve just said about the bad loans is a ratio of the total? What is the one thing you look for as the most profitable part of a bank?

Gordon: Well, the most profitable part of the bank is not consumer lending. It’s hard to make money at 2% on a 7-year SUV that cost $80,000 and all the guy has is a job. That’s what a lot of us do and we end up picking up the car and it’s trashed and you take it over to the auction and get half your money back. When you make a loan and you make 2% on it, you’ve got to collect every dime because if a loan goes bad, it would take you 50 years to get the money back. Although SEFCU makes a lot of money doing that and there are people that make money in the mortgage end of it, which is also consumer lending, house lending is a good thing. Although those are all government-backed loans and we’re just a broker, but there’s no risk to it because they’re all guaranteed. You put people on commission and if they make money; you make money, and it’s highly cyclical. You have to have the courage to lay them off when things go bad and hire them back when they’re good. The real money is in commercial lending, a good, solid family business like my dad had. He banked with the bank indicator and they made a lot of money on my dad because he had a line of credit and he kept all of his deposits there and he did all of his loans there. You end up loaning people their own deposits. That’s where you really make money, provided they don’t go broke. Now, during this pandemic, there are a lot of people that we are not going to get all of our money back on, restaurants being the number one candidate.

Chuck: One thing I have never understood is given what you just said about how commercial loans, that’s at the top tier in terms of bank revenue generation, and yet when there’s limited demand for those commercial loans you end up with a big investment portfolio. It strikes me that most banks, what they’ll do with their investment portfolio is they’ll really stick to municipal bonds and treasury bonds and they stay away from corporate bonds. This was an argument I had 100 times when I was in the industry is, “Wait a minute, isn’t that kind of like a commercial loan? If we’re not making enough commercial loans because of the fact that there’s not enough demand, isn’t this a way of essentially getting some more commercial loans on the books? We just don’t have to originate them and we can have a higher margin there or whatever.” What’s the reticence there with banks doing that?

Gordon: Rate. School bonds and municipal bonds, they have these investment bankers that charge a lot of money upfront but ended up charging a much lower interest rate and go much longer-term because they turn around and sell them to the banks in their portfolio. It’s crazy how that works. The investment municipal bonds, unless you’re a C-corp.

Ed: What do you mean by a C-corp?

Gordon: You pay a lot of taxes.

Ed: In other words, it’s a corporation that has elected to be taxed like a corporation versus a corporation that has elected to be taxed under Subchapter S.

Gordon: Municipal bonds are tax-free. That makes the yield much better.

Ed: Gordon, the issue sounds like the entrepreneur selection. A fellow walks in with a company that’s manufacturing widgets and wants a $1 million loan. What are the checkpoints in you determining whether you’re going to make this loan or recommend it to the loan committee? There’s the statistics, of course, the financials. Hopefully, they’re in good shape. Let’s assume they’re compiled not audited. How do you gauge the character of the proposed borrower?

Gordon: Back in the old days, when I was seven million, I would look at some of the older employees in the bank and they would either give me thumbs up or thumbs down. It was based on reputation. There are certain families that you just didn’t loan money to. Unfortunately, it’s certain families that were gold and certain religions. I grew up in a very strict religion, and it’s discrimination, but people from that religion tended to back each other up if they ever got in trouble like the Amish do today. We have a bank in an Amish community and we’ve never lost a dime in the Amish community.

Ed: It’s positive discrimination then, so to speak.

Gordon: I’m sure there’s something wrong with doing that when you ask somebody for an application if you ask them what their religion is.

Ed: The bottom line is you’re talking about someone with integrity, and that’s what it’s about.

Gordon: I always like to have a reference on an application, and a lot of people put down their minister. Back in the early days, I’d call the minister and say, “What do you think of this the fellow?” I think we should do that today, but we don’t.

