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“Finance & Lending Trends” Presented by: The Religious Institution Division, Bank of the West
11
HELPING LEADERS BECOME BETTER STEWARDS. Presented by: Religious Institution Division, Bank of the West Finance & Lending Trends
Transcript

H E L P I N G L E A D E R S B E C O M E B E T T E R S T E W A R D S .

Presented by: Religious Institution Division,

Bank of the West

Finance & Lending Trends

CHURCH EXECUTIVE • F I N A N C E & L E N D I N G T R E N D S2 churchexecutive.com

F I N A N C E & L E N D I N G T R E N D S • CHURCH EXECUTIVE 3churchexecutive.com

Table of Contents

RELIGIOUS INSTITUTION FINANCING TRUTHS — REGARDLESS OF THE LENDING CLIMATE 4You 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.

By Dan Mikes

DOES IT MAKE SENSE TO REFINANCE RIGHT NOW? (EVEN THOUGH YOU MIGHT BE FACING A PREPAYMENT PENALTY) 6While 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)? 8As 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 10A 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

THE STATE OF RELIGIOUS LENDING 11Religious 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.

By Dan Mikes

In future installments, religious lending expert Dan Mikes will survey the church finance landscape, including the availability of construction financing, the possibility of refinancing, property acquisition financing, financing satellite properties and more.

CHURCH EXECUTIVE • F I N A N C E & L E N D I N G T R E N D S4 churchexecutive.com

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.

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.

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.

F I N A N C E & L E N D I N G T R E N D S • CHURCH EXECUTIVE 5churchexecutive.com

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

CHURCH EXECUTIVE • F I N A N C E & L E N D I N G T R E N D S6 churchexecutive.com

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?

F I N A N C E & L E N D I N G T R E N D S • CHURCH EXECUTIVE 7churchexecutive.com

Running the numbersThe 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.

Please note that the above example only considers out-of-pocket-expense. 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 swapsIn 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

CHURCH EXECUTIVE • F I N A N C E & L E N D I N G T R E N D S8 churchexecutive.com

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 mergersIn 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

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 cost-effective 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-over-year attendance and net cash flow, the lender will entertain a request to purchase or build a facility. Conversely, if the religious institution plans

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.

Finance & Lending Trends

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Bank of the West

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WE BELIEVETRANQUILITYCAN COME INTRANQUILITYCAN COME INTRANQUILITY

MANY FORMS.

As a national leader in religious institution banking for over 25 years, we’ve provided more than $3.5 billion in financing to the faith community. Our affiliation with BNP Paribas, one of the world’s largest1 banks, and our industry expertise help us provide you with the services and solutions to best reach your financial goals.

To speak to a Relationship Manager, call 1-800-405-2327.

Member FDIC. Equal Housing Lender. ©2015 Bank of the West. Loans subject to credit approval. 1Bankrate.com, Q1 2015

S:7.25”S:9.75”

B:8.5”B:11.125”

CHURCH EXECUTIVE • F I N A N C E & L E N D I N G T R E N D S10 churchexecutive.com

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 loan-to-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 orderyour 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 plansand 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

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; ministry-specific 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.

Construction financing, revisited

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.

Finance & Lending Trends

Lender experience — and your preparation — are keys to success

F I N A N C E & L E N D I N G T R E N D S • CHURCH EXECUTIVE 11churchexecutive.com

Finance & Lending Trends

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 perspectiveAs 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

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 10-year 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.

The state of religious lending


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