HELPING LEADERS BECOME
B E T T E R S T E WA R D S .
Finance & Lending Trends
Presented by: Religious Institution Division, Bank of the West
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THE STATE OF RELIGIOUS LENDING
Table of Contents RELIGIOUS INSTITUTION FINANCING TRUTHS — REGARDLESS OF THE LENDING CLIMATE
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You don’t need to be an experienced commercial borrower to obtain financing for your religious institution. However, to do the best job for your ministry and make the way as smooth as possible, you should work with a lender that has a proven track record banking religious institutions.
A ROADMAP FOR SUCCESSFULLY FUNDING YOUR NEW BUILDING 12
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While many think rates are likely to increase in the future, no one knows how much they will rise or when. Now might prove to be a good time to refinance existing debt and secure a long-term fixed rate if possible. By Dan Mikes
TIME TO EXPAND TO NEW LOCATION(S)?
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As unemployment has declined and consumer confidence has grown, it appears that the post-meltdown reluctance to solicit donors for capital pledges for religious institution expansion is abating. This is giving way to pent-up demand for worship space. By Dan Mikes
CONSTRUCTION FINANCING, REVISITED 10 A true ministry banker understands that business administrators at religious institutions might only undertake a major commercial construction project once or twice in their careers. A lender with specialized expertise in financing religious institutions will not expect you to intimately understand or fully anticipate the commercial construction and related borrowing processes. Rather, a lender with a depth of experience banking this segment can provide consultation and guide you through the process. By Dan Mikes
At the same time, the religious institution segment as a whole seems to have learned from some of the challenges it faced through the downturn. In this post-meltdown era, physical expansion plans were less aggressive, and required a lower debt-to-income ratio. By Dan Mikes
By Dan Mikes
DOES IT MAKE SENSE TO REFINANCE RIGHT NOW? (EVEN THOUGH YOU MIGHT BE FACING A PREPAYMENT PENALTY)
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Religious institution expansion appears to be on the rebound, and the willingness of financial institutions to support this growth remains strong.
Developing a plan for physical plant expansion for a growing ministry is complex and lengthy. Assessing current and future space needs, and conceptualizing a design that functions well with your ministry’s personality and your development site’s physical characteristics, the process must synchronize with financial capacity. By Dan Mikes
SATELLITE EXPANSION FROM THE LENDER’S VIEW
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In recent years, the launching of congregational outposts — also known as satellite locations — has become a popular strategy for relieving the pressure of growing attendance on a “main site,” or for stretching the borders of the religious institution’s tent by expanding into a burgeoning suburban community. By Dan Mikes
WITH RATES RISING, SHOULD YOU TERMINATE YOUR INTEREST RATE SWAP AND REFINANCE
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As you might have noticed, interest rates have been on the move. Also, recent economic signals seem to imply the federal government will be more active in 2017. Against the backdrop of the rate movement, many leaders with religious institutions are likely wondering whether to break out of their interest rate swap and refinance now, before rates go much higher. Alternately, they could sit tight, avoid paying a swap “early termination fee,” and hope that interest rates are not much higher once their current swap matures. By Dan Mikes
IF YOU’RE CONSIDERING REFINANCING, BE AWARE OF THE ENVIRONMENTAL STATUS OF YOUR PROPERTY 15 Over 27 years, series author Dan Mikes has seen a number of instances in which all the financial and other factors were right, but the loan could not be made because the collateral (the land and buildings) was unacceptable due to environmental contamination.
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Finance & Lending Trends
Religious institution financing truths — regardless of the lending climate By Dan Mikes
As the business administrator of a religious institution, you don’t need to be an experienced commercial developer to get a construction loan — you just need an expert ministry bank.
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ou don’t need to be an experienced commercial borrower to obtain financing for your religious institution. However, to do the best job for your ministry and make the way as smooth as possible, you should work with a lender that has a proven track record banking religious institutions. Not every local banker is able to quickly process a construction loan or mortgage request from a religious institution. Even where there’s a strong and long-standing relationship, banks might be ill-equipped to provide construction loans to religious groups. This is primarily for two reasons: #1: They lack experience in making loans to religious institutions (which differ significantly from the loans they make every day to for-profit businesses and other entities) #2: They might expect that the religious institution lacks experience in undertaking a major commercial construction project.
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Not all banks have a full understanding of how religious institutions operate. A lender with a track record of serving religious institutions can provide guidance through the entire process, particularly early on when you might want help identifying your borrowing capacity following the launch of a pending capital pledge campaign. An experienced religious institution banker could also avail your ministry of user-friendly, low-cost loan products tailored to your special needs. For example, you might be able to avoid onerous loan covenants better suited to for-profit entities and which could undermine ministry management autonomy, such as liquidity requirements, minimum debt coverage ratios, and limitations on capital expenditures. Banks typically offer five-year term loans to commercial borrowers. This means that although the monthly debt service is based on a 15- to 25-year repayment period, the outstanding principal is actually due and payable at five years (referred to as a “balloon payment”). If the bank remains comfortable with the borrower, upon review of a fresh loan application, the loan might be “renewed” for another five years, resulting in the incurrence of another round of closing costs (appraisal, title insurance, environmental assessment, loan fee and so on). To minimize these redundant costs, look for a bank with a successful track record of lending to ministries. It might be willing to take a longer risk, offering a seven- or even a 10-year term duration. The loan offer might include a requirement to establish a depository relationship. To help get the best pricing on your loan, plan to look for a full-service institution that can meet all your needs, including equipment financing, cash management, merchant processing, electronic giving and commercial credit cards. Discussing deposits can work in the borrower’s favor because the lender will price the loan based on a “relationship yield.”
