Lending to Specialized Industries

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Nigel Dominic Osborne
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Lending to Specialized Industries Church Lending by the Numbers by John J.

to their own preferences and experience, then reap the benefits.

IronStone Bank, having been in existence since the 1800s, has a long history of successful

In recent years, we have extended our reach into the West.

1 Lending to Specialized Industries Church Lending by the Numbers by John J. McGovern Although it s often called church lending, this specialized form of lending applies to many other religious institutions. This article presents a decisioning tool geared toward term real estate lending for religious institutions. The author offers a tool for community banks active in church lending to duplicate and modify to their own preferences and experience, then reap the benefits. Lending to religious institutions has always been a great deal art and some science. IronStone Bank, having been in existence since the 1800s, has a long history of successful religious institution lending in North Carolina and elsewhere in the Southeast. In recent years, we have extended our reach into the West. We have had a religious institution credit policy for many years, but we ve given new priority to simplifying the policy and ensuring 2006 by RMA. John McGovern is a senior vice president and senior credit officer for IronStone Bank, a division of First Citizens Bancshares, Inc. His office is in San Diego, California. 30 The RMA Journal June 2006

2 consistency in our analyses. Therefore, we re now injecting more science into the equation. Lenders involved in religious institution lending know that the environment is changing. Within IronStone Bank s footprint, we have loaned to small rural churches, to urban congregations, and to what are now categorized as mega churches. While the loan amounts can be vastly different, church lenders know that certain financial parameters will fall into a fairly narrow range for healthy borrowing and financing. There is more to religious institution lending than financing sanctuaries and other church buildings, but term real estate lending tends to dominate. Throughout this article, I will use the terms religious institution and church interchangeably. Church lending has slipped into our lending vernacular, but if taken literally, it is too narrow a term for the potential credit opportunities we now enjoy. The Solution Those of us who manage portfolio quality put a high value on consistency policy consistency, underwriting consistency, and a consistently high level of loan quality. I have developed a tool that will not, by itself, make our church loan decision for us, but it does help ensure that we are not all over the board in our church lending analyses. The spreadsheet that follows is valuable in its ability to make the needed financial comparisons; however, with a modest amount of input, it also forces the relationship manager and initial underwriter to think about some of the quantifiable factors that make for a prudent term loan. Correct use of this tool does require the lender to do some probing with representatives of the religious institution who have accurate knowledge of where the revenues come from and the makeup of the congregation. The Decisioning Table The sample table shown in Table 1 has been constructed to accommodate three different churches for comparative value. It can be informative to compare the new prospect or request to other existing church credits that have now seasoned and whose relative strengths are known through experience. The alternate use of this design would be to compare multiple financial statement periods for the same organization. Three comparisons fit nicely on one page in portrait configuration. I have had occasion to expand it to six church columns when we have multiple church loans within the same denomination. That expansion can be done fairly quickly by adding columns in your Excel spreadsheet and then dragging the existing formulas over to the new columns. This is convenient when you dislike typing as much as I do, and it avoids muddling the formulas. The spreadsheet provides a number of places to compare our borrower to what we consider a healthy ratio or a prudent debtdollar value. Like so much of what we do, there are numerous qualitative and relationship considerations that will have a substantial influence on our ultimate decision about a loan size we are comfortable with. This decisioning tool not only fosters consistency and provides an easy summary view of the credit opportunity, but it encourages the less experienced lender in particular to evaluate the reasons his or her prospect falls below, or possibly well exceeds, what we would consider a reliable norm. The credit presentation prepared after this analysis should explain why the prospect falls short of some or all of the standards, at which time the lender may look for ways to mitigate the risks. We are comfortable at this time with the standards that have been set up in this decisioning tool. Some standards may evolve with additional experience, while others, such as the amount that constitutes strong giving levels, will evolve with inflation. If your bank adopts a decisioning tool based on this spreadsheet, the standards used can be adjusted to reflect your bank s experience, regional varia- W HILE THE LOAN AMOUNTS CAN BE VASTLY DIFFERENT, CHURCH LENDERS KNOW THAT CERTAIN FINANCIAL PARAMETERS WILL FALL INTO A FAIRLY NARROW RANGE FOR HEALTHY BORROWING AND FINANCING. 31

