Churches, Banks and Loans—What in the World is Going On?
Mark Helland

In the course of my work as a CPA, I perform financial statement audits and reviews for dozens of churches and ministries on an annual basis. Some of the churches that I work with are debt free, but most require some sort of outside financing for building programs, improvements and other equipment purchases. One thing that all of these churches with outside financing have in common is an ever-more difficult environment with their lenders. The “great recession” has brought about many changes and has been hard on everyone and churches have certainly not been exempt from all of this.

Generally speaking, many churches across the United States seemed to follow roughly the same expansion pattern that homeowners did during the past ten to fifteen years. During this period credit was relatively easy to access, interest rates were low and as such, many churches expanded and built new buildings or renovated existing facilities. Then came the great recession, stock market declines and housing bust and we have the current environment in which lending standards have tightened substantially. Making matters worse, in addition to declining or flat contributions from members, many churches were unable to lock in longer term loans when they had the opportunity. In my practice, I primarily tend to see loans with five year terms or less with balloon payments at the end of the loan term with the thought process being that the existing loan could easily be refinanced at the end of the loan term. However, the flaw in this thinking is that the banking environment has totally changed in the past few years and banks are much harder to deal with now as opposed to just a few years ago. I believe that there are three primary reasons for this trend to a tougher lending environment:

First, financial institution reform, specifically the Dodd-Frank Act has imposed myriad new details and requirements on banks. While some degree of financial statement reform was needed, preliminary reports on this legislation are not promising at all. Despite the Federal Reserve keeping interest rates low, in part to encourage banks to loan money, aspects of the Dodd-Frank Act seem to discourage banks from lending by piling on excessive regulations.

Next, nearly all forms of commercial property, including church buildings, have depreciated in value during the recent recession and one of the primary things that a lender is concerned with is the appraised value of the church facility. In certain cases where the appraised value of the property is below the amount owed to the lender, we have seen calls for potentially large sums of cash to make up for the difference between loan value and the depreciated value of the property. The reason for this is that banks are subject to many restrictions on loans that they write and they operate with a keen sense of risk. Typically, when banks loan money, the property and the other underlying business assets serve as collateral that the bank could foreclose on and then re-sell. In the case of a church, the bank’s ability to foreclose on the property is less attractive and does less to mitigate their risk due to the fact that a church building has a much more limited audience.

Finally, most banks do not deal with churches in any large number and churches tend to be “off the beaten path” for most banks. The majority of loans written by banks across the country are business and mortgage loans, so many banks don’t understand some of the nuances involved in working with churches. This factor makes it more difficult for churches to shop for loans as the pool of potential lenders is usually smaller than it would be for a private business.

All of these factors point to a difficult environment for churches to obtain financing and it creates a need for a much deeper understanding of what banks are looking for when they look at your financial statements.

Here is a list of the top items that we believe churches should to be doing now to enhance their financial statements and improve their credit status:

1. Check your current ratio.

An organization’s current ratio is one of the key indicators of financial health as it measures “liquidity.” Essentially, the current ratio measures the ability for an organization to fund its obligations over a one year period with the resources it has on hand at the organization’s financial reporting period. In other words, the sum total of an organization’s current assets (cash and cash equivalents, accounts receivable, short-term investments, inventory, prepaid expenses, etc.) should be at least equal to its current liabilities (accounts payable, accrued liabilities, current portion of long-term debt, etc.). Expressed as a ratio, the total current assets divided by current liabilities should be at least one (1) and preferably even higher. According to national averages for protestant churches, 2.6 is the median current ratio. This means that current assets on hand were more than double current liabilities owed. This ratio is a critical indicator and churches need to do everything to keep this ratio as strong as possible. Furthermore, churches should focus on keeping the cash portion of the current ratio as strong as possible. While accounts receivable and inventory also count in the current ratio, these assets are not as liquid as cash.