Prior to the commencement of a construction project, it’s essential that your institution has its financing commitment firmly in place. Never assume that you’ll be able to secure financing after breaking ground. Acquiring land, signing a construction contract, and breaking ground before a lending commitment is in hand can be a potentially fatal financial mistake. Aside from the matter of “broken lien priority,” which could obstruct or block your ability to secure title insurance (a standard loan requirement), you’ll be also fighting an uphill perception of leadership. Lenders will question why you would put your institution’s good name on a contract prior to securing the means to meet the financial obligations tied to it. Make sure your construction budget encompasses all costs before you break ground. After hard costs (the cost of the building itself) and soft costs (permits, inspections fees, soil-testing, engineering and architect fees), a well-planned budget must also include a margin for error, referred to as contingency. Every project can experience some surprises in the form of additional expense or unanticipated delay. Depending on whether the construction contract is a “Guaranteed Maximum Fixed Price” or a “Cost Plus” contract, the contingency budget should represent about 4 percent to 7 percent of total hard costs. Some banks allow either contractual format; some require the “G-Max.” A bank-approved construction budget will be attached as an exhibit to the loan documents at loan closing. The approved budget memorializes the scope and the line-item cost of the project. As projects progress, there will almost always be budget variances. If savings are realized on early stage elements — such as concrete and steel — the lender will allow the surplus from those line items to be held as a reserve for potential to overages on other line items, or for upgrades or change orders. Loan covenants typically prohibit unilateral execution of change orders without prior written authorization from the lender. If the project is near completion when such changes are presented, the lender might approve release of the remaining contingency as the means of funding the change order. If the project is in its early stages, the lender will be less likely to release a significant portion of the contingency. A well-planned project, with a good contractor and an experienced lender, can be completed on time and on budget. Your prospects of achieving this outcome increase if you begin by contacting a lender experienced in working with religious institutions early in the process. They already understand that a major commercial construction project is something you might face only once or twice in your entire ministry career, and will anticipate your questions and guide you through the process in a user-friendly fashion. Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, in San Ramon, CA. www.bankofthewest.com
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Finance & Lending Trends
Does it make sense to refinance right now? (Even though you might be facing a prepayment penalty) By Dan Mikes
If you haven’t already heard while listening to the evening news, the 15-year historic graphs — shown, left — indicate that while interest rates are still relatively low, they might have bottomed and be on their way up. While many think rates are likely to increase in the future, no one knows how much they will rise or when. Now might prove to be a good time to refinance existing debt and secure a long-term fixed rate if possible. What if your religious institution currently has debt and the loan is subject to a prepayment penalty? If your leadership team believes rates are headed upward, it might make sense to pay the penalty and secure a lower rate now. But, how might you do the math to provide perspective on whether it would make sense to pay the penalty now? How much would rates need to increase to justify paying the penalty? 6
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Running the numbers The following hypothetical example is for illustrative purposes only. It might help your leadership team to answer these questions by providing some high-level perspective. The template will enable your leadership team to identify how much rates would have to rise to justify paying the penalty and refinancing now. If your team feels rates will likely pass through the break-even threshold, you should refinance now. Let’s assume, for example, that four years ago your religious institution borrowed $5 million and the interest rate was originally fixed for five years at 6 percent, on a 25-year amortization. Your monthly payment is currently $32,215. Your lender tells you that if you refinance today, you face a prepayment penalty of $75,000. You decide to shop around, and you receive an offer at 5 percent fixed for five years. Based on your current loan balance of $4,628,922, and your remaining amortization duration of 21 years, your new monthly payment would be $29,705. While it’s great to see an immediate monthly savings and avoid the uncertainty of where rates might be as of loan maturity, we still haven’t identified how much interest rates would need to rise between now and your current loan maturity (12 months from now) to justify having paid the $75,000 penalty. One way to answer this question is to compare the two scenarios — refinance now versus wait — in terms of total-out-of-pocket-expense over the next 60 months. If you refinance now, your total payments over the next 60 months will equal $1,782,300. Add the $75,000 cost to exit your current loan, and your total out-of-pocket-expense increases to $1,857,300. Conversely, if you stay with your current loan through maturity, your next 12 payments will total $386,580. When you renew your loan, if your new interest rate is 5.35 percent, your new monthly payment will be $30,723. Over the next 48 months, your total payments will be $1,474,704. Consequently, over the next 60 months the total out-of-pocket-expense equals $1,861,284. Conclusion: Over the next 12 months, if your leadership team believes interest rates will increase 0.35 percent or more, fewer dollars will exit your pocket if you pay the prepayment penalty and refinance now. churchexecutive.com
Please note that the above example only considers out-of-pocketexpense. No cost has been assigned for the loss of investment income which might have been earned on $75,000 had it been retained rather than spent to satisfy the prepayment penalty. We also did not consider the financing cost should you desire to borrow the $75,000. While no one has a crystal ball, presenting this type of analysis to your leadership team might provide useful perspective in helping them to decide whether to refinance now or wait. Examining interest rate swaps In recent years, many religious institutions have secured fixed-rate financing by entering into an interest rate swap. As rates have declined, these borrowers have sought to refinance only to learn there is an “early termination cost” associated with refinancing their debt and terminating their interest rate swap prior to the scheduled maturity. However, even if the “mark-to-market” is currently negative (in other words, you owe “early termination cost”), you might still be able to refinance to the benefit of your institution. A knowledgeable banker can explain how your swap might be restructured to a longer term, very possibly at a lower interest rate. This is often referred to as a “blend-and-extend.” In such a scenario, the borrower’s loan balance does not increase, nor does the borrower need to write a check to pay the early termination cost. Instead, the termination cost is absorbed into the fixed interest rate from the new swap. If your banker cannot explain this to your satisfaction, seek one who can. Decisive action required If you pass up the opportunity to refinance now, you might find yourself renewing your loan at a higher interest rate in the future. Seek a knowledgeable lender who can work with you to achieve a level of understanding that will enable you to make the best possible decision for your religious institution. Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, in San Ramon, CA. www.bankofthewest.com
