By RaeAnn Slaybaugh
At a Church Executive live roundtable, high-level religious financing, compensation/benefits and fundraising experts surveyed the landscape surrounding these key areas of church management.
Our Roundtable Panel
- James R. Cook, National Outreach Manager, MMBB Financial Services
- Steve Hron, Senior Vice President, Ziegler
- Bill McMillan, Executive Vice President, RSI Stewardship
- Joel Mikell, President, RSI Stewardship
- Dan Mikes, Executive Vice President, Bank of the West
- William Scrivens, Reserve Specialist, Miller Dodson Associates, Inc.
- Paul Weers, Senior Benefit Consultant, MMBB Financial Service
On July 12, 2013 — at the National Association of Church Business Administration (NACBA) annual conference — Church Executive hosted a live roundtable on a timely topic: “new normal” challenges and solutions in the areas of financing, compensation/benefits and capital campaigns. Several high-level executives representing each sector came together to share their observations.
The highlights and takeaways of this insightful discussion are published as a two-part series in this issue of CE, as well as in our previous issue: Aug/Sept 2013.
In part 1, the panelists outlined the pre- and post-recession climates in their areas of expertise. Here, in the final installment, they’ll switch gears to “solution mode,” drilling down on strategies church leaders can employ to overcome new normal obstacles.
In part 1 of this roundtable, historically low property values and a strong emphasis on cash reserves were cited as stressors for churches in the new normal economy. What other challenges are they facing in this area?
Dan Mikes: Low property values means the borrower must generate more equity dollars for the next building phase to meet the overall loan-to-value contingency under the financing offer. The best way to do this is with a professionally orchestrated capital pledge drive. Over my 23 years in church lending, I’ve seen thousands of capital campaigns. As lenders, we know the actual collection rates against those pledges because we’re in relationship with the borrower through the term of the campaign and beyond. Without question, when a professional fundraiser is used, the pledge totals are higher, and the collection rates against those pledges are more predictable. Consequently when consulting with churches, we reinforce the strategy of engaging a professional capital fund raiser.
In today’s economic climate, it’s so critical that church leaders talk to experienced fundraisers, lenders, architects and builders.
Churches are a unique market segment. One of the bigger challenges within church expansion is that leadership teams will undertake a large physical plant expansion only once or twice in their entire careers. They don’t necessarily know a lot about borrowing capacity or how to think through the entire project. From the perspective of someone who has observed the process hundreds of times, we know fundraising via a pledge campaign provides the needed supplemental construction funds. Post-construction, the remaining incoming pledge receipts typically provide a measure of debt pre-payment, enabling a lower post-campaign debt level and an easier transition to debt servicing solely from operating cash flows. Leadership teams have plenty of questions: How do those metrics work? What can we expect? Do we factor in an assumption of congregational growth once we open the doors to the new facility? Will those new attendees begin to tithe right away? The church might need to increase staff to accommodate new attendees, and that staff expense might precede revenue growth. Also, with a larger facility, there are increased insurance, utilities and maintenance costs to consider. How do all those factors come together, and will the church be able to service debt from the operating cash flow when the campaign ends?
So, those are the challenges. I think the best way to address and overcome them is to get a lot of good counsel as early in the process as possible.
Steve Hron: One thing we haven’t discussed is that there are a lot of lenders in the marketplace that underwrite their loans with something called an “interest rate swap.” We’re finding out that’s really handcuffing a lot of churches in terms of being able to move ahead with building projects, refinancing or the like.
Let’s just say a church locked into a swap at 6.5 percent five years ago. That might have sounded great at the time. But, since interest rates have dropped, these swaps are “out of the money.” That can make it cost-prohibitive for a church to prepay its loan or refinance and get out of that interest rate swap. For example, we were talking to a church in Michigan where the swap unwind cost was $700,000. Another church in Arizona needs $450,000 to exit their swap. Another church — this one in Texas — needs almost $800,000. These are, in effect, prepayment penalties over and above the loan payoff that can make refinancing or new projects cost-prohibitive.
