Non-Profit Financing

Frequently Asked Questions (FAQs)

As one of the country’s leading Financial Advisors to non-profit

institutions seeking project debt financing, we routinely receive inquiries

from clients and prospects on matters of financing eligibility, alternatives,

cost and process. Here are some of the questions which we receive

most frequently and our responses:

1. Are regular bank loans and tax-exempt financing for 501(c)3

organizations generally the only types of financing you see

for non-profits or are there other popular financing vehicles?

Bank-based financing is the most prevalent form of debt financing

for non-profit organizations. Usually, such financing is structured to

be “tax-exempt” in order to secure a lower interest rate. Generally,

the only times that such financings are done as conventional

“taxable” loans are (1) if the financing amount is relatively small or

(2) the costs to be financed are not eligible for tax-exempt

obligations. Whether taxable or tax-exempt, such transactions are

usually structured as variable rate financings, although banks have

been more effective the past two years in offering a true fixed rate

option (ie. not swap-based). Tax-exempt financings are also sold

periodically in the capital markets as “publicly offered” bonds. For

non-profit borrowers with any of the following objectives or

constraints, a public offering of fixed rate bonds may be an

appropriate alternative:

true fixed rate financing with a term of 15 years or longer,

amortization structure of up to 40 years,

more liberal financial covenants,

lower fixed rates than available from banks due to strong,

investment grade rated, credit quality, or

bank loan to value (LTV) or other bank requirements or risk

considerations that cannot be satisfied (ie. relatively large

project and/or small equity contribution)

Inside This Issue

1 Bank-Based Financing for

Non-Profit Organizations

2 Financing Purposes, Cost

Effectiveness & Interest Rate

Benefit

3 Interest Rate Swaps and

General Advice for Non-Profit

Borrowers

Wye River Group is an

independent financial

advisory firm focused on

the financing and

investment needs of non-

profit organizations

SERIES 2011 | ISSUE 2

SUMMER 2011

Non-Profit Finance:

Fresh Perspectives

Page 2 NON-PROFIT FINANCE | FRESH PERSPECTIVES

2. Other than purchasing or refinancing a building, what other types of

major financing purposes do you see?

Under Federal tax law, tax-exempt financing can only be used for tangible

assets such as equipment, land or buildings. Typically such financing is used

for the acquisition, development, construction or renovation of facilities used

by a non-profit in its mission. There are no eligibility constraints for taxable debt

financing. Consequently, taxable financing is sometimes used by non-profit

borrowers for “tax-exempt financing ineligible” costs such as the following:

working capital,

rental property,

facilities in which religious services will occur or

facilities in which a commercial enterprise will be conducted

3. For 501(c)3 entities considering tax-exempt financing, what is

generally the “cut-off” in terms of the minimum amount of the loan for

cost effectiveness as far as transaction costs are concerned?

The major advantage of tax-exempt financing is that the interest cost is lower

than that of taxable debt financing. The relative interest cost advantage can

range from 20 to 33% depending on the size and credit quality of the

borrowing and the borrower. However, transaction costs for a tax-exempt

financing are generally higher than those for a taxable financing.

Consequently, in order for a tax-exempt financing to be “cost justifiable” in our

experience, the minimum borrowing amounts should usually be at least $2.5

million for a bank-based financing and $5 million for a public offering.

4. What kinds of interest rate benefit from traditional bank financing do

you see for tax-exempt financings?

Taking into effect the relative credit spreads and adjustments for the tax-

exemption, we are seeing interest rate benefits on tax-exempt bank

transactions (compared to taxable bank financings) ranging from 35-50 basis

points for variable rate deals and up to 300 basis points for true fixed rate

transactions. With respect to tax-exempt financing, there has been relatively

little difference in cost between various variable rate financing alternatives

offered.

Banks provide financing to non-profits in one of two ways: (1) through a direct

loan or purchase of tax-exempt bonds or (2) by “lending their credit” through

a letter or line of credit. In the latter case, a letter of credit (“LC”) is used to

secure the issuance of tax-exempt variable rate demand bonds (“VRDBs”)

which are sold primarily to institutional investors. Although the VRDB structure is

considerably more complicated than a direct bank financing, it has

historically been the most popular financing alternative among non-profit

borrowers. That has been the case largely for two reasons. First, absent a

specific exemption under Federal tax law (for instance the “bank qualified”

exemption or the “2 percent de-minimis exception”), banks are limited in their

ability to enjoy fully the “after tax” benefit of owning a tax-exempt obligation

(unlike individuals or other types of institutional investors). Second, until

recently, banks could “leverage” their capital much more with a LC than a

direct loan, thereby securing a better return on the capital exposed in a

financing. The combination of changing tax laws, changes in bank capital

and accounting requirements and the currently low interest rate climate have

had the collective effect of reducing the relative benefit to banks of LC based

VRDB financing over direct financing.

