How Much Debt Could My Religious Institution Successfully Manage?
By: Dan Mikes
In my 23 years of lending approximately $3.5 billion to religious institutions, there is no single question that elicits a more consistently divergent set of responses. When ministry grows and the demands of that growth are brought to bear on the limitations of the existing physical plant, the faith of the organization will no doubt be tested. A vision must be birthed and cast before the donors.
The challenge of balancing vision against financial realities is monumental. Use an appropriate amount of debt as a tool to leverage outreach to your community and the forward momentum of your ministry continues uninterrupted. Too much debt and you could end up in a place where the ministry is serving the building rather than the building serving the ministry. Outreach is curtailed, donor fatigue sets in, and your ministry ends up in a very different place – and not for the better.
As a lender, a man under authority at a bank, I will be the first to admit that my perspective as communicated hereafter is born of my standing as a risk manager. And, before you read on, I should also tell you that, among lenders, I am a conservative.
In spite of economic downturns, religious institution leadership transitions, and a host of other challenges, I have never found occasion to foreclose on a religious institution. Some would argue that achieving such a track record after making such a large volume of loans is evidence of being too conservative. Nevertheless, realizing that you are about to make an important financial decision in the life of your ministry, and if you would like some well-proven advice, read on.
Religious institutions contemplating debt should begin by identifying what lenders refer to as “total cash available for debt service.” Look at your financial results in each of the past few years. Begin with your net income and add back depreciation and interest expense. You can also add back any truly non-recurring expenses, such as a one-time gift to a new minister for a down payment on a parsonage or severance payments resulting from the closure of a school operation.
This sums up the total dollar amount you could have directed to principal and interest payments had you been carrying debt/more debt. Divide the total by 110% to allow for a minimal annual cash-flow cushion or debt coverage ratio. Then, using 25-year amortization and a current market rate, determine what amount of debt your current operational cash flow could have supported in recent years.
If you are like most religious institutions, the above exercise doesn’t carry you to a very significant number. That’s okay. You’re a non-profit, and you’ve been focused on providing ministry, not generating a large bottom line. But, for future reference, let’s refer to the above result as the “base debt capacity.”
In order to increase your borrowing capacity beyond the amount identified above, and set a course for new and larger facilities, the most conventional next step is a pledge campaign. The best advice is to hire a professional fundraiser. Professional fundraisers typically help you raise higher pledge totals.
Also, over the three-year term of the campaign, you will receive a greater percentage of those pledges. Generally, a religious institution can raise 1-1/2 to 3 times the amount of the total general offerings collected in the year prior to the pledge campaign.
Where you may fall within that range is a function of several factors, such as the level at which your donors are currently giving, how badly those donors need the new facilities your planning to build, and the demographics of your donor base – to name a few.
After you are several months into your pledge campaign, perform another “cash available for debt service” analysis based on a 12-month trailing period. With the pledge revenues adding to your total cash available for debt service, you may be able to achieve the 110% debt coverage ratio at a significantly higher debt capacity. Have these conversations with the lender and the fundraiser well in advance. Agree upon an achievable target, determine the maximum project cost, and task your architect accordingly.
Ideally, you will break ground within 3 to 9 months following the start of the capital pledge campaign. With the bricks and sticks on site, the pledge revenue will continue to flow. There is another practical reason for starting within this timeframe. Pledges received during construction minimize the amount of debt you will draw for the project costs. Pledges received following completion of construction should be applied to pre-pay debt.
Earlier we calculated what we referred to as the “base debt capacity.” Ideally, by the time your pledge campaign has ended, you will have pre-paid your debt down to this level. This is the most “cautious scenario” as the ministry will be able to transition to debt servicing solely from operating cash flows.
In other words, if you conservatively assume the new building will not produce any attendance and revenue growth, and assuming you have the same general offerings and expense budget you achieved prior to beginning the pledge campaign, you will be able to service the remaining debt from general operational cash flow.
Again, this is the ideal. Often, lenders may be comfortable knowing the religious institution is committed to a subsequent capital pledge campaign if such is needed depending upon the level of post-project congregational growth.
Your religious institution should discuss this possibility early in the planning process. You should consider that donors are not as enthusiastic about pledge campaigns solely for the purpose of debt service. Again, consult with your fundraiser. Generally speaking, such campaigns may raise only half the dollar amount of pledges raised for needed new facilities.
In closing, the best advice is to seek the safety of a multitude of counselors. Create a finance committee that includes board members or active attendees with expertise in finance, real estate, accounting, construction, and other disciplines that may prove beneficial. Most importantly, talk to prospective lenders and fundraisers before you task your architect.
It’s not easy to connect your vision with the realities of financial limitations. If you begin the process early, and incorporate a broad spectrum of gifts and talents, you can utilize debt appropriately to build facilities that keep your ministry on a path to a blessed outcome.
Dan Mikes is executive vice president and national manager in the Religious Institution Division at Bank of the West, a $64-billion asset bank based in San Francisco. He has more than 20 years of experience in banking and finance and can be reached at firstname.lastname@example.org.
* Opinions rendered in this article represent the author, and not Bank of the West.