3 Table 1 New Loan Payment Analysis and Credit Policy Comparison 2 Loan Amount (enter) $2,300,000 $2,950,000 $3,500,000 Decline Church Paradise Church Road Church 4 Interest Rate (enter) 6.15% 5.95% 6.25% 6 Number of Payments (enter) Monthly Payment $19, $24, $30, Annual Payment $235, $297, $360, NOI / Cash Flow Available for Debt Service (enter) $201,000 $842,000 $963, Debt Coverage Ratio Annual Revenue (enter) $521,000 $1,058,000 $1,240, Members (enter) , Giving Units (G.U.) (enter) Minimum Guideline 20 Annual Revenue per G.U. $1,861 $1,924 $2, $1.2M Good, $1.5M Above Average 22 $2.0M + Strong 23 Debt Service as a % of Annual Revenue 45.13% 28.14% 29.04% 24 Standard: 30% 25 Positive Variance from Standard % 1.86% 0.96% 26 Debt Service per Giving Unit $840 $541 $ Standard: 30% of Annual Revenue per G.U. $558 $577 $ Total Debt per Giving Unit $8,214 $5,364 $7, Standard: 2.25 to 3.0 X Annual Revenue per GU Loan Size to Annual Revenue Standard: 2.25 to 3.0 times 32 Three-year Average Annual Revenue (enter) $521,000 $1,058,000 $1,100, Total Church Assets (enter) $2,143,000 $7,916,000 $5,341, New Loan to Total Assets % 37.27% 65.53% 36 RMA Standard: Total LTD 29% of Assets 38 Net Worth (enter) $1,209,000 $4,876,000 $1,839, New Loan as a % of Net Worth % % 40 Standard: Total Debt to Net Worth.60:1 (60%) 41 New Debt, Limit Calculation 42 #1: Total m=members X $3,000 $1,401,000 $2,400,000 $3,000, #2: D/S Standard 30% of Annual Revenue $1,528,788 $3,144,475 $3,615, #3: Annual Revenue X 3 $1,563,000 $3,174,000 $3,720, #4: Annual Revenue/GU X 2.75X # GU $1,432,750 $2,909,500 $3,410, #5: Three-year Average Revenue X 3.0 $1,563,000 $3,174,000 $3,300, Maximum Debt Guideline (1-5 div by 5) $1,497,708 $2,960,395 $3,409, Loan Amount vs. Guideline Calculation $ (802,292) $10,395 $ (90,903) 49 Loan as a % of Guideline Calculation % 99.65% % 50 Loan Size (hypo) if DCR Were 1.5 $1,310,669 $5,561,117 $6,242, Loan Amount X.30, = s Ideal Annual D/S $156,300 $317,400 $372, Rate Factor to Get Ideal Loan Amount The RMA Journal June 2006

