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More Challenges for our Communities – Nonprofit Legacies at Risk
Nonprofit organizations are critical to communities across the nation, providing resources to enrich the lives of many who would otherwise be underserved. Over the past four years nonprofits have fought hard to maintain their private donations as American’s discretionary income declined due to involuntary wage reductions and/or lay-offs. Now many of these organizations are at a cross road with bank(s) that helped them finance large expansion projects pre-recession.
As these complex debt structures mature, banks are wanting to exit the relationship, leaving nonprofits to find a new bank to continue the legacy. Many reasons exist for the existing lender to exit the relationship. Two highly probable reasons are a threat to the organization’s cash flow as public funding sources are financially distressed (i.e., State of Illinois and the City of Detroit), and the value of the collateral being less than the debt. Regardless of why the Bank wants to exit, re-financing complex debt structures is not easy for nonprofits in today’s credit market.
Many nonprofits financed their expansion projects through publicly held variable rate, tax-free bonds issued by a state/local finance authority. These bonds require a credit enhancement in the form of a letter of credit or an insurance bond that serves as collateral for the bondholders in case of a default, usually issued by a bank, or an insurance company. Organizational assets (often real estate or endowments) are typically used as collateral for banks or insurance companies to support the credit enhancement. They also often require a guarantor, whether the organization or a foundation, if one exists. Additionally, many organizations wanted interest rate protection when they took on these variable rate bonds; signing fixed rate swap agreements that matured with the bond redemption period (up to 30 years). With interest rates currently at historical lows, the swap is likely upside down and the organization will need to realize the obligation by funding the swap at close through a new note.
On the surface it would seem that nonprofits should be able to easily refinance, especially with a history of servicing its current debt structure. Although banks are aggressively pursuing new loans because they are flush with cash, this is far from the truth, and many organizations are finding it to be time consuming, expensive and difficult exploring their options to refinance. The costs to refinance may be as expensive as the origination fees of the original bond and credit structure, in addition to the process being a full-time job for the executive team. Many of these bonds have complex redemption terms (if permitted), and hefty pre-payment penalties, which impact their ability to redeem if necessary.
Very few banks have strong enough balance sheets to be able to issue large letters of credit, and if they are able to issue the letter of credit, it still may not be acceptable to the trustee for the bondholders. Interest rates are trending up making it harder for cash flow challenged organizations to service these debt obligations in the future. Very few lenders are willing to assume long term swap obligations, and even fewer issuers are interested in transferring these obligations unless the obligations are cash collateralized. This forces organizations to cash out the obligation versus riding out the market over the life of the swap.
Lastly, many lenders that have an interest in lending to nonprofits often lack the sophistication to finance these complex debt structures, and/or don’t have the lending capacity to handle the debt. Re-financing these complex credit facilities can be an uphill battle, and it all starts with free cash flow to service the new debt structure, and takes some creative maneuvering to navigate through options to find the right partner to continue the legacy.