Ed: Now you’re talking now about Morton Community Bank, currently the largest privately-owned bank, with multiple locations, 30% owned by an ESOP. You still have one-on-one movement between you and the proposed borrower. Let’s talk about Chase or PNC or whatever, that can’t be there, or is it there? In other words, why a community bank versus a Chase?

Gordon: I think on the consumer side it’s all computers. Rocket Mortgage is a big new entry into this area, and it’s all done by computers. Nobody knows anybody. On the commercial side, the really big banks like Chase and Wells Fargo and so forth they might know the branch manager for a while until he gets promoted or fired or transferred, but we at Morton Community Bank like longevity. We pay our bonuses based to some degree on longevity. We give away pins on longevity and we try to pride ourself on how many Christmas presents we get from our customers because they like us. You can maybe sometimes get a little more margin from those people because you’re giving them even more service. Service being, and particularly right now with this PPP program that you’ve heard of Ed, in one week we put out 4,000 loans.

Ed: One week?

Gordon: In one week.

Ed: How many employees do you have?

Gordon: We have 500 but we only had 30 working on this project. All of those people will remember how– because there was a panic. If you remember last year when the PPP program came out, there was a worry that there wasn’t going to be enough money to go around, so everybody was panicking. I have a lot of emails where some of our employees are working at three o’clock in the morning to get these applications into the SBA to get money. There’ve been some surveys done and the big banks didn’t operate that way.

Chuck: Are you noticing the same concern now that there’s the second round of PPP? Are people having that same concern that the program’s going to run out of money or– [crosstalk]

Gordon: It was 600 million and I think we’re at 300 billion. At 600 billion, we’re only at 300 billion. Most of them have been coming in, but still today, I just talked to a loan officer this morning, he says, “I’ve got five more today.” I wanted to mention it to you folks because a lot of law firms are getting PPP money. If you haven’t looked into it, you should.

Chuck: That’s your call, Ed.

Ed: That would put me in a much higher bracket. We make so much money as lawyers. That’s the perception. The reality may be a little different, but why would law firms need any help with money coming out of their ears, Gordon? No, that’s not the case. Certainly, once you do that though you’d tend to be focusing on something other than the practice, I must tell you. I don’t know how you feel. Chuck. The practice is pretty much consuming. I can’t have energy devoted to something that doesn’t relate to providing the service. That’s because I’m fairly monolithic. I’m not really flexible.

Gordon: Timeout for a commercial.

Ed: Sure.

Gordon: Ed, you gave us a ESOP in 1979 and that saved us a bunch of money. It put us in a different bracket. Everybody recommends an ESOP for a bank. If you’re going to invest in a bank, if you have one that has an ESOP, I think that would be a plus. It has done miracles for our bank. I have made in the 40 years I’ve been in banking at least 60 millionaires.

Ed: Gordon it was very nice of you. I overcharged for that ESOP, didn’t I? How much was it? Do you remember?

Gordon: I think we ran it up to about– It wasn’t any more than $2,000 I know that for sure.

Ed: That would buy me a motor scooter today. Let’s go back over the ESOP, because that’s a valuable opportunity. The theory is that in an individual with “skin in the game,” meaning an economic relationship with the employer tends to outperform an individual without that economic relationship ownership. You can go to Hy-Vee grocery stores, you’ll see it’s employee-owned. Corp has an ESOP. Bottom line, from what I understand, you look at an ESOP, which is a form of tax-qualified arrangement. The employer gets a deduction for the amounts going in; the amounts accumulate tax deferred and then are distributed to the employee when the employee terminates. It is a form like a 401 (k) plan, but the difference is the investment is in the employer, at least partly. Now, with Morton Community Bank’s employee stock ownership plan and trust. It’s a trust but receives these shares, and when the distributions come out, there’s some special tax consequences favorable to the distributee employee. Your view this is a big deal in the sense that it establishes a nexus, a “skin in the game,” a relationship with the employee versus someone who is not. This idea of the number of millionaires, tell me more about that. I can’t fully appreciate that.