4 tions, and preferences based on your risk assumptions. The spreadsheet requires only 10 entries for each church or financial statement period. I have put the word enter in each appropriate cell and one can also color-code the cells that need entries for quick identification. Once that is completed, all the calculations will be made by the Excel program. This allows updates as well as the initial analysis to be set up fairly quickly. Spreadsheet Components, Row by Row Some of the components are fairly straightforward, while others are assisted by some explanation. One of my secondary objectives is for you to easily recreate this church lending spreadsheet on your own PC. To that end, I have included the calculations from those cells that have calculations and the appropriate row numbers. Loan Amount (enter) (row 2). Interest Rate (enter) (row 4). Number of Payments (enter) (row 6). We use a standard of 180 months as a reasonably conservative test. We may not let all of our loans have a term of 180 months. On the other hand, it might make sense for a church real estate loan to have an amortization period in excess of 180 months. To be conservative and consistent, we like to know that the proposed credit works at 15 years. Monthly Payment (row 8). Calculation: Excel will calculate monthly payments using the PMT formula, for the first column; = PMT(B4/12,B6,-B2). Annual Payment (row 10). Calculation: row 8 Monthly Payment X 12. NOI or Cash Flow Available for Debt Service (enter) (row 12). Healthy religious institutions often have some level of discretionary expenses. The objective here is to use a number that accurately reflects your borrower s situation and that can be backed up and defended. This is a 12-month figure. Debt Coverage Ratio (row 14). This is obviously a key piece of information in making our decision. I will not propose a standard here, as each lending institution has a perspective on how much coverage above 1:1 it would like to see. If your input numbers are good and you do not have a margin above 1:1, then it will be difficult for a favorable indication elsewhere in the table to outweigh the insufficient debt coverage calculated in row 14. Calculation: row 12 Cash Flow Available row 10 Annual Payment. Annual Revenue (enter) (row 16). All recurring revenue from your borrower s financial statements should be included here. Churches have a number of different ways to label this revenue, so the key is in its recurring nature. Watch for things like capital campaigns and non-cash donations of property. This is a likely area for discussion with your prospect s financial person prior to attempting a final calculation. Members (enter) (row 17). One might as readily call these regular attendees, as membership is handled in so many different ways. Some religious institutions do not emphasize formal membership and might have people coming at least once a week for decades without signing up as a member. Others continue to count as members those who joined years ago and have not been back for more than an occasional visit. Giving Units (enter) (row 18). A long dissertation is not necessary as giving units have been addressed in The RMA Journal more than once, but suffice it to say that this is an important number for any quantitative analysis of a religious institution. In order to get the most out of this analysis, it is important to press your borrower for as accurate a number as possible. Some will say that they do not use the term, or that they do not keep track that way. Once the concept is explained, however, they can all identify the number of family units that give on a regular and significant basis. This is not the dollar-in-the-plate-twice-a-year giver. This is the family or individual that the church can count on for some measurable contribution each year. Logically and statistically, the amount of giving units would be less than the number of regular attendees. The typical family contributing monthly or weekly will write one check that includes all members of the family. Some congregations will count adults and children when giving you attendance figures. This area is going to require some meaningful discussion with staff members of your borrower who have an accurate perspective on the revenue collection and dynamics of the church. 33

Minimum Suggested Giving Units (row 19). We use 250, and that number carries a good deal of precedent outside of our bank, but you should use a number that matches your credit policy.

5 Minimum Suggested Giving Units (row 19). We use 250, and that number carries a good deal of precedent outside of our bank, but you should use a number that matches your credit policy. Years ago, I spoke with pastors and read church publications that questioned the long-term sustainability of a congregation smaller than 200 members. If the prospect falls below the minimum, some mitigation is in order. Annual Revenue per Giving Unit (row 20). We refined this standard after consulting the Barna Group research and statistics from numerous recent church credits that cover a variety of congregation sizes, denominations, and demographic makeups. Calculation: row 16 Annual Revenue row 18 Giving Units. Standards (row 21). At this time, we consider $1,200 per giving unit per year as a good level of giving. We consider $1,500 to be above average and anything above $2,000 to be strong. 34 The RMA Journal June 2006 Debt Service as a Percent of Annual Revenue (row 23). For our purposes, we use a standard of 30%; church lending literature supports a range close to this percentage of acceptable Debt Service to Annual Revenue. This 30% standard will form the basis for other calculations within this decisioning table. Calculation: row 10 Annual Payment row 16 Annual Revenue. Positive Variance from Standard (row 25). This is an easy way to get a quick look at how much your borrower exceeds or falls short of this standard; while titled positive variance, it will at times be negative. Calculation: 30% standard - row 23 the derived Debt Service as a Percent of Annual Revenue. Debt Service per Giving Unit (rows 26 & 27). Logic tells us that if the loan s Annual Debt Service as a percent of Annual Revenue Preferred Standard is 30% or less, the debt service to be apportioned to each giving unit should be a similar proportion or 30%. Empirical data from a test of numerous church credits shows a median of 25.3% (debt service per giving unit as a percent of that church s loan). Calculation Row 26: row 10 Annual Payment row 18 Giving Units. Debt Service per Giving Unit Standard (row 27). To give some perspective to the debtservice-per-giving-unit number that has just been calculated, this cell shows what 30% of annual revenue divided by the number of that church s giving units would be in dollars. This allows you to quickly check to see if the dollar figure in row 26 is equal to or exceeds the standard in row 27. Calculation: row 20 Annual Revenue per Giving Unit X 30%. Total Debt per Giving Unit (row 28). This calculation lets you see the actual dollars of debt from this loan request that would theoretically be assigned to each giving unit of this congregation. row 18 Giving Units. Loan Size to Annual Revenue Ratio (row 30). My research shows that this is a common standard of measurement used by church lenders across the country. Lenders favor slightly different numbers, but the common thread puts the acceptable number between 2.25 times and 3.0 times annual revenue as the maximum desirable loan amount. row 16 Annual Revenue. Calculation row 29: row 28 Total Debt per Giving Unit row 20 Annual Revenue per Giving Unit. The calculation for row 29 also is compared against the row 30 standard of between 2.25 and 3.0. Three-year Average Annual Revenue (enter) (row 32). This information, taken from your borrower s financial statements, will be used further down in the table as part of the Maximum Debt, Guideline Calculation. As discussed above, you should be looking at recurring revenue, and there may be room for some discretionary expense add-back. Total Church Assets (enter) (row 34).