Banks have been stressed, too. If the church’s current lender can’t qualify the church for a loan right now, it might not be a result of the church’s credit profile, but that the bank isn’t able to do the loan because of the bank’s capital position. So, when there is a need to build a family life center or a new sanctuary but the church can’t get the additional loan from their current lender, they can’t go to another lender because the interest rate swap unwind cost is so great. In effect, they’re trapped with this particular lender and potentially blocked from expansion. In summary, an interest rate swap might make it cost-prohibitive to do any expansion or to simply refinance with another lender.
Dan Mikes: It’s all about timing. Look at where we are right now. Look at where we’ve been for an unprecedented extended period of time — historically low interest rates. In this environment, banks don’t want to carry a 10-year fixed-interest income stream on their balance sheet. These are specialty loans that are typically not securitized and sold off. Consequently, three or four years from now, the bank might be paying a higher rate on deposits than it’s receiving from the loans it’s making in today’s historic low rate environment. That’s not a good situation for the banking system, or for the economy.
Swaps enable the bank to move the interest rate risk to a counter party. This enables the borrower to get a 10-year fixed rate while paying only a quarter- to a half-percent loan origination fee rather than getting a long-term fixed rate via issuing church bonds with costs and fees totaling around 6 percent.
And by the way, that early termination equation — that prepayment penalty you mentioned — works much like the old-school yield maintenance provision that has historically been included in bank notes. If you prepay all or a portion of the debt at some point in the future, and interest rates are lower at that time, the borrower owes a penalty. However, the nice thing about the interest rate swap is, when interest rates rise in the future, if a church is prepaying against the swapped note, the church can get money back. It’s a two-way street. At this point in the interest rate cycle, the swap can be a very attractive tool for a portion of the church’s debt.
When considering some of the adverse commentary you might have heard regarding swaps, you must consider the context. Swaps were introduced to the church market place about 10 years ago. Since then, interest rates have steadily declined. Combine this with the fact many church borrowers didn’t clearly understand how the product worked. As rates declined and churches attempted to refinance or prepay, they incurred prepayment penalties. Consequently, we’ve all read the articles where borrowers say they were surprised and disappointed by the termination cost.
Again, the best guidance is to deal with a reputable institution. An institution which has invested hundreds of millions of dollars to establish a reputation of trust within the church market segment is not going to risk its good name on lack of disclosure or one-sided counsel. A committed church lender is going to place a high value on disclosure, comprehension and suitability. Ask for references.
When suitable, a church can diversify its interest rate risk management strategy by placing a portion of the debt under a long-term fixed rate note via a swap, and placing the remaining portion of the debt under a variable or shorter-term fixed rate note which has no risk of prepayment penalty. This strategy provides a measure of insulation against future rate volatility as well as the flexibility to prepay a portion of the debt with no risk of prepayment penalty. This is a low-cost approach, as banks only charge one-quarter to one-half-percent origination fee.
How should the borrower divide its debt across these various notes? I’ve been lending to churches for 23 years, and I manage a large pool of existing church loans. Every month, I analyze a large pool of church loan data on a 48-month trailing basis to identify actual prepayment rates. On average, churches prepay 2 percent a year. Consequently, with a 10-year debt structure — if the church places 70 percent under a swap and 30 percent of the debt into a note with which has no prepayment penalty — it will very likely have more prepayment flexibility than it will need while maximizing its insulation against future rate volatility. In the current rate environment, a church won’t have much to worry about unless, as Steve says, the lender has a problem and can’t accommodate the church’s future borrowing needs. But, that risk is present no matter which lender or what type of debt a church chooses.
And there again, it goes back to our earlier point: A church needs to deal with somebody who’s been lending for a long time. It needs to look at that lender’s safety and soundness rating.
Joel Mikell: Although this question isn’t totally in our wheelhouse, it’s our job to help raise the resources to pay [the financial institutions] here at the table. To that end, we’re seeing a greater focus on pledge cards.
