While many nonprofit organizations are debt-averse, there are compelling reasons why they may find it better to build now rather than later, including construction cost escalations and favorable financial markets.
Though price increases for some raw materials have moderated, building material costs are expected to increase by 6 to 8 percent a year through 2011. Waiting may mean that a project will never be affordable.
Access to capital should always be a consideration deciding when to build. Today there are favorable financial market conditions with relatively “easy” credit and lots of competition among banks. Borrowers can access capital with favorable terms and covenants, as well as aggressive fees and interest rates. With careful planning, nonprofits can incur debt which will allow their endowments to continue to grow and reduce the overall cost of capital.
Even though nonprofits are diverse, all need to follow the same basic process, in-cluding preliminary planning, development, finance plan determination and transaction execution.
In the preliminary planning phase, it is important for the organization to refer to its strategic plan, develop plans that fit within its mission and goals and reach a consensus among key stakeholders.
A plan should be developed that identifies facility needs and prioritizes building features based upon mission, health and safety regulations and affordability. Once the project’s scope is agreed to, preliminary design, engineering and land use planning can begin.
At the same time, the organization should conduct an internal feasibility and debt capacity analysis describing the projected timing and cost and the sources of capital to fund those costs. The debt capacity analysis will relate the organization’s current and projected financial statements to the proposed debt to demonstrate the ability to fund both increased operating costs and the proposed debt.
Any proposed project should be coordinated with fund-raising activities. A capital campaign feasibility study should be completed, and then it is vital that strong leadership embrace the goals of the campaign. If tax-exempt financing is contemplated, bond counsel should carefully review campaign materials and pledge forms.
In the development phase, the final design and construction bid package is developed. Once a bid package is available, negotiations begin and a contractor is selected. At the same time, permitting begins for any land use, environmental conditions and building construction.
The development of a finance plan will identify the financing amount, structure, timetable and financing scenarios under consideration. It should be run against the projections model to assure that the organization has the ability to service the proposed debt service.
Other aspects of the plan include determining the term, interest rate modality, amortization and security of the debt. The choice of fixed-rate versus variable-rate debt results from prioritizing the interest rate level, annual budget certainty, pre-payment flexibility and flexible financial and security covenants.
In analyzing the credit of a nonprofit organization, key metrics include debt service coverage, total cash and investments to direct debt, and operating margin. The evaluation is done on both an objective and subjective basis, independently, collectively and comparatively. In addition, the ratios are evaluated in the context of governance, key management, market position, demand, competition and mission. Balance sheet liquidity is a key factor, as it is the backup resource for debt service.
Most financing plans for nonprofit organizations combine debt supported by operations and debt supported by a capital campaign. Banks will be interested in the results of any prior capital campaigns, including actual dollars raised versus the goal, collection history and the pledge period. They will want to review a feasibility study for the capital campaign, including pledge projections, timing of gifts, and the pledge composition.
The last piece of advice is to keep it simple. Nonprofits have limited resources, and the additional time required for a major financing can put a great deal of stress on an organization. Be sure that you choose partners wisely. The right financial partner can provide a competitively priced, comprehensive, relationship-based service, assisting the nonprofit to achieve its financial goals and ultimately its mission to the community.
James Hagerty is the senior vice president for nonprofit lending at Citizens Bank.
