"Considering Bank or Bond Financing?"
There has been an ongoing debate within the Ministry Lending Market; which is better bond financing or bank financing … bank financing or bond financing. In this article I want to try to unpack the issues involved with each form of financing and help you and your ministry leaders determine which method is best for your ministry. We will be discussing the terms, flexibility, ongoing oversight of the lender and the level of membership involvement in each methodology of financing your ministry property expansion.
Terms & Amortization Schedule
The terms and amortization schedules offered by bond and bank financing vary substantially, which is one of the primary benefits of bond financing. As you can see below, bond financing typically offers your ministry a longer fixed interest rate term with a longer amortization schedule. This feature of bond financing provides your ministry with additional confidence that your ministry can afford to service mortgage debt while not worrying about any rate adjustments over the life of the mortgage.
Bond Terms: 20 – 30 Year Fixed Rates/20 – 30 year Amortization Schedules
Bank Terms: 1 – 7 Year Fixed Rates/15 – 30 Year Amortization Schedules
Costs of Financing
This is probably the most “hot button” issue that ministry leaders consider when comparing bond financing to conventional bank financing. Yes, it is true that the upfront issuance costs of bond financing are higher than a bank loan, but how do they compare over the life of the loan?
Just as when your ministry is deciding which HVAC system to purchase for your facility; based upon the overall utilities & other costs over the life of the building, the same is true for financing. Bond financing costs higher on the front end with a 2% - 3.5% underwriting fee and a 4% - 6% brokerage fee (only on bonds sold outside of the congregation and friends of the ministry) compared to the relative low cost of bank financing (1/4% - 2%). What many ministry leaders don’t consider is what would a bank loan cost your ministry over the next 15 – 30 years. Since conventional lenders typically offer shorter term fixed rates, undoubtedly your ministry will experience a rate adjustment or refinance due to the expiration of the fixed rate. This will require your ministry to incur additional issuance/refinance costs including loan points, new appraisal, title insurance and a new amortization schedule in which the majority of your payments will be applied to interest rather than principal.
Bond financing also allows for additional debt to be issued without disrupting any existing bond debt, while this is not the case with bank financing since they typically will combine any existing debt into an new loan which will result in new interest rates, fees and amortization schedules to any preexisting debt. When this occurs, your ministry might experience a rate increase and a re-amortizing of the over debt; thus increasing the interest expense over the life of the loan.
Flexibility of Underwriting Guidelines
It is well known that bond financing offers much more flexible underwriting guidelines than bank lenders, but what exactly does that mean? Bond financing is accompanied by a different set of underwriting guidelines which will allow your ministry to more easily qualify for financing and in most cases qualify for more financing than what a conventional bank would approve.
Bond financing allows ministries to qualify for a maximum loan amount of 4 times (in some cases more than 4 times) the total annual income while bank financing typically caps total mortgage debt at 3 times total annual income. Bond financing underwriting guidelines also allow for the use capital stewardship campaign/building fund income as qualified income for future debt while many conventional lenders will not consider ANY CSP or building fund income. This feature is essential when it comes to the ability of a ministry to historically demonstrate that they have the ability to service future debt, which is the next area of underwriting guidelines that we will discuss.
All lenders use an underwriting metric called; debt coverage to determine whether borrowers have the ability to service the requested amount of debt. Conventional bank lenders want to see historical debt coverage of 1:1.25 or 125% (not including CSP) while bond financing only require 1:1 or 100% (in some cases less). This is a huge advantage for bond financing since many ministries run close to a zero net income budget and need their CSP income to qualify for future debt. What about for the ministries who need a little additional flexibility when it comes to the initial 12 – 18 months of payments after financing is concluded? Well, bond financing offers an answer to that question as well.
Conventional bank lenders have certain regulatory guidelines that they must follow when it comes to construction and interest only financing. The same is true of bond financing but still with additional flexibility. Bond financing allows for borrowers to have an extended interest only period for as long as 24 – 36 months, deferred/no payments for 6 – 18 months and/or a 3 – 5 year graduated payment which allows ministry borrowers to grow into their full payment.
Ongoing Oversight
An industry standard of conventional bank lending is the implementation of lending covenants that are geared to limit and direct the finances of a ministry. Typical bank covenants include:
- Personal Guarantors: Senior Pastor and/or Board Members Personally Guarantee Mortgage
- Liquidity Covenants and/or Reserve Accounts Designated to Mortgage Payments
- Net Worth Covenants: Limitations on the Net Worth of a Ministry Borrower
- Total Debt Covenants: Limitations on the Total Amount of Debt Allowed
- Key Man Life Insurance: Life Insurance in the case of the Senior Pastors Death
- Leadership Change: Loan can be reassessed if the Senior Pastor leaves the Ministry
- Full Banking Relationship: Transfer of All Operating Accounts
- Annual CPA Prepared Financial Statements: Increase of Interest Rate if Not Submitted in Time
While this might be common for bank lenders, this is not common with bond financing. In fact, in the past eight years I have only see a Key Man Life Insurance Policy requested twice and none of the other covenants over that period of time through bond financing. These covenants can be very limiting to ministry borrowers and can result in the mortgage becoming immediately callable if violated. Another advantage of bond financing is the lack of pre-payment penalties, which is absolutely common place with bank lenders. Bond financing allows ministry borrowers to pre-pay any and all bonds at any point in time, which bank lenders typically will assess a 1% - 5% penalty for pre-payment over a 1 – 5 year period of time.
Membership Involvement
The fact that the ministry membership and friends of the ministry need to be involved in the financing of a church project is one area that many pastors feel differently about. Some see this as a disadvantage while others really value the opportunity to involve their membership in the raising of capital. In my opinion, this is a huge advantage since bond financing allows membership to receive the financial benefit from the financing of debt compared to allowing the financial benefit to be realized by a bank. Typically there are no minimum levels of involvement or amount of bonds that need to be purchased by the church congregation, as the remaining portion of bonds will be sold on the open market to other Christian investors throughout the United States of America. Although the overall issuance costs and interest rates are typically reduced by placing more than less bonds within the relational matrix of the ministry. The pooling of Christian capital to fund Kingdom growth is a Biblical principal that many Believers have overlooked as an essential component of funding the expansion of the Kingdom through the local church. I have written another article named “Kingdom Resources Funding Kingdom Growth” that discusses this issue in greater depth. Please click on this link in order to read more.
As you can see, there are many issues involved in deciding between a conventional bank loan and that offered through bond financing. Bond financing offers a distinct advantage through the flexibility of underwriting guidelines and while the initial cost of bond financing is higher, it is considerably cheaper over the life of the loan when considering all the rate adjustments and conditions imposed by a conventional lender.
Posted February 14, 2010
By: David Dennison |