6 Y EARS AGO, I SPOKE WITH PASTORS AND READ CHURCH PUBLICATIONS THAT QUESTIONED THE LONG- TERM SUSTAINABILITY OF A CONGREGATION SMALLER THAN 200 MEMBERS. IF THE PROSPECT FALLS BELOW THE MINIMUM, SOME MITIGATION IS IN ORDER. New Loan to Total Assets (row 35). This standard is based on RMA s Annual Statement Studies mid-quartile ratios. Keep in mind whenever using this ratio that the RMA average is all long-term debt to total assets; our number is only for the subject new loan. While our church borrower s total LTD is often composed of one RE loan, a final comparison would have to include any other LTD in the ratio. The five most typical asset and sales size religious organizations were used and averaged (there was only a slight deviation), and LTD being 29% of total assets was the result of this averaging. row 34 Total Church Assets. Total Debt to Net Worth Standard (row 40). This standard is based on RMA mid-quartile averages and can be adjusted as those averages change or if your church borrower fits in an asset or revenue size that would reflect another number. Net Worth (enter) (row 38). New Loan as a Percent of Net Worth (row 39). row 38 Net Worth. New Debt, Suggested Limit Calculation (row 41). The suggested debt-limit calculation was inspired by a formula I found in an article by Willis L. Kirk in Religious Product News, September I adapted three of his components to more closely reflect our experience and created two others #2 and #4 that more closely fit our guidelines and the logic of our analysis. #1 (row 42). Total members are multiplied by $3,000. This figure relates back to the guidelines for Annual Revenue per Giving Unit, and reflects that there would typically be approximately two members for every giving unit, on average. It tends to produce a result on the lower end of the five calculations, providing a tempering, conservative effect on average. Calculation: row 17 Total Members X 3,000. #2 (row 43). This suggested loan limit maximum is based on our accepted premise that debt service should not exceed 30% of the church s annual revenue. The calculation takes Annual Revenue, multiplies it by 30%, and comes up with a Maximum Annual Debt Service (row 51). It then applies the interest rate used for the proposed loan (see factor calculation, row 52) and calculates the loan amount, at the suggested interest rate, that is equal to the annual debt service number, which is 30% of the church s annual revenue. Calculation: row 51 Ideal Annual Debt Service X row 52 Rate Factor. # 3 (row 44). This is Annual Revenue multiplied by 3, which relates back to the well-accepted standard that church lenders do not expect to see loan amounts in excess of three times annual revenue. Calculation: row 16 Annual Revenue X 3. # 4 (row 45). This is Annual Revenue per Giving Unit multiplied by 2.75 and multiplied by Giving Units. Tying back to the same standards discussed elsewhere and comparing a number of churches, it appears that a conservative but reasonable factor to apply here is 2.75 times Annual Revenue per Giving Unit and then applying an accurate giving unit count. Calculation: row 20 Annual Revenue per Giving Unit X 2.75; that result X row 18 Giving Units. # 5 (row 46). This is shown as the Three-year Average Annual Revenue times three. Similar to #3, it adds a degree of conservatism as it modifies the effect of the current year s revenue possibly being atypical. Calculation: row 32 Three-year Average Annual Revenue X 3. Maximum Debt Guideline (row 47). This capstone calculation takes #1-#5 above and divides the total by five for an average dollar figure. This calculation is only a guideline. If the resultant numbers in rows 48 and 49 vary significantly in an adverse fashion from the guideline in dollars or 100% of guideline, this should raise the discussion of why the church being 35