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Finance & Lending Trends
Time to expand to new location(s)? By Dan Mikes
As unemployment has declined and consumer confidence has grown, it appears that the post-meltdown reluctance to solicit donors for capital pledges for religious institution expansion is abating. This is giving way to pent-up demand for worship space. Other accommodative factors — such as recovering real estate values and relatively low interest rates — might also be contributing to an increase in worship facility expansion, facilities acquisitions, and the launching of leased satellite locations. In recent years, banks have continued to anticipate a faster rate of economic expansion. Consequently, loan volume targets continue to exceed demand. Qualified religious institution borrowers are finding no shortage of willing financial partners. Historically, the conventional approach to religious institution expansion was to purchase land, build a larger sanctuary, and relocate. In more recent times, congregational expansion strategies include the leasing of facilities with associated tenant improvement costs, purchasing and converting an existing commercial structure, or the merger of a strong and growing congregation with another religious institution which might be in transition or distress. Each of these approaches carries its own subset of lender focal points. For example, if your religious institution is planning to acquire land now and build later, you should know the lender’s advance rate against undeveloped land will be lower. The Interagency Guidelines for Real Estate Lending Policies provides guidance to banks on advance rate limits for various categories of commercial real estate. For instance, the loan offer to your religious institution might be limited to the sum of 75 percent of the appraised value of your existing facilities, plus 60 percent of the appraised value of the raw land. When growth puts pressure on existing space limitations, another common approach is to lease a facility along the perimeter of the current donor-commute circumference. Improving a tenant space can be a costeffective and scalable way to relieve some pressure on your current site while also availing yourself of growth from outside the religious institution’s current draw perimeter. The lender will consider the lease duration. Is it short enough to accommodate a subsequent relocation if growth should warrant, yet long enough to justify the dollar cost of tenant improvements? There is no set rule in this regard. However, lenders are unlikely to be receptive to a plan to make a multimillion-dollar investment in tenant improvements to a facility with a short-term lease. The inclusion of an option to purchase the property might mitigate this concern. The lender will also want to understand the religious institution’s overall vision for satellite expansion. Typically, once the satellite congregation reaches sufficient size, with stable or increasing year-overyear attendance and net cash flow, the lender will entertain a request to purchase or build a facility. Conversely, if the religious institution plans 8
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numerous additional long-term leased satellite locations, the lender might become sensitive to the percent of total contributions coming from leased locations. If the location(s) secured by the bank’s mortgage(s) generate the majority of total revenue, the lender is more likely to remain confident that in the worst of times, the religious institution will make every possible effort to sustain operations at the collateral site. Examining church mergers In the wake of the economic downturn, there has been an increasing incidence of expansion by way of merger. Larger, financially stable congregations are being approached by smaller, faltering religious institutions. This can result in a mutually beneficial outcome. The merger is often accomplished by rolling the assets of one corporate entity into the other, and then dissolving the smaller 501(c )3. However, if the congregation which your religious institution plans to acquire has debt, be sure to discuss the plan with your lender in advance. Your legal counsel might advise that retaining separate corporate entities will shield the parent organization from the liabilities of the other congregation. While this might be correct, your lender might have other concerns. Your existing donor base would likely view the two organizations as one, with a single spiritual leader and leadership team. If the merger does not succeed, your religious institution could suffer widely publicized reputational damage, thereby having an adverse impact on attendance and revenue. In a worst-case scenario, if the acquired congregation defaults on its debt and the other lender forecloses, the local media will likely tie the good name of the parent organization to the financial failure. At that point, your donors might not take comfort in the technicality of the two separate legal entities. Some portion of your donors might fear for the solvency of the parent organization and decide not to “throw good money after bad.” Lenders are risk managers. They are compelled to consider worst-case scenarios. Nevertheless, if your religious institution is contemplating acquiring an indebted, struggling congregation, your lender will likely be supportive if your organization has a history of stable revenue, strong net cash flow, and ample reserves. After pausing for a few years following the downturn, it’s great to see physical plant expansion return to the religious institution arena. The diverse strategies for accommodating congregational growth will be familiar to an experienced religious institution lender. While there might be numerous banks competing to support your congregational growth, in the long term, you will be better served by an institution with a track record of supporting diverse religious institution models. Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, in San Ramon, CA. www.bankofthewest.com
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Finance & Lending Trends
Construction financing, revisited Lender experience — and your preparation — are keys to success By Dan Mikes
A true ministry banker understands that business administrators at religious institutions might only undertake a major commercial construction project once or twice in their careers.