Gordon: When you’re making 15% and you’re putting 10% to 15% of somebody’s pay in the trust, the theory of compound interest works wonderful. Particularly those last five years. We just had two employees tell us they’re going to retire this year. They’re upper-middle management. Maybe not even upper, maybe middle management. One’s got $2million and one’s got $1.5 million. I don’t think either one of them have made much more than $70,000 or $75,000.

Ed: Gordon, let’s make sure in the interest of transparency, that’s because the company’s done well. The predicate is the employer has made money. Morton Community Bank has had an enormous growth rate over a long period of time, but an ESOP isn’t for everyone. If the company goes south, I think of– what was the big guy you told me that went south?

Chuck: You’re thinking of Enron.

Ed: Yes. Maybe too much of a good thing is not a very good thing. The predicate is that the business has got to be profitable, so we can’t oversell. Chuck, any observations there?

Chuck: Well, no, I think you’re absolutely right, but I think that the banking industry is one where that risk is a little lower than in many other industries because you’ve got– one of the things that is often complained about it can actually be a help here, which is the heavy dose of government regulation that tends to make the industry a little more homogenous than it would otherwise be but also serves in many ways as a check on the sorts of overreaching and unscrupulous practices that occurred with Enron. One of the things I wanted to ask you, and maybe you don’t know the answer to this, Gordon, but I’m curious. When you think about the financial crisis that occurred in 2007 and 2008. We have another one now even though it hasn’t stretched to the banking industry as much, there were a lot of banking failures. Have you ever seen any statistics about how many of those failures actually resulted in shareholders losing essentially– I know there were a few banks that ended up being purchased for a dollar, but it struck me that there were very few of those types of failures that occurred, that quite often, what happened is when a bank went down, it was purchased in a stock for stock type transaction or some other transaction occurred where the shareholders might’ve lost money but they didn’t lose everything. Do you know what the statistics are on that?

Gordon: No, I don’t. I’ve had trouble finding out how many banks have significant ESOPs, but I do know one interesting statistic. I think we are the largest ESOP sub-S bank in the country.

Ed: In other words, you have not only an ESOP but you’re likely to be taxed as if the corporate tax didn’t exist. The earnings are distributable to the shareholders ratably over the course of the year, plus at least an amount necessary to pay the tax. In other words, you’re taxed as if the corporation didn’t exist, as if you had a partnership.

Gordon: Like a partnership.

Ed: The takeaway, the lesson, and challenged me on this, is that the ESOP tends to work best when we have a capital-intensive business organization as contrasted with an accounting firm, a law firm, a construction firm that has limited capital, mostly assets are leased. The pick and choose opportunity is, where do you work? If you have a choice, you’ve got to go to a company with a lot of capital versus all these dot-com bubble starts where we have only human capital. Chuck.

Chuck: No, I think you’re absolutely right about that. Your comment I think applies to stock ownership generally by employees. It’s not just in the ESOP setting, but any type of stock ownership by employees, whether that’s through the or an ESOP, or just, we’ve talked about this before, the restricted stock options and so forth. Where that’s going to provide the biggest punch is in the types of industries that you’ve listed. Now, of course, famously these dot-coms, people have become fantastically rich by getting shares of stock as part of their compensation, then these things take off and they soar. Those would be extremely poor choices for companies to establish something like an ESOP where the retirement savings of the employees is dependent on that stock taking off, since so many of them fail instead, right?

Gordon: Yes.

Chuck: What you’ve got here is an industry that it’s not just that there’s a capital intensiveness to the industry itself, but it’s also relatively predictable performance. It’s a relatively conservative investment compared to, for instance, a dot com.

Gordon: I think banking fits this pretty well. Now, one you can be too good. I think this local newspaper had one; it got so high in value that they had to sell because people leaving would take too much out of it.

