Banks with troubled nonprofit portfolios are often in a tough position. Nonprofits typically operate on peril’s edge—tight cash flow and insufficient surplus to withstand late or decreasing revenue payments. Their very nature creates a desire for a line of credit and/or loans to purchase basic operating equipment. Unfortunately, when nonprofits are late on loan payments it’s usually the tip of the iceberg. At this point, if the bank enforces loan provisions the community might view them as pushing the nonprofit toward demise. Proper underwriting, and urging nonprofits to be more business savvy, is a more responsible and long-term community stewardship strategy.
While I assume that the vast majority of banks follow sound procedures and collaborate professionally with community nonprofits, because Benoit Consulting Services works with troubled nonprofits I have come in contact with some astoundingly poor banking practices. Banks who fail to work smarter with their nonprofit portfolios will see increasing, damaging loan defaults.
Just when you think you’ve seen it all . . .
It may be hard to believe the examples described here but they are real.
>>A nonprofit Executive Director (ED) provided excuses as to why financial statements weren’t provided to the bank holding their mortgage (a loan requirement). The bank accepted these excuses. Several months later when the statements surfaced, payables had grown to over $100,000 and several monthly losses materialized in a nonprofit with very tight cash flow.
>>Bankers claimed that they were prevented by banking privacy provisions from contacting board members when a local nonprofit bounced checks over a 12-month period. In this case the seriousness of checking account issues was successfully hidden from the board by the ED. The board, not the ED is the nonprofit account holder.
>>A bank extended a personal loan to a nonprofit employee for the purpose of helping his/her nonprofit employer, creating a dual role that is hard to overcome in which the employee is also an investor/creditor. This nonprofit eventually dissolved.
>>There are more . . . .
Nonprofits and For-Profits are different in important ways
When for-profit business practices in human resources management, technology and financial management are used by disciplined nonprofits these organizations run more effectively and responsibly. However, the core business foundation is where significant differences between commercial businesses and nonprofits can be found. The nature of these differences creates implications for lenders particularly if commercial loan underwriting practices are based upon for-profit operations.
Mission, programming and funding
The areas of greatest difference are in three factors: the social mission, program development and funding. Nonprofits must concern themselves with ethics and stewardship on the effective use of public funding AND demonstrate the achievement of social service outcomes. Program and service development is often confined by funding sources. Unfortunately, nonprofit funders, particularly states are shrinking allocated funds so that grants rarely cover the actual cost of providing a program or service. This results in squeezing already tight “profit” margins. Regarding funding adequacy and improvements, nonprofits don’t have commercial investors to support capital improvements. They must set up an infrastructure to pry loose numerous small donations from interested private donors in competition with other nonprofits with equally compelling missions. Private donations are difficult and costly to raise. Finally, cash flow management is essential to avoid going into debt. Many nonprofits barely have cash sufficient to cover payroll and expenses. When they dip into the “red” they must be very careful to know where the funds will come from to cover budgeted deficits and formal debt.
Sound banking and community “ownership”
Bankers have told me that they had concerns about an executive director’s financial management practices but didn’t speak to the board thinking it’s not their “place.” On the matter of the public trust – transparency and ethics the nonprofit really is accountable to its “shareholders” meaning the whole community. This is most important when the board or executive director have not been responsible mission stewards. In my view bankers, insurance companies and other community vendors (office supplies, printers, even the person who plows the driveway) have an obligation to speak up when they suspect something is amiss such as: receiving vendor payments that are returned for insufficient funds. These vendors do represent the community but they often don’t speak up in hopes that things will turn around and they will get funds owed to them. If an executive director has hidden financial matters from the board the first notice they receive may be from an outside community party.
SIX Strategies of successful banks (when lending to nonprofits)
For the best overall results banks can:
1. Know the fundamental differences between nonprofits and for-profits – if you don’t have this expertise, get some training specifically on nonprofit financials.
2. If the nonprofit can’t produce readable financial statements – there is no excuse. This is available at very low-cost via a contracted bookkeeper using automation.
3. Underwrite the loan – if you can’t get the proper documents or nonprofit representatives don’t get back to you, take notice and speak to a board member. If the financials are troubling help the nonprofit get in a better financial position by recommending action steps, a consultant or consider serving on the board.
4. When trouble surfaces – begin the dialogue with ED AND the board right away. You can negotiate on some loan provisions but don’t let them slide altogether. The situation doesn’t usually solve itself and the longer a financial issue goes unattended, the harder it will be for the nonprofit to correct it.
5. If a nonprofit agrees on a corrective course – set up a specific date and time to meet and check in with the board AND ED. This will prevent day-to-day operations from distracting them from required improvements.
6. Understand that your account holder is the Board, not the executive director – if you have questions about the executive director, request that a board member (preferably the treasurer) sit in on meetings or meet with the board member privately.
The book, “What Banks Need to Know about Lending to Nonprofits” is available at Books for sale including richer examples and more detail regarding the difference between nonprofits and for-profit corporations.