A lender with specialized expertise in financing religious institutions will not expect you to intimately understand or fully anticipate the commercial construction and related borrowing processes. Rather, a lender with a depth of experience banking this segment can provide consultation and guide you through the process. Nevertheless, the ministry will be best served when adequately prepared about what to expect. To assure that your lender selection process goes as smoothly as possible, start by looking for lenders with an established track record of working with religious institutions. Good indications that lenders have a focused commitment to the religious segment include: a long history of providing loans and banking services to religious institutions; full-time designated staff with a depth of religious banking experience; specific mention of religious institution lending on the lender’s website; ministryspecific marketing brochures and support materials; and, of course, a long list of religious institutions references. An experienced lender can help your religious institution identify its borrowing capacity when planning a construction project. It is most beneficial to seek this consultation in advance of working with your architect to develop a design concept. Be prepared to share the details of any pending capital pledge campaign, such as the campaign start date, target total pledge goal and desired construction start date. One of the more common mistakes religious institutions make is not allowing enough time between submitting loan applications to lenders and the desired project start date. First, your religious institutions should allow 30 days to submit loan applications and receive financing offers. 10
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Once offers are in hand, your leadership team should make a final lender selection 90 days prior to the desired project start date. Normally, a construction loan can be closed within 60 days. By allowing 90 days, you will have time to work through any unanticipated issues related to “clouds” on land title (old unreleased mortgages, easements) or environmental issues. No matter what, never start construction before you have a firm financing commitment in hand, with all contingencies met (appraisal, environmental and so on). Aside from the matter of “broken lien priority” — which could complicate your ability to secure title insurance (a standard loan requirement) — you also risk your credibility with potential lenders. Lenders might question why you would put your institution’s good name on a construction contract prior to securing the means to meet the financial obligations under that contract. Given your financing offer will be contingent upon a maximum loanto-value, your property value and proposed improvements will need to be appraised. Consequently, your religious institutions will also need to coordinate the timeline for the development of the architectural plans and a line-item construction budget. These generally need to be at least 75-percent complete at the time of lender selection for the lender to order your appraisal. The appraisal can take from four to six weeks to complete. Additionally, your lender might require that a cost engineer be engaged to review the construction plan and budget. The cost review can usually be completed within two or three weeks, assuming the architectural plans and budget are 95-percent complete upon submission to the engineer. As you near loan closing, you will need to provide the lender with comprehensive lists of the “Sources and Uses” of funding. Both these dollar amount totals must match as of loan closing. The “sources” list should only include three items: costs already paid prior to loan closing; cash on hand for the project; and amount of loan commitment. Some borrowers mistakenly include a fourth source: future cash from incoming pledges during construction. Most lenders will not want to assume the risk of liens or even litigation, which could arise should unforeseen economic or other events cause the pledge campaign to stall out after the loan is closed. The total “uses-of-funds” list is not limited to the construction contract amount. The “uses” list must also include other project-related costs, such as architectural fees, permits, soil tests, landscaping, off-site items (turning lanes or street lights, for example), loan closing costs and so on. Loan covenants typically prohibit unilateral execution of change orders without prior written authorization from the lender. In some cases, lenders might approve release of a portion of the amount budgeted for “contingency” as the means of funding a change order. When considering releasing contingency, one point-of-focus for the lender will be the percent-of-project-completed-to-date. Generally speaking, lenders prefer the percent-of-contingency-released-to-date to remain within proximity of the percent-of-project-completed. Consequently, a bank will be less likely to release a significant amount of the contingency early in the project cycle. A well-planned project timeline and a thoughtfully managed financing process can be achieved when you seek the safety of the right lender. Your prospects of achieving this outcome increase when you begin by contacting an experienced religious institutions lender early in the process. A major commercial construction project is not a simple undertaking, and there is no point in making it more complicated by having to school your lender on all things religious institutions-specific. Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, in San Ramon, CA. www.bankofthewest.com churchexecutive.com
Finance & Lending Trends
The state of religious lending By Dan Mikes Religious institution expansion appears to be on the rebound, and the willingness of financial institutions to support this growth remains strong. At the same time, the religious institution segment as a whole seems to have learned from some of the challenges it faced through the downturn. In this post-meltdown era, physical expansion plans were less aggressive, and required a lower debt-to-income ratio. I should begin by stating that data to support these comments is not easy to come by. In fact, for this publication, the editor requested that the author provide observations supported by the experience of a single lender to religious institutions — albeit one which has loaned nearly $4 billion to houses of worship over 20 years of uninterrupted service to the segment — and one who reviews hundreds of loan applications annually. The loan applications alone provide insight into the expansion plans of these institutions, regardless of whether the loan amount was or was not approved. First, some historical perspective As we all know, the early 2000s were marked by strong growth. While home ownership was expanding at a rapid pace — due, in part, to lax credit standards — per the market observations of the aforementioned lender, so too were houses of worship. Many applicants reported receiving loan commitments for amounts in excess of the limit which the contributing lender was willing to approve. Prior to the downturn, the words “religious institution” and “foreclosure” were rarely spoken in the same sentence. Unfortunately, that changed when the economy took a turn for the worse, and many congregations struggled. Immediately following the downturn — between 2009 and 2013 — congregations kept their finger on the expansion “pause” button, perhaps churchexecutive.com