Ed: Talk about Peoria Journal Star. It went bankrupt, but that gets to the issue of journalism. Today’s podcast is a representative of what we think journalism is going. Are we going to have a printed newspaper 10 years from now, 5 years from now? When you have the Journal Star, which produces newspapers, maybe some other investments, other activities, the issue is where is the world going. Leads me to my other observation I need some help on, the future of banking, Gordon. You’ve been around for a long time. You’ve got opportunity to sit back and think of it. Where is banking going?

Gordon: I think Rocket Mortgage is the example. It’s all going to go digital. It’s all going to be in the pandemic. Of course, it sped that. I hate what’s happening, but you’re going to be talking to your loan officer through a zoom. In some ways, it might be more communicative than it is now, and there’ll always be some people that want to come in and talk across the desk, but unfortunately, it’s all going more and more digital. I keep track of the mortgages in Tazewell County, about 130 mortgages weekly, mainly house mortgages. The dot com people are getting a growing share. They are about 5%, going on to 10%, are not local community or even large bank mortgages. They’re Rocket Mortgage and other people like Rocket Mortgage that are sneaking in and doing it all by computer.

Ed: My impression is that even outside the consumer lending market and particularly the mortgage lending market, when you go to even the commercial lending, which would be in some ways the most personalized and most human-intensive component of banking, my impression is that more and more, even though there’s a loan officer there, there’s a computer algorithm that’s driving a lot of what’s happening, even in community banks. There’s some computer analysis being done that spits out a recommendation about how you rate this loan, how you price this loan, how you structure this loan, and then you’ve got a person there who’s doing the negotiation with the borrower, but how long before you’re to the point in– Let me back up a step. What seems like what makes Rocket Mortgage successful or the market conditions that allowed that type of delivery to take over the home mortgage market is the fact that the bank’s role in originating those loans has over the years converted over to essentially being a sales channel and the bank wasn’t really doing any underwriting. How long before that’s the way commercial loans are too, where you’ve got a computer that’s really making all the decisions and the role of the loan officer is just to sell it right? Is that going to happen in 20 years?

Gordon: Commercial credit cards are gaining a lot of speed, a lot of solicitations come to these small businesses every day and, “Hey, just sign here and you got $10,000 or something. If you pay that back, maybe next year we’ll give you $20,000, and pretty soon–” When we look at everybody’s financial statement you see they owe us a lot of money, but what’s this $25,000 over here that they’re paying 15% on? It’s because somebody called him in a weak moment and offered some loose credit. Competition in laxity is one of our challenges.

Chuck: How many of those competitors are not really banks? It strikes me that one of the challenges that the banking industry faces is that you guys are regulated and you’re competing against unregulated competitors. This thing I mentioned before about computer algorithms generating loan underwriting for even these commercial loans, one advantage of that is that the regulators love it. They come in and the whole thing, as long as the computer program is sound, then they love the analysis. Somebody who’s essentially just a loan company, a shareholder-owned lender that’s issuing business credit, they don’t have to worry about that. They don’t have the same kind of balance sheet, the regulation.

Ed: All this math that we’ve talked about, which is very appropriate in this industry, one lesson that I’ve learned working with entrepreneurs is that oftentimes the entrepreneur wants someone to bounce the ideas off that can be objective, that has some history. It seems to me, Gordon, a challenge, man. The Morton Community Bank has enormous success. You’re rated number one or two or three in the State of Illinois for profitability every year. Is it because you add some value? Other than numbers and dollars, do you add value? The entrepreneur comes in and wants to make a loan and with a question as well, “Okay, let’s talk about it.” Is that some value that persists?

Gordon: That’s why we have what we have. You can’t believe, and I almost brought it, but this PPP program indicates how many small businesses we serve. It goes from here to that wall. So many small businesses and they got their loan officer that they rely on, just like you said.

Ed: It’s almost a psychological boost. I don’t know, Chuck. I still recall the first loan, which was $1,000 I secured from the bank. It was building we’re now in. I didn’t have anything, but I was a tenant at the bank in the bank building, and the fellow said, “Well, Ed, let’s see your collateral.” [laughs] I said, “Collateral? I don’t have any collateral. I just got out of law school.” “Why should we make this loan to you?” I said, “Well, I’m a tenant.” “Oh, that’s good enough.” I got a loan for $1,000.

