Church Loan Question

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Carl53
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Church Loan Question

Post by Carl53 » Thu Dec 05, 2019 6:02 am

I've been asked to join the church finance committee. Looking at some of their documents is making me wondering what is going on. The mortgage was refinanced back a few years. Apparently there is a prepayment penalty, so there was a subsequent agreement that seems to split the mortgage into a notional amount and separate amount of perhaps ten percent of the total. The interest rate on the smaller amount is tied to the 30 day Libor while the larger amount is fixed. Some of this is called a swap.

Is this type of financing common for commercial loans such as churches? This notional amount has been reset twice now over the last couple of years as extra payments were to be applied to the smaller loan (I haven't seen documentation of those payments yet) but it appears to be happening. The interest rate on the main loan is 5% with the Libor tied amount at a similar rate. These seem to be rather steep rates in the current climate, particularly for a property that has a value of roughly three times the remaining loan total. I would appreciate any BHs chiming in on the rate or whether traditional mortgage loans might be available without the concepts of notional amounts, swaps, 360 day year etc.

Valuethinker
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Re: Church Loan Question

Post by Valuethinker » Thu Dec 05, 2019 6:12 am

Carl53 wrote:
Thu Dec 05, 2019 6:02 am
I've been asked to join the church finance committee. Looking at some of their documents is making me wondering what is going on. The mortgage was refinanced back a few years. Apparently there is a prepayment penalty, so there was a subsequent agreement that seems to split the mortgage into a notional amount and separate amount of perhaps ten percent of the total. The interest rate on the smaller amount is tied to the 30 day Libor while the larger amount is fixed. Some of this is called a swap.

Is this type of financing common for commercial loans such as churches? This notional amount has been reset twice now over the last couple of years as extra payments were to be applied to the smaller loan (I haven't seen documentation of those payments yet) but it appears to be happening. The interest rate on the main loan is 5% with the Libor tied amount at a similar rate. These seem to be rather steep rates in the current climate, particularly for a property that has a value of roughly three times the remaining loan total. I would appreciate any BHs chiming in on the rate or whether traditional mortgage loans might be available without the concepts of notional amounts, swaps, 360 day year etc.

Caveat. I am British so what I say may be incorrect in an American context.


A few side notes. 360 day year is normal practice for American (USD) money markets - 12 30 day months so 15 Feb to 15 March is always 30 days. It's actually much more common than 365 day (British Pound & most of the former colonies eg Canada, Australia). Euro is 360 day for example

This really does smell to me. I don't see why a church would be involved in such a complex financial transaction. LIBOR is low right now, so again that should imply a lower interest rate (normally short term rates are lower than long term rates, although right now in US markets that is not true).

A swap is an exchange of payments. For example I agree to pay you 5% for 5 years, you agree to pay me LIBOR rate for 5 years. If LIBOR is above 5% then I win, below 5% then you win. In my case if I have a floating rate loan, completely separate, I can "fix" the interest rate for 5 years at 5% by entering into this "plain vanilla interest rate swap".

But complexity. Some salesman at a bank took a commission for arranging this. This seems too complex for the needs of an ordinary church.

If there is a serious financial problem for the Church, there may be a case for financial malfeasance case against the bank, and compensation for miss selling.

The UK has had some horrible cases where "consultants" who were closely linked to banks advised Local Councils (municipalities) to enter into 30 year+ swap agreements that have cost them (literally) hundreds of millions of pounds.

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djpeteski
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Re: Church Loan Question

Post by djpeteski » Thu Dec 05, 2019 7:02 am

[Deleted]

While it is tough being the new guy on a board, they probably expect you to listen to them more then talk, my bent would be to advocate the start of an aggressive repayment program. [Deleted]

Additionally the complexity of the transaction would concern me.

[Edits by moderator oldcomputerguy]

jbmitt
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Re: Church Loan Question

Post by jbmitt » Thu Dec 05, 2019 7:11 am

Not all churches are bad with finances.

For example, my dad is ordained clergy (MDiv) and also earned his MBA and has a background in finance and fundraising for a church organization.

I’d see what organization is responsible for the loan and if there are any benefits to how it’s structured. It could be related to non-profit tax exempt status or supporting an organization that they are affiliated with

I know the ELCA Lutheran church has the mission investment fund which is used to make loans to its congregations for facilities.