due to higher unemployment rates and a general reluctance to go to their donors with a capital-pledge fundraising request, as typically coincides with religious institution physical expansion. For example, between 2003 and 2009, the hundreds of millions of dollars which were loaned to new customers was split 54 percent for refinancing, and 46 percent for new construction. (It should be remembered that bank loans typically term-out, and must be renewed or refinanced, at five- or 10year intervals.) By contrast, of the hundreds of millions of dollars loaned to new customers between 2010 and 2014, only 22 percent of those funds were for construction. However, in 2014 and 2015, construction within the religious institution segment increased — seemingly taking its cue from a declining unemployment rate. During those two years, 44 percent of the hundreds of millions which the referenced lender advanced to new customers were for construction. Based on the above, one might wonder if attendance at religious institutions drove the variability in construction activity. After all, why would an institution need (or want) to expand if adult attendance was in decline? Data provided by the same lender seems to imply an answer. Between 2005 and 2015, the average adult worship attendance across this lender’s total pool of customers increased every year except one. This seems to support the assumption that the apparent down-tick in construction activity was related to a reluctance to undertake capital expansion fundraising. While any correlation to fundraising and the unemployment rate is (from a purely statistical perspective) anecdotal, it is worth mentioning that this lender further supports its market observations based on continuing dialogue with its hundreds of religious institution customers. Expansion plans seem to be more moderate, with debt requests requiring lower debt-to-income ratios. This observation is based on the lender’s observation of an increase in its own “approval ratio,” or the percentage of loan applications which were approved for the requested amount of debt. It should be noted that financing offers typically carry contingencies like a loan-to-value limitation. However, the “approval ratio” is calculated without consideration of the eventual collateral appraisal valuations and, therefore, does not reflect the impact of fluctuations in the real-estate market. Also, this up-tick is not a function of any change in credit policy, as this lender’s credit policy remained static through the timeframes referenced in this writing. One final bit of good news for the borrower… The referenced lender reports a relatively stable “acceptance-ratio” (offers extended versus new customers won) through the periods referenced in the writing. This might imply that in spite of the problems which some religious institutions faced during the downturn, there appears to be no shortage of lenders willing to link arms with houses of worship — and march forward with them in support of their visions! Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, San Ramon, CA. www.bankofthewest.com The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of Bank of the West. F I N A N C E & L E N D I N G T R E N D S • CHURCH EXECUTIVE
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Finance & Lending Trends
A roadmap for successfully funding your new building By Dan Mikes
D
eveloping a plan for physical plant expansion for a growing ministry is complex and lengthy. Assessing current and future space needs, and conceptualizing a design that functions well with your ministry’s personality and your development site’s physical characteristics, the process must synchronize with financial capacity.
To assure that the financial means of your congregation align with the cost of your new facility and your target break-ground date, identify your fundraising ability and borrowing capacity as early as possible. While I don’t claim extensive capital pledge campaign expertise, in my third decade as a lender to religious institutions, I have tracked the pledge campaign collection results of several hundred pledge campaigns. Standard loan covenants require ministry borrowers to provide annual financial statements to the lender throughout the life of the loan. Consequently, I have seen the results of internally and professionally orchestrated capital pledge campaigns. Accordingly, I firmly believe hiring a professional fundraiser is in your congregation’s best interest. This expert will typically guide your institution to a higher pledge total, and the pace and rate of collections against those pledges will be more predictable. This can help you qualify for a larger loan. The predictability of the actual pledge revenue streams enables the experienced religious institution lender to give greater weight to your pledge campaign funds in calculating your borrowing capacity. So, interview a few fundraisers early. Get their opinions as to a reasonable pledge target. When it comes to borrowing, cash flow is important. However, experienced ministry lenders understand that houses of worship typically do not spin off significant excess cash flow. Consequently, when the lender analyzes your previous three years of financial performance, the annual “cash-available-for-debt-service” will not likely be on par with the level of debt needed to fund the physical plant expansion your donors want and need. After establishing a solid perspective on your fundraising capability, sit down with an experienced lender who can work with you to layer your borrowing capacity into your overall plan. Again, it is imperative to have these two meetings early in your planning cycle. Otherwise, leadership might end up having to walk back a prematurely cast vision concept. Having to downsize the renderings (which have already been hung in the lobby) hurts confidence in leadership and hinders fundraising. Based on a well-conceived pledge campaign target, a seasoned religious institution banker can work with you to develop a “roadmap” which specifies your borrowing capacity based on a forecast of pledge receipts during the three to six months preceding the loan closing and groundbreaking. Experienced lenders know what the first few months 12