Gordon: You mentioned this. I just had my teeth cleaned this morning. The guy that owns the clinic now has seven clinics and so forth. He’s an East Peoria boy, and I remember, this must have been 30 years ago, he came in, he didn’t have a dime, I said, “Send me your grade transcript.” He still kids me today when he sees me, he says, “You’re the guy that wanted to see my grade transcript for dental school.”

Chuck: That’s great.

Ed: It’s this value that’s emotional, that’s qualitative, the value is two sides of a coin. We have the quantitative value that we’ve talked about, algorithms, numbers, and whatever, but we also have a qualitative value. What makes you go to the office every day, Gordon? Is it the numbers, the dollars, or is it the qualitative value? There’s a combination of both.

Gordon: I’m not really hands-on. I don’t have my own portfolio, but every day– I had a guy pop in the other day and of course, everybody’s got a mask on, and this guy was just going on and on about how I helped him. I couldn’t see who he was.

Gordon: I said, “Well, thank you. That’s very kind of you.” It is rewarding when you can look back and have helped so many people you can’t even remember them all anymore.

Ed: That’s the qualitative you’ve created. My favorite question is what’s the second question that you’re asked, and that is what do you do? Because it defines you as a human being and so you’re permitting your activities. Your resources are permitting individuals to define themselves. I’m in business. I work, I own, whatever, so there’s something, a higher reward than the dollars and cents that seems to me Morton Community Bank may be involved in. Is that fair?

Gordon: I think I get a lot of Christmas cards is all I can say.

Ed: Okay, Gordon. Is there anything that we haven’t gone over that you’d like to talk about? I find this engaging. Chuck, any observations or questions?

Chuck: I’ve probably stolen the show more than my fair share today.

Ed: Well, because you’re part banker too. That I’m not sure is a good thing, but then.

Chuck: No. The one thing we haven’t really talked about is what was my portfolio, which was the non-interest income side of the banking. I’m just curious if you see that as a growing part of what happens in these financial institutions, or is that always going to be the role it plays now, which is a buffer, I guess, or a buttress to the basic operations?

Gordon: That goes to the question, “What do you do when the margins are thin?” There’s two things you do, and you’re very well aware of acquisitions. Illinois has got 400 banks; we’ll have 200 banks in 5 years.

Ed: Oh, what? Say that again.

Gordon: We have 400 bank charters in Illinois and it’ll be cut in half in the next seven years or so.

Ed: Why?

Gordon: Because the investment bankers sell the idea and it’s true that if you put two banks together, you can eliminate 1/3 of the overhead of one of the banks. As the margins get thinner– I used to have a motto, number of millions of dollars per person. When I started, I had seven people and seven million. Now that’s one million per person. You know what we are now today, 10 million per person. 10 times. We’re 4.7 billion and we have 500 employees.

Ed: When you started, what was the size of the bank?

Gordon: Seven million.

Ed: Now it’s?

Gordon: 4.7 billion.

Ed: How many years?

Gordon: 40.

Ed: What’s that percentage?

Gordon: I don’t know.

Ed: That’s a big increase.

Chuck: It is kind of weird how you’re seeing fewer and fewer banks in total. Each of those banks is in more and more places. You end up like in Champaign where I live, a consumer actually has more different banks they can choose from that have physical locations in that community [crosstalk] than they had 30 years ago. Even though the number of banks that exist in the State of Illinois has dropped precipitously over that same period of time.

Gordon: Busey is the one bank that’s bigger than us in Central Illinois, and they’re 10 billion now. They’ve gone over that threshold. All their auditing is headquartered, I’m sure, in Champaign. We have 44 branches; they probably have 100.

Ed: Now 44 branches, you mean 44 separate locations and not just cash–

Gordon: They’re departments really, but we call them branches or whatever.

