Benefits of Bond Financing

Why a bond issue may be the perfect financial option for your Church?

As you consider selecting a financing partner for your Church, it may be important to examine the differences between two financing alternatives:

Consider a bank loan. When a Church borrows money from a bank, the bank is using its depositor’s money, and in return the bank pays those depositors a specified rate of interest for using their money. The bank then makes loans to borrowers who then pay the money back to the bank with interest. The difference between the rate of interest that the bank borrows from its depositors and lends to its borrowers is called the “spread.”

The same concept applies to a bond issue. The Church is the borrower and the bond purchaser is the lender. A bond underwriter is the organization that sells the bonds to investors. A bond trustee is the registrar and paying agent that collects the money from the Church and pays the bondholders, or investors. The Church is making a promise to pay the borrowed money back with interest to the bondholders.

Even though both alternatives have certain similarities, there are also some very distinct differences. With both financing options, there are origination costs. With a bank loan, the origination cost is usually lower than the origination cost for a bond issue. The reason for this is to compensate the bond underwriter and its sales force for selling the bonds. On the other hand, in return for the underwriting fee, in most cases the Church can secure more attractive loan terms than might be available with a bank loan. Many Churches have found that bond financing has been the best alternative over the long term.

The origination fee can vary depending on the bond underwriter, the size of the bond issue, and the strength of the Church’s credit. Bond investors consider credit quality, and compare one bond issue with another in an effort to decide which bond issue may be a more attractive investment.

Many US corporations issue bonds, since bonds offer a number of benefits that they do not get from bank financing.

One advantage that a bond issue provides a Church is total certainty of fixing the payment for the life of the bond issue. With a bond issue, the Church can fix the interest rate, the terms, and the repayment of the loan for the full term of the bond issue. Banks generally protect themselves at the expense of the Church, by loaning money with a longer amortization schedule, but a shorter-term fixed interest rate guarantee, with a number of conditions to the loan.

Why would this be important to the Church? The primary reason is that as Church leaders go through their budgeting and planning process, they will know that their debt service payments are established up-front, and will stay constant for the life of the bond issue. By selecting a bond issue, the Church can take away that risk by setting up a permanent repayment plan. There will not be a constantly changing dynamic that the Church may get with a bank loan with fluctuating interest rates, changing loan officers, or bank consolidations.

A second major advantage that a Church may realize with bond financing is that there are usually less loan covenants with bond financing than with a bank loan. What does this mean to the Church? This can provide the Church with more flexibility as well as control.

For example, the bank may write into the loan certain on-going operational covenants. What if the Church elected to spend any additional money over its debt service payments for capital improvements? In this case, the Church may have to go to the bank for permission to spend that money. This certainly does not mean that the Church would not get permission from the bank. On the other hand, the bank would be allowed to control an independent decision about what a Church could do and how it can spend its money.

With a bond issue, the Church does not have to come to the underwriter for permission. This can be very important to a Church and its congregation, since instead of the Church leadership and congregation being able to manage the Church, there is an outside entity reviewing the Church’s financial affairs and ultimately deciding what the Church can do.

Another common loan covenant that Churches should be aware of are financial performance ratios. These say that each calendar quarter or each year, the Church has to measure its financial performance and determine how it is measures up to certain benchmarks.

For example, a bank may have written into the Church’s loan that it has to maintain a certain debt service coverage ratio. This means that based on certain financial ratios, the Church may have generated a surplus of cash that must go to pay on the mortgage over and above the actual mortgage cost. If the Church does not meet these requirements, then the bank would then have the right to renegotiate the loan. And, what if interest rates went up between the time that the original loan was written and the time the loan was renegotiated? Banks make money on the interest they receive on the loan. Again, the Church is back to reporting to the bank.

Typically, these problems are not a problem with bond financing. As long as the Church is current with its mortgage payments, the loan terms under a bond issue will not change.