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of a healthy and predictable campaign look like. Applying for the loan at that point can provide the lender with evidence of increased capacity to service debt. The assumptions underlying the roadmap enable a timeline that begins with the launch of the pledge campaign; identifies the timing for loan application; specifies the formula which could yield a sufficient upfront loan commitment; approximates the post-construction and post-campaign debt load and related annual debt service; and ends by defining the extent to which a subsequent softer fundraising effort might be needed to supplement the increased operational cash flow coming from your larger building and the congregational growth it will likely enable. If this sounds overwhelming, just remember — if you are dealing with an experienced church lender — that all you need to bring to the table is three years of financial statements and your capital pledge target. An intersecting topic when planning your project is the balancing of “Sources-and-Uses” — industry jargon which means your Total Project Costs must equal your Cash Contribution, plus your Loan Commitment. Also consider the timing of the cash contribution. Typically, the ministry’s business administrator will build a cash flow model which forecasts pledge receipts during construction, the construction draw disbursements, the monthly debt service, etc. One of the byproducts of doing so is to identify the highwater mark on the construction loan. Said another way: During construction, each month you will use your incoming pledge receipts to fund construction costs, thereby limiting the amount you need to draw against your construction loan. Consequently, when defining your Sources-and-Uses, the common mistake is to equate that high-water-mark on the construction loan with your needed Loan Commitment. This could prove disastrous. When you are ready to affix your institution’s good name to a construction contract, you want to be absolutely certain that — no matter what happens the next day, week or month — the funding is wholly in place. Consequently, your Loan Commitment should be based on your Total Project Cost, minus your Cash Contribution as of loan closing. If, for some unforeseeable reason, the capital pledge revenues drops off a cliff the day after you sign a construction contract, you won’t have to worry about a failed construction project, legal disputes with unpaid contractors, and damage to donor confidence. With a roadmap, a clear picture of sources and uses, and an experienced lender, you are well on your way to your goal of funding the building your growing congregation needs. Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, San Ramon, CA.[ bankofthewest.com ] Opinions rendered in this article represent the author, and not Bank of the West. churchexecutive.com
Finance & Lending Trends
Satellite expansion from the lender’s view By Dan Mikes
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n recent years, the launching of congregational outposts — also known as satellite locations — has become a popular strategy for relieving the pressure of growing attendance on a “main site,” or for stretching the borders of the religious institution’s tent by expanding into a burgeoning suburban community.
retain ownership of the mortgaged facility. If a majority of contributions are collected at leased facilities, the lender might fear the borrower could easily walk away from the mortgaged property. In my experience, lenders will be more likely to support your satellite expansion plan if they know 70 percent or more of your contributions are being collected at owned facilities which are part of the lender’s collateral pool.
Historically, religious institutions tended to try to grow at a single location by implementing a multi-phase masterplan whereby early growth was housed in one or more structures in a single location which could later be converted to classrooms or offices after congregational growth leveled off and better defined the needed size of the final structure: the worship center. Lenders have grown comfortable, however, with the multi-location approach, due, in part, to its scalability. From a risk manager’s perspective, if the religious institutions were to face financial challenges due to either an economic downturn or a leadership transition, having one large mortgage payment presents fewer options than two smaller ones. A decline in contributions could be offset by the closure of a satellite location. Nevertheless, while lenders are generally comfortable with the satellite trend, there are several dos-and-don’ts which your religious institutions leadership team should be aware of in order to secure the long-term support of a financial partner.
Another recent trend is satellite expansion by way of merger. Since the economic downturn, many larger financially stable congregations have been approached by smaller faltering ministries in need of rescue. This can present a win-win opportunity. The merger is often effected by rolling the assets of one entity into the other and then dissolving the smaller corporate entity. In other instances, two corporate entities continue under a common name and pulpit leadership. In either case, if the ministry which you are taking under your wing has debt, be sure to discuss your plan with your lender prior to moving forward with the merger. Your attorney might tell you that retaining separate corporate entities will shield the parent organization from the liabilities of the smaller ministry. While this might be legally correct, your lender might have other concerns. Regardless of the corporate distinctions, the lender realizes that the surrounding communities will view the two organizations as one with a single spiritual leader. Consequently, if the smaller congregation struggles with its debt, the parent entity might be compelled to assume the burden of financial subsidy in order to avoid reputation risk. In a worst-case scenario, if the satellite church defaults and another lender forecloses on the building, the local media will likely associate your good name with the foreclosure. Should this occur, your lender will be concerned about your congregation’s perception of the event and a potential decline in your congregation’s confidence in your leadership, along with their financial contributions. In spite of your best efforts to explain the technical separation between the two legal entities, some percentage of your donors might not understand the nuances and might be reluctant to “throw good money after bad.”