Ed: 44 different sites around Downstate, nothing in Chicago or in suburbs of Chicago, it’s all Downstate. What’s the future of Morton Community Bank look like in terms of number of banks, locations, focus, and the like?

Gordon: We’re going to keep doing what we’ve been doing, and that is if there’s an acquisition, we would entertain it if it fits our culture and so forth. There’s one town that has got about four independent banks that are all about 3/4s of a billion. They are ripe for the plucking and the pandemic has put a hold on it because nobody knows what their portfolio is really worth. Nobody knows what anybody’s portfolio is really worth right now, but those will be going up for bid here in the next two or three years. We may be interested; we may not be. That’s one way to keep the earnings per share. Ed wants me to keep the earnings per share going up every year, so that’s a problem.

Ed: Ed also wants a full head of hair.

Ed: I don’t think that’s going to happen. It sounds to me that you have a niche, Gordon, is that fair? You have a niche. You’re not competing with the bigs but you’re–

Gordon: We’re the king of $5 million loan. The little banks around here don’t have the lending size and the big banks don’t have the personality, so we have a great niche for the $5 million loan. It might be $10 million, it might be $2 million, but the average is $5 million. That’s just a comfort zone that we have. We have a good, it’s not an algorithm, we just call it the credit department. We spread the statements and look at the numbers manually with a computer but we don’t run it through an algorithm. A loan that size, we run it through about three different committees. We still don’t call their minister, though. We’ve got to get back to that. [laughs]

Ed: I understand. It sounds to me like there is a way of making money by owning a bank, that is you can get a good return by owning a bank and you can get a good return by borrowing money from a bank that’s going to help out rather than just done if you miss a payment. Chuck, any other questions?

Chuck: Nope.

Ed: Gordon, what haven’t we talked about that we should talk about?

Gordon: What’s this in the front of this building here? I had to crawl over something to get in here. What’s going?

Ed: The building is a little older than normal. They’re I think tuckpointing it but doing something more. It’s like a bunch of woodpeckers outside our window, which gets to the issue why this bank shouldn’t own– I don’t think the bank did own the building. We’ll get to the issue of commercial real estate at another time but that’s not a real good story in today’s world, commercial real estate as an investment. It sounds to me that maybe the Morton Community Bank may be a better investment than most– Putting it another way. Community banks aren’t all that bad.

Gordon: The only problem with vesting in Morton Community Bank is you have to be related, because you could only have 100 families and we’ve got 99. You have to be Lebanese, Italian or Apostolic Christian, which is a form of German ethnic group out of Morton.

Ed: Gordon, this is a form of discrimination occasioned by limitations imposed on ownership of shares of an S corporation. The government doesn’t realize how discriminatory this is, but maybe we’ll increase that to 200.

Gordon: The good news about you, Ed, is you don’t have relatives that are involved. We’re going after the single shareholders. In case we want to merge with somebody that insists on buying stock, I’ve got to buy out with a single shareholder.

Ed: You’ve got to have one shareholder so you don’t exceed the 100 limit.

Gordon: There’s one group we can never buy out because I think a third of the bank is owned by this one family because you could go back four generations. The guy who’s got the genealogy is so old we can’t find a picture of him. We found his gravestone but we can’t even find a picture of him.

Ed: Isn’t this crazy talk? You’re talking about the Internal Revenue Code dictating ownership of a bank. It’s just over the top crazy. It’s silly, nonetheless, that’s what you have to work with, so that imposes a bit of a constraint on the expansion of the bank unlike everything else.

Gordon: It’s not really a constraint. I just got the genealogy book from one family that has some stock and they have 150 people that all live around here. They’re just one of a 100.

Ed: You seek out very prolific male shareholders.

Ed: That’s the takeaway. One consideration before you own stock of Morton Community Bank, you’ve got to make sure that this individual can breed like rabbits.

Ed: Well, Gordon, thanks for your time, energy, and it’s been a pleasure. Again, best regards.

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