Daryl
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Re: Church Loan Question

Post by Daryl » Thu Dec 05, 2019 7:20 am

djpeteski wrote:
Thu Dec 05, 2019 7:02 am
Additionally the complexity of the transaction would concern me.
+1

If I was serving on a Board and heard about something like this, I'd be asking a lot of questions! I'd assume that you have a fiduciary duty to do so as well. There may have been a very good reason to structure the mortgage in this way. Alternatively, the prior church finance team leadership may have gotten taken advantage of by an unscrupulous mortgage broker. It might be a fun learning experience to obtain a copy of the current mortgage documents and talk with a trusted commercial mortgage broker about refinancing options. He/She should be able to explain your options, reduce your church's debt service costs, and allow your church to shift more money towards mission/ministry. Good luck!

carolinaman
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Re: Church Loan Question

Post by carolinaman » Thu Dec 05, 2019 7:56 am

As a newbie on the Finance committee, you need to listen and also ask questions about things you do not understand before drawing any conclusions. This split mortgage seems odd, and as someone else said, was likely sold to the Committee by some aggressive salesperson. Another poster recommended aggressively paying off the loan since it is only 10% of total mortgage debt. That may be a good solution. However, get a good understanding of this situation first. Why did the church do this in the first place?

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Stinky
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Re: Church Loan Question

Post by Stinky » Thu Dec 05, 2019 8:01 am

carolinaman wrote:
Thu Dec 05, 2019 7:56 am
As a newbie on the Finance committee, you need to listen and also ask questions about things you do not understand before drawing any conclusions. This split mortgage seems odd, and as someone else said, was likely sold to the Committee by some aggressive salesperson. Another poster recommended aggressively paying off the loan since it is only 10% of total mortgage debt. That may be a good solution. However, get a good understanding of this situation first. Why did the church do this in the first place?
I agree with listening, and then asking discreet questions. Maybe you can search out the prior church treasurer or finance person for a one-on-one about the loan structuring - but very much in an "I want to understand" mode, as opposed to "This looks like a problem".

My personal knowledge is limited to my church situation. We just took out a credit line from our denominational extension fund to finance improvements, with a mortgage secured by the facility. The floating interest rate on the loan is currently 5%.
It's a GREAT day to be alive - Travis Tritt

retiringwhen
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Re: Church Loan Question

Post by retiringwhen » Thu Dec 05, 2019 8:35 am

I have first hand experience with negotiating commercial loans from commercial banks for a church (new construction in 2005).

What you described was offered to us as well. It was partially sold as a way to lock in rates (via the swap) against upside risk.

The other Deacons and I agreed that upside was low in 2009/10 when we did our first rate reset, so we did not go for it. It allowed us to reset again later down to 3.875% in I believe 2011. That was an all time low for rates if I remember.

The finance committee probably made the other decision (protect again rate increases) and locked in the 5%. 5% is not bad for a commercial loan (and on a church, as churches are notorious bad loans for commercial banks since a foreclosure leaves the bank with bad PR and usually a white elephant that is very hard to sell. We got a loan in the crazy days of the real estate mania that would likely never be repeated.)

It sounds like the church is not in bad situation and the decision to employ the swap was reasonable (rates were probably at what felt like long-term lows at the time)

Now going forward, I would suggest two things to look at:

1.) What rules are there on pre-payment. For example a pretty standard clause is only 10% of balance pre-payment per year. If that exists, look to see if the budget can sustain that level of pre-payment. That is almost surely the best bang for the buck that the church can get. (Our church does regular debt reduction offerings that go straight to paying down balance, for example)

2.) You could do a cursory search on alternative commercial loans. I think you will find two things. First, commercial banks find house of worship loans to be toxic and the available provider list is very short. Two, 5% rates in the current environment will be hard to beat especially on a re-finance unless the church will bring other loans, assets/investments to the bank. (for example our bank, a large well known bank that gets regularly discussed on this forum has told us repeatedly that if we move our operating checking out of the bank, they will call our loan and we have been paying faithfully for 14 years! Of course their daily banking services are neanderthal.)

Hope that helps.

