Lending to Nonprofits: Considerations for Credit Analysis
U.S. nonprofits are growing in number, revenue, and assets, according to the most recent data available on this important segment of the economy. Financial institutions considering lending to nonprofits may want to be aware of these recent financial trends, as well as some of the ways lending to these organizations might differ from lending to for-profit businesses.
According to the Urban Institute’s “Nonprofit Sector in Brief 2015,” the number of nonprofits registered with the Internal Revenue Service increased by about 3,000 a year between 2003 and 2013. Religious congregations and organizations generating less than $50,000 in annual revenue aren’t required to register, however, so the total number of nonprofits is unknown, according to the report.
Finances related to U.S. nonprofits are also opaque, considering only a small percentage is required to file some version of Form 990, the return for organizations exempt from income tax. Based on filings with the IRS, however, reporting nonprofits’ revenues and assets grew more quickly between 2012 and 2013 than did their expenses, the Urban Institute said. Revenues increased 3 percent to $2.26 trillion; assets rose 5.2 percent to $5.17 trillion, and expenses grew 1.7 percent to $2.10 trillion.
Nonprofits, excluding those serving government and business, contributed an estimated $905.9 billion to the U.S. economy in 2013, or roughly 5 percent of GDP.
As nonprofits grow and expand their efforts, some financial institutions are providing capital to help organizations bridge any gaps between revenue and spending.
Accounting and consulting firm The Whitlock Co. of Springfield, Mo., notes that some nonprofits facing tighter funding from federal and state governments are turning to community banks for commercial loans and lines of credit. According to the Urban Institute, government contracts and grants constitute nearly one-third of 2013 nonprofit revenues, so if government funding goes down, that can leave a huge hole in a nonprofit’s budget.
The Whitlock Co., however, cautions in a recent blog post that banks should recognize fundamental differences between nonprofit and for-profit lending so they don’t end up suffering losses due to nonprofit delinquencies.
Here are two mistakes to avoid when lending to nonprofits, according to the firm:
1. Basing repayment on the wrong funds.
Remember that nonprofits have three broad categories of revenue accounts: permanently restricted (the donor or state law imposes restrictions on usage), temporarily restricted (the donor imposes time or purpose restrictions on the use of funds) and unrestricted funds. “Bankers must remember that permanently and temporarily restricted funds are already earmarked for specific uses by donors or law,” the firm advises. “Therefore repayment analysis needs to be based on unrestricted funds.”
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2. Failing to hold the nonprofit to proper financial management and reporting standards.
To reduce the likelihood of delinquencies and losses, the bank should make sure that nonprofits provide regular financial statements and meet loan covenants in the same way that commercial entities are required to do so. “The charitable mission of the nonprofit must be separated from the underwriting process,” The Whitlock Co. said. “Financial capability of the nonprofit must be viewed on its own to make sure that the entity can repay their obligation.”
Using a streamlined credit analysis for nonprofit borrowers can help provide loan officers with a more accurate assessment of creditworthiness and can consistently measure and document the risk in the borrower. Some credit solutions use real-time benchmarking data to show how a nonprofit borrower compares financially to other organizations in that National Taxonomy of Exempt Entities (NTEE) or sector code. Having a streamlined credit analysis process for nonprofits ensures that the bank can make safe loans while the nonprofits can continue its mission with support from the community bank.