Churches that need to borrow money for building construction and other capital needs may find bond financing an attractive alternative to bank loans. Generally speaking, bonds are debt instruments issued by a wide variety of governmental, corporate, and non-profit entities to raise money on a long-term basis from investors.
They are essentially IOUs, where the issuing entity ("the borrower") pledges to pay borrowed money back to the investor(s) that buy the bonds ("the lender") at a stated rate of interest over a specified period of time.
A church that wants to pursue bond financing for a project will typically utilize the services of an underwriter, in many cases an investment banking firm that, for a fee, purchases the bonds at a discount and then resells them to investors.
Many churches have found that, compared with mortgage loans from conventional lending sources, bonds are a better and more economical way to finance long-term capital projects, according to Martin Northern, vice president and branch manager of Great Nation Investment Corp., an Amarillo, Texas-based investment banking firm that specializes in church financing.
"In most cases, funds from conventional lending sources require the church to adjust the interest rate of the loan every three to five years, periodically reapply or re-qualify for the loan, and pay all the related fees," says Northern. Because of its fixed-rate quality, he notes, "Bond financing protects the church from fluctuations in interest rates, as well as the need for costly interim construction financing, associated fees, and what are usually higher interest rates in the first place."
"A perfect storm"
Bond financing is increasingly popular among churches in today's market for a number of reasons, according to Northern.
"We are in a sort of perfect storm,'" Northern says. Demand for church bonds and the interest income they generate are strong, he notes. Meanwhile, in addition to a tougher lending environment for anyone wishing to borrow money, "Many banks have backed away from lending to churches due to their reliance on voluntary income."
There are three scenarios in which it makes sense for a church to seriously consider bonds as an option for financing a capital project, according to Scott Rolfs, managing director and group head of the Investment Banking/Religion and Education unit for Milwaukee, Wis.-based Ziegler Capital Markets.
"The first is where the church is looking at borrowing a sum of money greater than $1.5 million, and is not 100% confident of [its] ability to pay back the debt within the confines of a three-year capital campaign," Rolfs says.
Another scenario is where a church has plans for additional expansion and capital needs beyond the initial loan they are seeking.
"Bonds are excellent for phased projects and multi-site needs as churches in strong growth phases will generally be back in the market for financing," says Rolfs. Bonds can also be attractive when a church wants its members to have a bigger stake in a facility than they would have under financing structures.
"Some churches like the opportunity to have their members purchase bonds and invest in the church's project in a way beyond just participating in a capital campaign," says Rolfs, adding, "For some bond underwriters including Ziegler, member participation is optional."
Indeed, the current low level of interest rates in today's market can, in many instances, make bond financing a better option for financing church projects than conventional borrowing, according to Rolfs, because bonds allow a church to lock in an interest rate for a long period of time.
"Most bank loan terms are only for five years, and require renegotiation or an interest rate reset at the end of that period," says Rolfs, "while bonds provide a 20- or 25-year fixed interest rate that can provide complete protection against rising rates."
Caveats to keep in mind
Rolfs adds that bond financing does not make sense if the church truly will have funds available from pledge programs to pay down the debt over a shorter period of time. But at the same time, churches need to be very careful about overestimating their capacity to pay off a loan quickly.
"Many times churches are overly optimistic on how quickly they can pay debt off," Rolfs explains. In today's slow economy, running multiple capital campaigns back-to-back to quickly pay down debt is more challenging than it was in more prosperous times, he notes, exposing borrowers utilizing conventional loan financing to the risk of being hit with higher interest rates over time.
As a precaution, Rolfs states, "Churches should run a sensitivity analysis on their proposed debt and whether their budget can handle interest rate increases of 2%, 4% and 6% higher on their proposed loan."
He adds that it is important to keep in mind that bond financing isn't just for new projects.
"The long-term structure of bond financing makes it an excellent option for churches that have already borrowed and completed their building, but are now looking for permanent financing," Rolfs says. And he adds, "A substantial portion of our clients of late are churches looking to refinance existing bank debt long-term to take advantage of today's low interest rates."