Over the past several years, many Church leaders have not been concerned with giving levels since the economy has been strong. However, with the last real recession of the early 1990s, there were many Churches that saw their income drop. This is a concern of many Churches when considering a conventional bank loan, and being required to maintain certain financial performance ratios.

Another factor that Church leaders should consider are pre-payment penalties. In many cases, the longer that a bank will agree to fix the interest rate, the larger the pre-payment penalty a Church would face should it elect to pay off the loan early. Many times these pre-payment penalties are variable, and are commonly known as “market-to-market” pre-payment penalties.

In this case, the bank might offer to provide a fixed interest rate for the next seven years, which on the surface might sound like good terms. However, the bank may also say that if the Church were to decide to prepay or refinance the loan, for example in year three, then the Church would have to pay what the bank’s profit would have been for the remaining four years of the loan. Therefore, the Church would have to pay the interest differential back on what the bank would have earned on the Church’s loan, and the current rate the bank could loan on the same amount of money for a new borrower.

Does this sound confusing? Let’s take a look at an example: A Church borrows $3 million three years ago, with a twenty-year amortization, but has a fixed rate of 8 percent for the first seven years. For any of a number of reasons, the Church wants to refinance the loan. Today, the current lending rate for the bank is 7 percent for new clients. The bank is planning on receiving money from the Church for the next four years at 8 percent. Therefore, the bank looses the 1 percent difference for the remaining four years, and some formula of this amount would have to be paid to the bank in order for the Church to be able to prepay the loan.

In many cases, Church leaders may not realize that these types of variables exist. They look at the up-front costs of a bond issue and see the larger origination fee, and believe that they will save money by going with a bank loan. After a couple of years into the bank loan, circumstances occur that they decide to refinance, take out another loan, or pay off the loan. All of a sudden, the Church will have to pay a lot more money back to the bank – even more than if they had selected a bond issue in the beginning and paid the difference in the origination fees. These are expenses that many times the Church leaders never realize exist until they encounter them later.

Another benefit of bond financing through Great Nation is the open-ended mortgage feature. With this feature, the Church may have the option to do additional financing by issuing additional bonds later without being required to refinance the first or original loan.

Consider this example: A Church issues $3 million in bonds today when interest rates are 8 percent. Then, four years later, the same Church wants to take out another loan for $2 million, but interest rates have risen to 10 percent. With a bond issue, the Church can borrow the additional $2 million in needs at 10 percent, without being required to refinance the original $3 million at the then current rate of 10 percent. The Church can keep the original $3 million loan at 8 percent. On the other hand, had the Church elected to take out a bank loan, in most cases the bank would require the Church to refinance the first loan at the then current interest rate in order to secure the second loan.

Also, some Churches would prefer to pay interest to its members and other Christian investors than to a bank.

It is important to note that both type of financing, bond financing as well as bank financing works well in the right situation. If a Church were only to need the money for a year or two as a bridge loan for a capital stewardship campaign, a bank loan could be a better alternative. However, given the many benefits of longer-term bond financing, it certainly makes sense to consider the option of a bond issue as well.

Bond financing has been available for hundreds of years. It has proven to be a conservative, time-tested method of borrowing money, not only for Churches, but corporations, state and local governments, as well as the United States Treasury. Permanence of the Church loan is important, since conventional bank lending has typically run hot and cold depending upon the economy at the time. If you are a Church leader considering bank financing, it is important to realize that if we are in a bad economy, if the financial position of your Church were to change, or the bank that you are doing business with is consumed by a larger bank, then a bank may not want to continue your loan when your loan is up for renewal. With bond financing, a Church has permanence that it does not have with a conventional bank loan. Bond financing may not fit in every circumstance, but it is a time-tested method of borrowing money, and offers a number of benefits to Churches.

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If you have questions at any time, please don't hesitate to contact us at:
GREAT NATION INVESTMENT CORPORATION
Attn: Martin Northern Vice President and Branch Manager
P. O. Box 1302
Benton, AR 72018-1302
Phone: (501) 316-3100 * (800) 468-3007
Fax: (501) 316-3110
Email: martin@martinnorthern.com

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