I was working with a church in South Carolina yesterday. There was a banker on the capital campaign team helping them with some interim loans. We emphasized the need to have pledge cards for their campaign. He looked at me as the consultant and said, “It’s one thing to get a stack of pledge cards in hand, but what are you seeing in terms of your fulfillment ratio? Eighty percent? Ninety?” So, there’s greater focus on our side of the table in those three years of fulfillment as opposed to saying, “Let’s just get the pledge cards in hand.”
What strategies and solutions are church leaders employing — successfully — to surmount financing challenges?
Joel Mikell: What we’re seeing — and have seen over the last couple of years — is a lot of pressure from the pews for churches to have a strategy in place to be debt-free. There has been a preponderance of debt campaigns to free up cash from the operational budget and to position churches to expand, but also to borrow more in the future. Historically, we’d see debt, added to debt, added to debt.
Today, the focus from the platform is on financial education programs that teach members how to live within their means — to live with margin. That’s what’s coming from the platform out to the people. And the people are saying back to the church, “Well, then, you do it, too. Don’t borrow until you have to, and only borrow what you have to. And, let’s pair with that a strategy that says we’re going to pay this off in a three-year or a five-year campaign.” So, there’s some focus on — if a church is going to borrow from a lender — pairing that with a strategy that doesn’t become pressure against the operational budget.
Stagnation of wages and benefits for entry- and mid-level church staff, as well as cutbacks in both areas, were cited as new normal challenges in part 1. What strategies and solutions are church leaders employing to surmount these?
James R. Cook: It’s becoming more common for churches to go through an evaluation of their compensation and benefits packages on a regular basis.
Another thing we’ve seen through the downturn of the last few years is that some church staffs haven’t grown. In some, we’ve seen pullback due to layoffs in some cases. In other churches, employee consolidation is the norm now; as people retire, they aren’t replaced. Obviously, though, if the overall church is growing, it’s a completely different situation.
It’s not uncommon to find churches with somebody in the administrator position with really strong HR experience in the benefits area. We find that we can walk in and assist them with restructuring their plan, because it’s important for churches to understand that there really are two key pieces to an effective benefits plan.
First, they need to have a benefits plan that works with their budget. You can’t be so rich that your budget is bleeding red ink.
Second, they need to understand that a benefit has to be of benefit to both the church and the employee. If you make eligibility too stringent, reduce matching or significantly reduce other benefits to accommodate it, then it won’t be perceived as a benefit by the employees. If a church has a strong benefit policy in place, that’s perceived by the staff as having high value. Then, it really does benefit by allowing them to hire and retain the best over a long period of time.
So, we really believe that if a church is struggling, we can walk in and work with them in a consultative manner to restructure their plan to be able to balance those two things really well.
Paul Weers: I’d like to add that, in some cases, our greatest competition isn’t the retirement benefits churches are offering, but escalating health insurance premiums. It’s in the newspapers and on television every day. We don’t know what Obamacare is going to look like, so certainly stay tuned.
William Scrivens: I watched a very interesting TED talk a few weeks ago about the perception that an NGO or a nonprofit should really be managing itself at no cost, and the pitfalls doing otherwise presents. That kind of ties into what we were just talking about — that if your church’s benefits package is healthy, you’re going to attract the best. And, they’ll do a better job for you.
James R. Cook: This calls to mind an excellent administrator here at NACBA who told me, “By its very nature, everybody who gets a job gets a paycheck. The difference is that not every job provides benefits.”
He said his church is competing for administrative staff with the bank down the street. The bank will probably pay a little higher salary, but if he can beat them on a benefits package, then he can get the expertise needed to run his church at the absolute highest level of efficiency.
Unfortunately, that’s something some churches don’t understand — the value of benefits to their employees. Benefits are especially critical when you’re going to the open market for employees. While we all hope that the people who work in our churches will have a real passion for the mission, as our churches get larger and larger, we need the kind of expertise that forces us to go out into the open market. For some people, working at a church will just be a job; but, if we need that expertise, we need that expertise.