2. Segment your restricted/designated funds.

Many churches are woefully unorganized when it comes to segmenting and clearly denoting cash that has been received in the form of restricted contributions. For example, a cash contribution that has been restricted for missions should be segmented and listed as “restricted” until it has been spent for the purpose designated by the donor. Including restricted cash in a single total for “cash” is misleading to your lender because the restricted funds are simply being held in “escrow” by the church until they are spent for the designated purpose and are not available for general use. As in previous articles, I would strongly urge all churches to retain their restricted funds in a completely separate bank account, apart from operating funds.

3. Understand your loan covenants and terms.

Simply obtaining financing and making the monthly payments is not the end of your obligations to your lender. Loans may be subject to varying levels of restrictive covenants and these covenants must be fully understood before a loan agreement is finalized with a lender. For example, a lender may have covenants requiring that certain cash levels be maintained, an annual audited financial statement be provided within a specific time frame or that additional debt may not be taken on while the loan is in effect. It is important to understand that a failure to comply with a restrictive covenant could result in the bank calling the loan due at any point during the life of the loan. Loan covenants can actually be easily violated if not fully understood. For example, I have seen “no additional debt” covenants be violated by the fact that a church entered into an equipment lease which, under U.S. generally accepted accounting standards, was actually a capital lease rather than an operating lease (a capital lease is essentially the same as a loan). So, in effect the “no additional debt” loan covenant had been violated and when a loan covenant is violated you are completely at the mercy of the lender as to whether they will forgive the violation or not. Additionally, loans may have all sorts of terms such as pre-payment restrictions and even participation by multiple investors which can make compliance or refinance during the loan period difficult. The bottom line is that it is a good idea to have any loan agreement reviewed by church legal counsel to be sure that all the terms are understood up front.

So, the best thing that your church can do right now is to take inventory of where you are at right now and be proactive in advance planning for future lending needs. If your church’s cash position is not where it should be in terms of the current ratio that I mentioned above, get aggressive to fix it!  Here are some ideas to get you started:

1. Examine all of your expenses and classify them into two categories.

Fixed and variable costs. Fixed costs are those that cannot be modified without significant effort or change – for example, a monthly mortgage payment. Variable costs are those that change each month or could be modified with a reasonable degree of effort. You will find that some costs have a fixed component and a variable component—for example, utilities can be reduced to a degree by cautious usage, but at some point the electric bill can only be reduced so far. Overall, this is a great exercise to figure out what your expenses are and what can be reduced or cut.

2. Sell assets!

Churches have some great tools available to them that simply were not available in the past, that being websites like eBay, Amazon and Craigslist. Many churches have equipment sitting idle that could be converted into cash. Keep in mind that internal controls are an issue here and the listing and receipt of cash (and custody of assets) should be tightly controlled by key staff members. Also, make sure that any assets sold aren’t restricted as collateral by loan covenants!

3. Be creative with debt reduction efforts via contributions from your congregation.

I have seen a lot of very creative efforts by some of my church clients to get their congregation fired up about debt reduction. Some ideas I have seen are the $1 program, whereby the congregation members are encouraged to bring an additional $1 per week to contribute to debt reduction. Another idea I have seen is “I love my church” where small change and additional small contributions are gathered to help reduce debt. The exponential nature of many people participating in these types of programs can be effective in turning seemingly insignificant sums of money into significant debt reduction.

One final piece of advice from an audit standpoint—make sure that you have solid, accurate financial information ready for your lender. This is assumed to be a basic pre-requisite and nothing can torpedo your position with a lender faster than inaccurate or incomprehensible financial information. Our firm specializes in helping churches with these issues—let us know if we can help!

This article is designed to provide accurate and authoritative information in regard to the subject matter covered. It is shared with the understanding that neither the author nor Tony Cooke Ministries is engaged in rendering legal, accounting, psychological, medical or other professional services. Laws and regulations are continually changing, and can vary according to location and time. No representation is made that the information herein is applicable for all locations and times. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.