BTW, I am of a minority opinion about being quiet and discreet. Ask as many questions as required to make sure YOU as an active member of the committee can add value. I say this for two reasons. 1.) Often the committees are dominated by one individual who may or may not be doing a good job, that needs to be tested in a productive manner. 2.) There may be poor or poorly managed decisions that need to be revisited, only by testing and probing can that be found.

As in all things though, be humble and make sure the questions and probing are for the good of the church's finances and your ability to add value.

A word warning, if you ask too many questions, you'll probably end up being the finance committee chair :shock:

2babogle
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Re: Church Loan Question

Post by 2babogle » Thu Dec 05, 2019 8:53 am

It's also possible, that if this church is part of a broader organization, say across the state, nationally or even globally, that the structure is decided by "headquarters." There are plenty of such churches and I can see why they may enter things this way.
Either way, figure it out. If you get booted for being concerned then you have an answer. But take the approach that you may not have all the facts, so be nice.

soccerrules
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Re: Church Loan Question

Post by soccerrules » Thu Dec 05, 2019 9:04 am

Another vote for taking more time to fully understand the backstory. I am not familiar with that structure of a loan so I would not be of help.

I would encourage an effort to become "debt free" as a church. I would look at how much interest you are paying yearly to service the debt. That is really wasted money that could be used to support your ministries.

Good luck
Don't let your outflow exceed your income or your upkeep will be your downfall.

jpelder
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Re: Church Loan Question

Post by jpelder » Thu Dec 05, 2019 10:03 am

This setup does seem weird. I'm not on the Vestry (lay governing board) at my church, but our finances are open at annual meetings. We have a standard commercial mortgage (20-year amortization, 7 year balloon payment, fixed interest rate) on a building we built about 10 years ago. I'm not sure whether the arrangement you stated is common or not. I agree with the other posters that asking questions in a non-judgmental way ("This is a setup I haven't seen before, why did we do it this way?") would be a good way to proceed.

I can also say that we just finished a large capital campaign at my church, with 25% of the campaign proceeds earmarked to paying off a big chunk of the building mortgage and refinancing before the balloon came due.

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Meg77
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Re: Church Loan Question

Post by Meg77 » Thu Dec 05, 2019 12:57 pm

I'm a banker, and I've seen a few church loans in my day. I've always worked for smaller banks who don't use swaps or interest rate hedging, but this doesn't seem super unusual to me. You're not going to get much lower than 5% on a church loan regardless. And prepayment penalties on commercial loans are not uncommon at all.

Regarding the collateral value: even if the asset is worth 3x the loan, churches (and schools and certain other "single-use" properties) are considered VERY risky because they can't be easily sold or used by another group or government entity. And because the income (donations) cannot be reliably counted on even in large established congregations. The value is totally subjective in most cases - unlike a residential home where there are lots of comps and many possible users/owners. If the church dissolves, there may not be another one who can move in or be formed and just immediately have the income stream (donations) to buy the property or even pay a mortgage. Having a low loan to value is a basic requirement of getting a church loan, but it's not a particular strength.

Also, PR is a huge issue. Even if a church defaults, what bank wants to be in the news for foreclosing on a church? We just recently did a loan for a synagogue on my team, and the President of the Bank said as much. If they default we will have to just eat this because we could never foreclose from a marketing perspective. I was surprised, but he's right.

Many banks won't do church loans at all for these reasons.
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retiringwhen
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Re: Church Loan Question

Post by retiringwhen » Thu Dec 05, 2019 1:26 pm

Meg77 wrote:
Thu Dec 05, 2019 12:57 pm
I'm a banker, and I've seen a few church loans in my day. I've always worked for smaller banks who don't use swaps or interest rate hedging, but this doesn't seem super unusual to me. You're not going to get much lower than 5% on a church loan regardless. And prepayment penalties on commercial loans are not uncommon at all.

Regarding the collateral value: even if the asset is worth 3x the loan, churches (and schools and certain other "single-use" properties) are considered VERY risky because they can't be easily sold or used by another group or government entity. And because the income (donations) cannot be reliably counted on even in large established congregations. The value is totally subjective in most cases - unlike a residential home where there are lots of comps and many possible users/owners. If the church dissolves, there may not be another one who can move in or be formed and just immediately have the income stream (donations) to buy the property or even pay a mortgage. Having a low loan to value is a basic requirement of getting a church loan, but it's not a particular strength.