7 analyzed would not fit that guideline. Comparison to other ratios in this table will provide additional perspective and will help direct your analysis and credit decision. Just as for most of the numbers and ratios we use in community bank credit analysis, this guideline should not be used in a vacuum. Calculation: (row ) 5. Loan Amount Compared to Guideline Calculation (row 48). Here is your quick bird s-eye view of whether or not your proposed loan is lining up to an estimate of the norm. Calculation: row 2 Loan Amount - row 47 Maximum Debt Guideline. Loan Amount as a Percentage of the Guideline Calculation (row 49). This calculation provides another helpful high-level comparison in order to get a quick feel for how much better or worse your prospective loan is from the guideline calculation. row 47 Maximum Debt Guideline. Loan Size if DCR Were 1.5 (row 50). This shows the hypothetical calculation if the debt coverage ratio for this loan were 1.5. It shows what size loan would be covered by this church s cash flow available for debt service at a coverage ratio of 1.5. This is not part of the Maximum Debt, Guideline calculation (row 47), because it would skew results if the actual DCR were either low or high. In a situation where your borrower has a high existing DCR, this calculation gives some perspective on the potential margin of comfort. Calculation: row 12 Cash Available for Debt Service 1.5; that result row 52 Rate Factor. Ideal Annual Debt Service (row 51). This row and calculation were created primarily to derive the calculation used in #2 (row 43) of the suggested debt limit calculation. Calculation: row 16 Annual Revenue X 0.30 (30%). Rate Factor Used to Determine Ideal Loan Amount (row 52). This calculation derives two of the numbers above. It is used to derive the calculation used in #2 (row 43) of the suggested debt limit calculation. This factor is also key to determining what the loan size would be if the debt coverage ratio were 1.5:1 (row 50). row 10 Annual Payment. When one prints the final table for a prospective loan situation, rows 51 and 52 do not need to be printed as they exist to make the calculations further up in the table, and they do not need to be analyzed independently. The Churches in the Sample Table The church loan scenarios used in this sample are based on real situations, with names and financials altered. Decline Church (left column) was not problematic in most qualitative ways, but one had the sense early on that the building and loan requested were too costly for the church to comfortably afford. This was one of those fairly frequent situations where the congregation either needed to scale back plans for the building or make a substantial increase to the building fund through donations before they could acquire a church campus of this size. Paradise Church (middle column) is a main-line denomination, where giving per person/unit tends to be somewhat less than in many evangelical churches, but they were located in an affluent area. In this case, they were adding to a good-sized church campus that they owned free and clear. Road Church (right column) is in a middle-class neighborhood, but their culture and faith tradition foster a generous level of giving per person, with a fairly high proportion of tithers (those who contribute 10% of their income). Conclusion The decisioning tool spreadsheet presented in this article has been useful to IronStone Bank in creating a platform for summarizing key financial parameters of our religious institution term loans. In addition to being one easy-to-fillin vehicle for quick analysis, it forces a consistency of underwriting analysis that brings with it numerous benefits. I refer to it as a tool because it should be used in conjunction with a well-thoughtout and defined religious institution credit policy, and all of the qualitative analysis that best-practice community bank underwriting would bring with it. My expectation is that other community banks active in church lending will be able to duplicate it, modify it to their preferences and experience, and then reap the benefits from it that we have enjoyed. Contact John McGovern by at john.mcgovern@ironstonebank.com. 36 The RMA Journal June 2006

Credit Risk. Church. Lending by the Numbers. An Update. Photodisc/Thinkstock. 40 October 2012 The RMA Journal

Credit Risk. Church. Lending by the Numbers. An Update. Photodisc/Thinkstock. 40 October 2012 The RMA Journal CR Credit Risk Church Lending by the Numbers Photodisc/Thinkstock An Update 40 October 2012 The RMA Journal Six years after writing about his bank s approach to church lending, the author has taken another