Just a year or two ago most Americans were feeling financially secure if not downright prosperous. Their homes were appreciating in value, the job market was strong and they were earning solid returns on their savings and investments. This sense of financial well being spilled over to churches as the faithful made generous contributions or tithed 10 percent of their income. There seemed to be no question that capital campaign pledges would be paid as agreed.
For churches looking to finance new building projects, another benefit was that credit was readily available at low rates. Financial institutions, many of which had previously not been involved in lending to churches, were fighting to win new loan business, often offering loan amounts much higher than what had historically seemed prudent. Against the backdrop of rapidly escalating construction costs, many churches felt pressure to move forward quickly with aggressive new building plans. No one stopped to ask how long the good times might last or what would happen if the economy slowed down.
These inexperienced lenders often failed to understand the dynamic of churches, and failed to appreciate the need to be more prudent in this niche than in other lines of business. After all, it is a totally different situation when a church has to cut back ministry than it is for a business to cut back production of widgets. A church’s services are most in need when times are tough. Cutbacks in programming, outreach and missions can have a profound impact on the church body and the community. A church’s purpose is not to serve its buildings, but rather the buildings should be serving ministry.
Feeling the impact
The current economic slowdown may be a short term blip without dire or long lasting affects on most churches nationwide. For many churches, giving has not declined, and may even have increased as attendance has grown. However, there is no doubt that a number of churches are feeling the impact of a weak economy. Many people, such as retirees or those in the building or mortgage industry have seen their incomes decline.
Most churches can make the necessary expense adjustments to ride out this downturn without having to make any major adjustments in staffing or ministries. While this slowdown may be short and relatively painless, it offers an opportunity for churches to review their debt situation from perhaps a different perspective.
Churches that undertook major expansion plans based on the notion that they would grow into the debt may have some difficult times ahead. The long established rule of thumb in church lending has been that a church’s maximum debt should not exceed approximately three times its unrestricted contributions and capital campaign collections. However, the unusual or non-recurring nature of the capital campaign pledges should be taken into account, such that the church’s debt after a campaign has ended should not exceed approximately three times its general fund giving.
When a professionally orchestrated capital campaign for new facilities is underway, experienced church lenders may offer borrowers a higher loan amount initially to fund construction. However, they may require that a portion of the remaining outstanding pledges be used to pay down the loan before construction line converts to a lower “permanent” or “take out loan.”
Formula for maximum debt
This general formula for maximum debt fits in with the theory that approximately one-third of a church’s annual income can go to salaries and benefits, one-third to ministry and missions, and up to one-third to debt service. Most experienced church lenders would caution churches against committing more than about 30 percent of their income to debt service, to allow a cushion for higher rates or lower income levels in the future.
Prudent lenders advise churches not to rely on continued attendance growth and probe whether the churches have plans for subsequent capital campaigns. They will share their experience that campaigns focused on debt reduction are not as successful as those for new buildings.
Did your lender provide good counsel regarding your church’s debt capacity, or did they woo you with an amount even higher than what you wanted? Did they have years of experience to bring to the table to help you realize that their advice had value? Did your lender talk with you about your plans for debt repayment? Many lenders offer churches a choice between a variable rate loan and a fixed rate loan affected through execution of a swap contract.
While swap contracts can offer many benefits to borrowers, such as the ability to enjoy a cash payout upon prepayment if the prepayment is made when rates are higher than the fixed rate on the swap, they also carry downside risk if prepaid when rates are lower. Did your lender fully disclose the benefits and consequences of the swap contract?
Good lender relationship
When you reflect back on your current situation, are you pleased with your choice? It is always desirable to have a good relationship with your lender, who should be a long term financing partner rather than a transactional intermediary. Some of these new entrants into the church lending arena made their loans, took their profits and sold the “paper” to third parties.
Going forward you won’t be working with anyone who really understands or cares about your church. Given the complexity of modern loan products, it is best to have a financing partner who can help you evaluate your options and structure your debt to minimize interest payments yet maximize your flexibility. Some financial institutions with a long history of church lending will understand all your needs and be able to offer you full service banking such as cash management services.
As with many things in life, sometimes the value of resource or relationship isn’t fully recognized until there is a stressor event that brings unforeseen issues to the forefront. Now may be a good time to reflect on your situation and consider the benefits that a dedicated and experienced church lender can bring to your church.
Dan Mikes is executive vice president of church and educational institution banking division for Bank of the West, Walnut Creek, CA. [bankofthewest.com]