Also, PR is a huge issue. Even if a church defaults, what bank wants to be in the news for foreclosing on a church? We just recently did a loan for a synagogue on my team, and the President of the Bank said as much. If they default we will have to just eat this because we could never foreclose from a marketing perspective. I was surprised, but he's right.

Many banks won't do church loans at all for these reasons.
There is a church in my county (not my church) that has been delinquent for nearly 10 years, their property comes up for sheriff sales every 90 days, and gets pulled the day before. They'll never take the property for all the reasons you mention.

boaski
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Re: Church Loan Question

Post by boaski » Thu Dec 05, 2019 2:06 pm

I thought the Dodd Frank act made prepayment penalties illegal.

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dm200
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Re: Church Loan Question

Post by dm200 » Thu Dec 05, 2019 2:46 pm

boaski wrote:
Thu Dec 05, 2019 2:06 pm
I thought the Dodd Frank act made prepayment penalties illegal.
While I do not know the specifics, it is often the case that many such laws and regulations do not apply to commercial lending.

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dm200
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Re: Church Loan Question

Post by dm200 » Thu Dec 05, 2019 2:57 pm

Carl53 wrote:
Thu Dec 05, 2019 6:02 am
I've been asked to join the church finance committee. Looking at some of their documents is making me wondering what is going on. The mortgage was refinanced back a few years. Apparently there is a prepayment penalty, so there was a subsequent agreement that seems to split the mortgage into a notional amount and separate amount of perhaps ten percent of the total. The interest rate on the smaller amount is tied to the 30 day Libor while the larger amount is fixed. Some of this is called a swap.
Is this type of financing common for commercial loans such as churches? This notional amount has been reset twice now over the last couple of years as extra payments were to be applied to the smaller loan (I haven't seen documentation of those payments yet) but it appears to be happening. The interest rate on the main loan is 5% with the Libor tied amount at a similar rate. These seem to be rather steep rates in the current climate, particularly for a property that has a value of roughly three times the remaining loan total. I would appreciate any BHs chiming in on the rate or whether traditional mortgage loans might be available without the concepts of notional amounts, swaps, 360 day year etc.
I am (and have been for many years) active in a similar role. In our case, a very "hierarchical" denomination, a parish is only allowed to get such "mortgage" loans from a centralized fund. It is a really good deal, financially, though. This required centralization of individual parish savings and lending was put into place several decades ago.

In your case, I might suggest doing some research. Who/what is the lender? Does it only do church loans? If so, just for certain denominations? And so on. Perhaps, depending on details, discuss the situation with other churches in the same denomination.

While I tend to lean against such organizations taking on too much debt, I have come to realize that there are sound reasons for such financing - and then have/keep/raise funds to provide for needed liquidity and meeting unexpected expenses and/or decline in income. Some churches, for example, have seen donations drop a bit due to income tax changes on tax deduction changes. Demographic changes can greatly affect (both ways) the finances of churches.

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Re: Church Loan Question

Post by Grt2bOutdoors » Thu Dec 05, 2019 3:05 pm

boaski wrote:
Thu Dec 05, 2019 2:06 pm
I thought the Dodd Frank act made prepayment penalties illegal.
It is not applicable to commercial banking transactions.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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dm200
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Re: Church Loan Question

Post by dm200 » Thu Dec 05, 2019 4:37 pm

There are (and I have seen both) advantages/benefits as well as disadvantages where an individual church/parish is part of a very hierarchical denomination that offers or requires centralized services and controls. When done well, there may be lower costs of financing, purchase of good/services, etc. Often, centralized control of large building and renovation projects can lower many of the risks.

On the other hand, I have also seen where the centralized organization decides to spend extra money on certain goods and services - because they can just pass on those higher costs to all of the churches/parishes.

I am aware of an organization whose role was the financing of church (and related) buildings (for many different denominations). For many, many years/decades, such mortgage loans were a "sure thing" and very, very low (or no) risk. Then, for some reason, many of such loans defaulted and some were "repossessed". Then, the problem became trying to get the money back by trying to sell such church buildings - and there was often little demand for such specific buildings.

In a "centralized" and controlled denomination lending environment, I think such lending usually ends up "low risk" because the centralized entity can manage/control the finances of the individual church/parish.

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