In part 1, the need for every capital campaign to be customized in the new normal economy, plus a far greater emphasis on pre-campaign due diligence — up to a year or two in advance — were offered up as common challenges. How are church leaders tackling these?
Steve Hron: That’s an interesting question. I’m curious: Have the metrics changed? In past years, [capital campaign firms] could say, “We can raise three times the general fund.” Would they now say, “We can raise two times the general fund?” I know every situation is customized, but are there any broad-based metrics that exist?
Joel Mikell: We’re still very, very connected to the project and very, very connected to the passion and vision.
I got an email yesterday from one of our consultants who just wrapped up two of our campaigns. They both exceeded the goal by three times. In both cases, the compelling vision was the driver; vision trumps all. People give to the vision, not to the project. When there’s a compelling vision, an applicable project, and great leadership on the platform, the metrics haven’t changed. We still see churches exceed 3X and 4X. If it’s a debt campaign, it’s more like 1X, although 1.5X results are still common. If it’s a Christian Life Center (CLC), it’s usually in the 1.5X to 2X range. So, results are less connected to the economy than to a campaign’s passion and vision.
Bill McMillan: We’re doing a lot of blending of capital need with mission and organizational needs, in the budget.
Dan Mikes: I’m curious what percent of your business deals with three-year capital campaigns?
Bill McMillan: We’re doing many two-year and 18-month campaigns.
Joel Mikell: There’s no standard model — it depends on the amount of money a church needs to raise, and how many times it’s “been to the well.” We’re working with a church in Minnesota that has a $150-million mission. That incorporates 10 years’ worth of campaigns they’ve already told their people they’re going to do, in a series of five two-year campaigns.
We’re also getting ready to work with a large church in Tennessee that’s doing an 18-month campaign which will likely wrap their over-and-above giving into some kind of annual vision.
And, I’m going to be working with a church in Louisville, KY, that wants to do a three-year campaign because they had a great experience with it 10 years ago. They haven’t been back to the well, and they loved the involvement factor of the campaign.
So, you can no longer say, “This is the standard capital campaign.” I think the common denominator is always going to be that a campaign must be co-created with the church leadership.
Any final thoughts on the new normal economy and its impact on churches’ financials?
Dan Mikes: Let’s look at where we are right now in the economic cycle. We’ve had an unprecedented period of government stimulus. We’ve had an extended period of intervention in the financial markets by the Fed — $85 billion a month in cash printing for the purpose of buying back our own treasuries and buying mortgage securities to try to keep borrowing rates low, in an effort to stimulate housing and bring back employment in everything from construction, to housing, to textiles, to appliances and so on.
We’re trying to bring the unemployment number down. It’s happening very, very slowly. We’ve had this long period of low rates. So, the planning at the church level needs to include contemplation of the impact of these factors.
It means great things for churches, now — especially if they’re refinancing debt or undertaking a building project. But, when interest rates adjust in the future, what will be the impact on the ministry?
Once the money that’s being printed starts chasing a limited supply of goods and services, it’s going to force prices up and create inflation. Hypothetically, if inflation rises to 4 percent or 5 percent, the investors bidding in financial markets and influencing interest rates are going to want a rate return above that 4 percent or 5 percent — some real appreciation in the buying power of their dollar. As a result, at a point in this cycle, we might see a spike in interest rates. We’ve seen a 100 basis-point increase at the 10-year part of the yield curve in just the last 40 days, primarily based on concerns about the Fed slowing the pace of cash-printing. And, we have yet to see the unemployment rate come down to historic targets of 4 percent to 6 percent; it’s still at nearly 8 percent. Lower unemployment means more consumers spending, which puts pressure on price inflation. So, there’s an increase in interest rates coming, and this is where fixing the interest rate for a long period of time is a real plus.
But, even if you fix the rate for 10 years or 20 years, circumstances probably will dictate that you eventually expose yourself to a different rate environment due to refinancing in conjunction with a subsequent building phase or some other set of circumstances. So, that’s out there in the future, and it’s something churches need to start thinking about and preparing for.