When adding a new worship location, the most common and fiscally prudent approach is to begin by leasing a facility. Starting with a relatively smaller space enables the parent organization to limit its startup costs and potential impact to consolidated cash flow. The lease duration should also be short enough to accommodate a subsequent relocation if growth should warrant, yet long enough to justify the dollar cost of tenant improvements required for ministry use. There are no set rules in this regard; however, lenders are unlikely to be receptive to a plan to make a multimillion-dollar investment in tenant improvements to a facility with a short-term (12- to 24-month) lease. Depending upon the age and stability of the satellite congregation, the inclusion of an option to purchase might mitigate this concern. Once the satellite matures to a state of steady worship attendance and contributions, the lender will likely entertain a request to purchase or build a facility for the satellite congregation. Conversely, you can expect that your lender will be reluctant to make a $5 million loan to buy or build a facility for a startup satellite at a location where you have no track record of attendance. Operating multiple leased satellite locations in various stages of maturity is not uncommon; however, the ratio of attendance at leased locations versus owned sites can cause your lender concern. If your religious institution has one mortgaged location and five leased locations, and only 50 percent of your total institution’s revenue is being generated at the lender’s collateral site, the lender might feel that (depending upon the duration of the leases) the religious institution’s consolidated cash flow is excessively vulnerable to facilities which it does not control. Also, in a worst-case default and potential foreclosure scenario, the lender might wonder how hard the religious institution will work to churchexecutive.com
Satellite ministry expansion is clearly a trend which is gathering momentum. Experienced lenders with a track record of funding religious institutions can sit down with your leadership team and define the dosand-don’ts of satellite expansion. Broaching this topic early with your lender can only be beneficial to your religious institution and help ensure a rewarding relationship with your financial partner. Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, San Ramon, CA.[ bankofthewest.com ]
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of Bank of the West. This article originally appeared in inSight, a professional journal of The Church Network. Reprinted with permission. ©2014 The Church Network (www.thechurchnetwork.com / (800) 898-8085).
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With rates rising, should you terminate your interest rate swap and refinance? By Dan Mikes As you might have noticed, interest rates have been on the move. Also, recent economic signals seem to imply the federal government will be more active in 2017. Consider comments economist Dr. Scott Anderson made on February 17 under the heading, “Inflation Runs Hot, Will the Fed?”: The urgency to hike interest rates once again is ramping up in the United States on the heels of stronger than expected producer and consumer inflation in January. January headline and core consumer inflation — at 2.5% and 2.3% from a year ago — hasn’t been this high in five years. Headline inflation’s climb has been even more impressive, climbing swiftly from –0.2% two years ago. Indeed, inflation pressure has visibly accelerated over the past year under a tightening labor market and stronger wage gains, a convincing rebound in energy and commodity prices, and accommodative monetary policy and financial conditions.1
Federal Reserve Economic Data, St. Louis Federal Bank and TheFinancials.com
No one knows exactly how much, how soon or how fast interest rates might increase. Against the backdrop of the rate movement, many leaders with religious institutions are likely wondering whether to break out of their interest rate swap and refinance now, before rates go much higher. Alternately, they could sit tight, avoid paying a swap “early termination fee,” and hope that interest rates are not much higher once their current swap matures. I just used the term “early termination fee” — which might sound a bit foreign. Perhaps it is best to begin with some general information about what an interest rate swap is, and how it works. A swap is a separate contract apart from the loan. The borrower pays the swap fixed rate and the swap pays the borrower a variable 14
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London Interbank Offered Rate, or LIBOR, plus the Loan Margin. This variable payment aligns with the borrower’s payment obligation on the underlying variable rate loan. Therefore, at its simplest, the swap might be considered a LIBOR hedge that essentially fixes the variable rate nature of the underlying LIBOR rate of the loan. The legal relationship is governed by the International Swaps and Derivatives Association, Inc. (ISDA) documentation. The swap is designed to match your loan amount. So, if you make nothing more than regularly scheduled loan payments until the swap matures (the loan and swap maturity dates usually match), everything remains relatively simple. However, if you choose to make additional loan payments, or if you prepay your loan in full prior to the maturity of the swap, your outstanding swap amount will be larger than your outstanding loan amount, which means the swap amount will be larger than your outstanding loan balance. In this scenario, the bank might require you to reduce the swap. This reducing of the swap is referred to as “early termination.” Generally, if rates rise after a borrower enters into a swap, the borrower might realize a gain (bank pays the borrower) upon early termination of the swap; or conversely, if rates stay the same or move lower, a loss might be incurred (borrower pays the bank), which might be substantial. Consequently, over the life of the swap, the swap has an inherent positive or negative value. This valuation is commonly referred to as the “mark-tomarket (MTM).” Take one quick glance at the historic interest rate graphs at left and you will realize that borrowers who entered into swaps between 2009 and 2012 probably currently have a negative mark-to-market. Many of these borrower’s loans and swaps are now near maturity, and as they see rates rising, they are wondering if they should terminate their swap prior to maturity, pay the early termination cost, and refinance now before interest rates increase further. Borrowers often add these termination costs to the balance on their next loan. Alternatively, the borrower might write a check to pay the termination cost. If your organization is considering refinancing now, but is facing an early termination cost, there is a refinancing option which you might not be aware of. You might be able to get a lower interest rate which is fixed for a longer term than what remains on your current swap, and you might be able to do this without adding that amount of the termination cost to your loan balance or writing a check for the termination cost. The termination cost is effectively absorbed into the interest rate on the new swap. This is commonly referred to as a “blend-and-extend.” If your banker cannot explain the blend-and-extend to your satisfaction, seek one who can. Terminating your current swap and paying an early termination cost, might prove more expensive than doing a blend-andextend swap. Now is the time to become informed on, and to consider, your options. Reviewing these options now might enable you to avoid paying a termination cost, and prevent the need to refinance at a higher rate down the road. Reach out to an experienced lender who can assist you in expanding your knowledge, which can empower you to make the most appropriate choices for your religious institution. 1 Inflation Runs Hot, Will the Fed?, Scott Anderson, PhD, Bank of the West Economics, Chief Economist
Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, San Ramon, CA. [ www.bankofthewest.com ] The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of Bank of the West.
