Scott Rolfs, Managing Director, Ziegler Investment Bank
Scott Rolfs, Managing Director, Ziegler Investment Bank

To understand the religious sector today, it’s important to first consider the events of the past two decades. The strong economy and stock market that prevailed in the late 1990s, combined with the Federal Reserve’s easy money policy after the terrorist attacks on September 11, 2001, created a perfect storm for churches to grow and expand, both in terms of congregation and facility size. In the 90s, the stock market wealth ushered in a new level of church stewardship by congregation members who desired to donate funds for new building projects. At the same time, low interest rates created an abundance of funds to lend.

This led to a significant building boom in the religious community. U.S Census Bureau data shows that annualized construction for “houses of worship” topped out at approximately $8 billion in 2003. This boom was linked to a growing U.S. population that was moving to the suburbs and requiring new infrastructure, including churches. At the same time, low interest rates and a glut of cash worldwide was bringing capital into the sector looking for yield. As a result, between 2003 and 2008 a number of niche church lenders sprang up or greatly expanded their reach. Capital flowed freely to fund new church construction, whether from banks, credit unions or bond underwriters.

The attitude toward lending in the religious industry resembled everything else going on in U.S. lending in the mid-2000s: find those in need of capital and offer funding at significantly higher levels than had been previously available. As with the home mortgage industry, the federal government got involved to some extent. As a centerpiece of his election campaigns, President George W. Bush championed faith-based outreach initiatives to churches nationally. A number of religious organizations received federal funding for certain secular welfare and outreach programs they were already operating. This new government funding for certain churches, including many located in American inner cities, also helped contribute to the demand for new facilities and the associated expansion of church lending.

At the peak of religious lending in 2007 and 2008, borrowers were regularly interacting with specialty lenders, such as the Evangelical Christian Credit Union, Church Mortgage Acceptance Corporation and Strongtower Financial along with Ziegler. A number of major regional banks also got in on the action. National City Bank and Bank of America both ramped up lending to the religious community.

What Happened — and Why?

Then came 2008. When the real estate market crashed in September of that year, it took the church lending market along with it.

Most of the lenders mentioned above — and countless others — exited the industry as their loan portfolios took a beating. Some lenders voluntarily pulled back from the religious sector and some had regulators pull them back. Others had their investors depart after encountering heavy losses. Default rates on newly originated church loan portfolios pushed past 20% for certain market participants. As defaults accelerated, lenders had trouble recouping their principal, given the difficult commercial property market at the time. Previous recovery rates from foreclosure and property sales did not hold up in the new environment, and church lenders lost significant amounts of money.

There are several reasons the church lending industry found itself in such a mess post-2008.

The Mystery of Church Loans

Church loans are not homogenous. They do not lend themselves to objective metric tests used to evaluate other borrowers. For example: a particular church might post high scores on lending metrics such as debt-service coverage ratio, day’s cash on hand and loan-to-value. Terrific, right? But the church might also be located in a town where the congregants all depend on a particular employer for their jobs — a company town — and when that company falls on hard times, so does the congregation’s cash flow.

One major church lender bridge-financed a congregation approximately $10 million for a new building on the basis of a future $10 million pledge made by a congregant who was a real estate developer. When the local real estate market crashed, so did the developer’s business. The $10 million pledge was never fulfilled, and the church and its bank were left holding the bag on a loan the other members of the church could not afford to service.

Predicting the Financial Growth of a Church Borrower is Tricky

A number of religious lenders that used static scoring models learned this lesson the hard way. Just because a particular minister has successfully built a congregation from 80 to 800 adherents doesn’t necessarily guarantee he or she can take that 800-member church up to 2,500 members — or whatever growth metric is required to support the new loan. The lack of congregation growth, especially post loan funding, became worse as the 2008 recession took hold. Many churches found members and potential members unable to donate at previous levels, and some members had to leave the area (and their church) in search of new employment.

Too Much Cash Chasing Too Few Good Loans

As with other sectors in the mid-2000s credit bubble, the glut of worldwide cash seeking a return found its way to the U.S. — and the religious lending arena. Credit unions and bond companies that previously ran small church loan origination operations suddenly had the ability to attract hundreds of millions in investment dollars. In some cases, they used these dollars to increase their annual lending volume by factors of five to seven times what they had previously done. However, they didn’t have the experienced staffs to handle such a massive increase in underwriting activity. At the same time, tested credit metrics sometimes went out the window in favor of trying to buy marketplace advantage through sheer loan volume.

A congregation on the East Coast, for example, borrowed approximately $30 million to build a new facility. Sloppy lender-borrower coordination and underwriting failed to discover that the actual construction cost of the project was $50 million. Since the initial $30 million was quickly funded — presumably to meet origination quotas of the lender — construction began before the error was discovered. After the initial $30 million was spent, the building was left unfinished because the congregation was not able to support or attract the additional $20 million in financing needed to complete the project.

Experience and Specialization Are Key

While many religious lenders have come and gone over the years as the market peaked and bottomed out, Ziegler has been the one constant player ever since the bank’s first religious project — a $30,000 bond financing for the construction of Holy Angels Church and School in West Bend, WI, in 1913.
Since 1980 the firm’s adjusted net default rate on religious lending projects remains at a sub-1% level, even after accounting for the tough environment in the post-2008 world. The keys are experience and specialization. Why? The complexity and uncertainty of the religious sector, which relies heavily on the changing desires and economic fortunes of congregants, is difficult to navigate for lenders who do not deal in that industry every day. Further, the underwriting process for religious institution loans requires significant due diligence, as the industry does not lend itself to static credit scoring models

To reduce uncertainty and minimize risk, Ziegler obtains funding through taxable (and sometimes tax-exempt) bond issues, which it underwrites and sells to both retail and institutional investors — reliable investment bases it has carefully cultivated over decades.
Over the years, Ziegler has made a conscious decision to sit out the market bubbles that seem to happen every decade or so, rather than overextending or lending to less-than-ideal borrowers simply to raise volumes.

Sector Forecast: Modest Growth

Current Census Bureau reports indicate that annualized construction in the religious sector will be in the range of $3.5 billion for 2017. This represents a modest increase over previous years and an indication that the industry is finally healing. The primary factor holding back growth in the sector has been a stagnant economy. If consistent GDP growth of 2% or greater can be achieved, some of those dollars will flow through to congregation members, allowing many churches to dust off their shelved blueprints for expansion. The sector may never again reach the highs of the 2003 construction peak, but we should start to see a solid recovery in the near-term.