October 2012 The RMA Journal

by Emily martin

48

Credit riskCR

An RMA LinkedIn discussion about the do’s and don’ts of lending to fraternities sparked interesting comments from bankers, many of whom are also fraternity alumni. This article summarizes the advice offered in the discussion, as well as a brief interview with a lender from State College, Pennsylvania.

When fraternity brothers installed a large, 10-person hot tub in the side yard of their fraternity house, it became a popular attraction for students hoping to party early and stay late. It was far less popular with neighbors, whose complaints resulted in a visit from the town’s code officer and an order to build an enclosure for the hot tub or remove it from the premises. The town also leveled fines against the fraternity for the zoning transgression.

Fraternities everywhere are notorious for partying. So does that mean that loans for improvements to their houses are a bad risk? Not necessarily.

“If banks treat and evaluate fraternities or sororities’ credit risk in a manner similar to student housing, then they are probably going to have a lower risk scenario than an Animal House,” said Brad Chovit, senior vice president, Northwest Savings, referring to the 1978 comedy film about a rowdy fraternity. “The surprise comes about when you book things in your portfolio that you are not watch-ing every weekend.”

In the LinkedIn discussion, RMA members offered the following advice:• Payattentiontocashflow.Itisaprimaryconcernwhen

lending to fraternities and comes mostly from one col-lection: rent. This means that the more brothers living inthehouse,thelargerthecashflow.Itwouldbenefitbanks to find the breakeven occupancy relative to the

RMA LinkedIn Discussion Focuses on

Lending to Fraternities

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October 2012 The RMA Journal 49

fixed- and variable-cost obligations of the fraternity. Any extraordinary event causing a substantial number of brothers to move out could significantly reduce cash flow.

• Knowwhoownsthegroundthehousesitson.Thatperson or organization sets the terms and conditions for the structure’s use.

• Becertainthatthedesignatedoversightgrouporindi-vidual supervising the fraternity’s compliance with all rules and regulations is dutiful in fulfilling this respon-sibility. This could save the fraternity from contractual misdemeanors resulting in fines or even termination by the university.

• Orderanenvironmentalassessmentpriortoanyrenova-tions or additional construction. These facilities are often damaged through carelessness and misuse. A participant in the discussion group said he had performed envi-ronmental impact assessments on fraternity houses and found issues big and small—the biggest being a historical record of a meth lab in the basement.

• Researchthereputationofthefraternity.Itwouldbeadvisable to check its conduct standing with the uni-versity. As one discussion participant noted, there is no success in lending to the fraternities who resemble the one in Animal House, despite the chance the bank could get assignment of movie royalties and book sales.

RMA LinkedIn Discussion Focuses on

Lending to Fraternities

• Considerthestrengthofcommitmentfromthealumniand parents. Fraternities with unyielding support of-ten benefit from the alumni and parents standing behind them in the form of sweat equity. It’s com-mon for the fraternity brothers to invite the alumni and parents to an event where they clean and renovate the house together.Although lending to a fraternity may have risks, there

are ways to mitigate them and make these loans profitable for the bank and an asset to the university town.

“Every credit officer at a bank worries that if they finance a fraternity it’s going to turn out like Animal House. They worry that they’ll lose money, respect, and damage the reputation of their bank by being involved. Anything that can mitigate against it makes a loan much easier,” said Chovit. v

••Emily Martin, a senior at Penn State University, completed this article while working as a summer intern at RMA.

ΑΙΘ ΑΙΘ

Although lending to a fraternity may have risks, there are ways to mitigate those risks and make these loans profitable for the bank and an asset to the university town.