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Finance & Lending Trends
If you’re considering refinancing, be aware of the environmental status of your property By Dan Mikes
Throughout my 27 years of providing financing for religious institutions, I have seen a number of instances in which all the financial and other factors were right, but the loan could not be made because the collateral (the land and buildings) was unacceptable due to environmental contamination. While this is a fairly rare occurrence, it is not uncommon for a loan closing to be delayed due to the need for additional environmental testing — even in instances where the current lender deemed a previous environmental study to be sufficient to support the existing mortgage. Your leadership team should be aware of this risk, and, when seeking refinancing, should provide prospective lenders with copies of old environmental studies early in the process.
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gainst the backdrop of another round of headlines about rising interest rates, many religious institutions (RIs) have reached out to lenders to assess whether now might be a good time to refinance. Even if you have a year or two remaining on your current note, it might make sense to seek a longer-term fixed rate now rather than take your chances with where rates might be when your loan matures. It typically takes about 90 days to go through the loan review and decision process, which includes securing a property appraisal, a title insurance commitment, etc. Ninety days might seem like a long time if you are concerned about rising rates. Vetting the environmental condition of your property early in the process can help you avoid unnecessary delays. Prior to funding a loan, lenders require that a certain level of due diligence is performed on the property being offered as collateral for the loan. These contingencies are typically listed in the financing offer letter. Most borrowers anticipate that the loan will be contingent upon a current churchexecutive.com
Market Value Appraisal evidencing that the loan does not exceed the lender’s maximum Loan-to-Value limit, typically 75 percent. However, many borrowers don’t realize that a great appraisal valuation doesn’t mean that the bank will accept your property as collateral. Appraisals are typically based upon an assumption that the property is free of any contamination. The following disclaimer language, or language similar to it, commonly appears in property appraisals: “No studies have been provided to us indicating the presence or absence of hazardous materials on the subject property or in the improvements, and our valuation is predicated upon the assumption that the subject property is free and clear of any environment hazards including, without limitation, hazardous wastes, toxic substances and mold. No representations or warranties are made regarding the environmental condition of the subject property.” In addition to the Market Value Appraisal, lenders typically require a clean “Phase I” environmental site assessment as a condition of the loan. The Phase I identifies potential or known environmental contamination liabilities associated with both the underlying land as well as the physical improvements to the property. The lender needs to be confident that if the property ever had to be sold to satisfy the loan, the value and marketability of the property would not be adversely impacted by environmental contamination. Quite naturally, RIs with existing debt might assume that if their property has met the hurdles set by their current lender, there should be nothing to worry about upon refinancing. After all, the prior lender required a “Phase I” before closing the existing loan. However, environmental standards can change, and sensitivities can also vary from one lender to the next. As an example of a fairly common scenario, a dated Phase I study references the past removal of a heating oil underground storage tank (UST), yet fails to reference any removal and closure documentation, or sample analytical results. Upon reviewing the old Phase I report, the new lender might require a ground-penetrating radar survey to confirm whether the storage tank remains on-site. In a worstcase scenario, a leaking UST is identified and, consequently, the piping, and any significantly contaminated soil, must be removed and disposed of offsite. Further, a “Phase II” will then likely be required whereby soil samples of the surrounding area are taken and analyzed. If your RI ever finds itself in this situation, prior to authorizing the Phase II work, ask your lender to review and approve your environmental consultant’s qualifications, as well as a map of the proposed sampling locations. This will limit the risk of having to go back for additional sampling. Also, whenever your RI is in the market to purchase land or buildings, be sure to require the seller to provide an environmental study. If one is not made available up front, any purchase agreement should be contingent upon the receipt and acceptable review of a clean study prior to the purchase. If a report is offered by the seller, be sure to have your lender look at it as early in the process as possible. I have seen instances where lenders have spotted issues like the one outlined in the preceding paragraph, yet the seller refused to undertake any further analysis of the property for fear of “opening a can of worms.” No buyer — particularly a RI — should be willing take on the reputational or financial risk of proceeding past such a red flag only to later find their leaking UST is contaminating a nearby water supply. The Federal Reserve has increased its key interest rates recently, and now might prove to be a good time to consider refinancing your debt. Upon engaging prospective lenders, be sure to share copies of any existing environmental studies early in the process. A qualified commercial lender can provide you with prompt feedback about what, if any, additional precautionary analysis you might need to initiate. Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, San Ramon, CA. [ www. bankofthewest.com ] The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of Bank of the West.
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