In order for a tax-

exempt financing to be

“cost justifiable” in our

experience, the

minimum borrowing

amounts should be at

least $2.5 million for a

bank-based financing

The combination of

changing tax laws,

changes in bank

capital and

accounting

requirements and the

currently low interest

rate climate have had

the collective effect of

reducing the relative

benefit to banks of LC

based VRDB financing

over direct financing

Page 3 NON-PROFIT FINANCE | FRESH PERSPECTIVES

Under current market conditions, we have not witnessed a meaningful difference in the “credit spreads”

offered by banks for LCs and direct loans. Because LC spreads are not as advantageous, relatively speaking,

as they once were, there has been increased participation in, and competition for, non-profit financings from

community and regional banks which are not investment grade rated and do not have rated LC capability.

That greater competition is good for non-profit borrowers and has served to bring credit spreads down from

the horrendous levels that prevailed in late 2008 and 2009 as a result of the credit crisis. In general, through the

regular competitive solicitations that we conduct for non-profit borrowers, we have seen recent credit spreads

that range from 85 up to 250 basis points (generally over LIBOR) depending on such factors as the borrower’s

credit quality, the borrower’s industry sector (ie. education, healthcare, association) and size of financing.

5. What are your thoughts and advice with respect to interest rate swaps?

We approach interest rate swaps and similar derivatives based transactions with great care and skepticism.

The problems with derivatives are several: complexity, accounting treatment and lack of pricing transparency.

In general, if our client wants a fixed rate borrowing, we strive in our solicitation to secure “true” fixed rate

financing proposals from the banks. However, many banks remain, by virtue of structure and strategy,

“variable rate” lenders. Consequently, in our solicitations, we typically secure alternate bidding for the

variable rate modality and then compute a “synthetic” fixed rate borrowing cost based on prevailing swap

levels. When acquiring a swap for a client, we prefer to conduct a competitive bid process. Sometimes,

because of transaction size or credit circumstances, that is not practical and so we “negotiate” the swap

terms with the same bank that is providing the financing. In recent years, we have found the banks to be

more cooperative in negotiating up front their “markup” in the swap so that our clients and we can be assured

of market competitive pricing on the swap in advance of making a commitment.

6. What general advice would you have for a non-profit considering a financing?

We think borrowers are very well served hiring an independent financial advisor such as our firm if they are

considering or pursuing a debt financing. The capital markets are complex and bank pricing strategies and

market conditions are sophisticated and constantly evolving. We specialize in this area and because of our

regular involvement in financing solicitations, negotiations and implementations, are very current on prevailing

rates, credit spread ranges and “market” terms and covenants. Consequently, a borrower would benefit

appreciably from the type of analysis, market knowledge and stewardship that a firm like ours can provide in

first determining what type and structure of financing is most appropriate to its need and then securing its

preferred type of financing on the best combination of price and terms through a competitive solicitation

process. We have developed a very time and cost efficient process using a combination of web-based tools

and information dissemination techniques to solicit upwards of 25 pre-qualified financial institutions for each

transaction. Our process insures the following:

the most market competitive pricing and terms,

the most cost efficient way to canvas the market for the best deal,

fairness among all of the competing banks and

informed decision-making, considerable time and cost savings, and peace of mind for the borrower.

Wye River Group

Independent Financial Advisors

522 Chesapeake Avenue | 2nd Floor | Annapolis, MD 21403 | 410.267.8811

4733 Bethesda Avenue | Suite 520 | Bethesda, MD 20814 | 240.383.1250

285 West Broadway | Suite 200 | New York, NY 10013 | 212.203.4179 www.wyeriver.net

…..we have seen recent credit spreads that range from 85 to 250 basis points

(generally over LIBOR) depending on such factors as the borrower’s credit

quality, the borrower’s industry sector (ie. education, healthcare, association)

and size and term of the financing…..