Not For Profits Questions and Answers
In the Question and Answer segments of our recent webcasts on Not For Profits, we responded to the questions submitted. However, we have repeated the questions (slightly edited in some instances) and have provided more detailed answers to each below.
Q: What roles do you see non-profits in the future economy?
A: Not for profits will likely fare in direct relationship to the state of the economy. The next year or two may be a very tough time for them until the unemployment rate begins to drop considerably, the consumers work off their debt overhang, and the economy begins to truly rebound. Watch the unemployment figures and movements. They are the best indicators of underlying economic strength and direction.
Q: Do you agree that non-profit organizations are especially vulnerable in today's economy particularly if restricted funds are a high percentage of assets?
A: Absolutely. Not for profits fare in direct relationship to the state and trend in economic activity and the status and trends in the U.S. economy are hardly encouraging for either sustained or increased donations from the contributing public. Further, a not for profit in today’s environment with a high percentage of restricted funds will likely find its flexibility severely limited in responding to crises that require the immediate use of unrestricted resources.
Q: What is your recommendation in cases where the non-profit financial statements are not of high quality (small church, etc.) and there is no ability to get personal guarantees?
A: Follow the same process you would follow for any borrower, i.e., kick the tires, in effect, and ask all the tough financial and non-financial questions you feel are necessary to provide you with sufficient information to make a credit decision. If you fail to get the information you need, or fail to feel sufficiently comfortable with the information, then pass on the opportunity.
Q: Is a possible solution to a small church or YMCA loan request with no high quality financials to participate with other local banks if the credit decision is positive?
A: In theory it should be possible, but it would certainly depend on the quality of the credit assessment since a potential participant would look to the lead lender to assure the credit quality. There may be comfort in numbers, but if potential participants are skeptical about the quality of the asset they are asked to acquire, it may be very difficult to spread the risk.
Q: What causes or what enables restricted assets to be released? Is the original donor contacted for permission to release?
A: The restricted assets are released when they are used in accordance with the stipulations imposed by the donors. Management will judge whether it has, in fact, performed as required. It is very difficult to determine – from outside the organization – if the assets were used as intended. Audits presumably address this issue, but there are numerous levels of audit quality. Further, many not for profits do not provide audited statements, which makes it even more difficult to assure that contributions are used as intended.
Q: Doesn't the diocese have a responsibility, an obligation, to the donors of restricted funds to hold those funds for the designated purpose? Is the diocese allowed to essentially borrow those restricted funds?
A: A diocese or a not for profit organization does, indeed, have a responsibility to hold and use the restricted funds for their designated purposes. But, as crises arise, management will use all its resources to meet the most critical needs, which may result in borrowing funds for short or longer term. At the end of the day, whether management borrows restricted funds may depend upon a) the severity of a cash flow crisis, b) the expected duration of the borrowing need, and c) the prospects that such use of restricted funds would come to the attention of the donors in question.
Q: In an instance where the diocese spent restricted funds, could the donors of those restricted donations demand and that the diocese return their donations? And would the diocese be obligated to return the donations if the donors so demand?
A: Donors could indeed make such demands. Whether they would be successful in obtaining the funds is another question that would depend on the cash position of the not for profit organization. The not for profit has a moral obligation to return funds it has not used or has used improperly. Whether it has a legal obligation may depend on internal governance documents that establish its duties and responsibilities with respect to specific restricted funds.
Q: If you could kindly further explain the footnote #8 regarding interest rate swaps – that the derivative is held only for the purposes of hedging such risk and not for speculation? Does that mean it is an actual liability the org will have to pay?
A: The organization is obligated to pay the contractual fixed interest rate that is defined in the swap agreement. That is its year-by-year obligation. The derivative asset or liability balance on the balance sheet, which indicates that the not for profit is in or out of the money, is a score card that reflects the wisdom of the swap. If the not for profit organization is in the money, it means that the fixed rate is – up to this point in time – less than the variable rate. If the organization is out of the money and has a liability balance on its balance sheet, it means that – up to this point – the fixed rate is more than the variable rate. But the company is not obligated to pay a liability balance. Nor does it benefit from an asset balance. The balance sheet amounts are scorecards, not obligations or benefits.
Q: Is there really a borrowing need for Community Chapel if they are asking for short term financing (anything other than term debt)?
A: No, there is no borrowing need – certainly not in 2008 or in 2009. The organization has no short-term debt. It enjoyed a cash flow surplus for the past two years, which means it had no borrowing needs of any nature. It could encounter a cash flow deficit in 2010 if it fails to receive another $1,000,000 bequest, but it could likely fund any shortfall from unrestricted cash. The church does use long-term debt to support long-term assets, but it is paying down that long-term debt balance.
In effect, Community Chapel seems in very good financial shape, with quite decent back-up cash support. But the organization does need to repeat its 2009 revenue/donation performance in 2010 to ride out the storm without being compelled to use its balance sheet resources – or turn to additional interest-bearing debt.
Q: What roles do you see non-profits in the future economy?
A: Not for profits will likely fare in direct relationship to the state of the economy. The next year or two may be a very tough time for them until the unemployment rate begins to drop considerably, the consumers work off their debt overhang, and the economy begins to truly rebound. Watch the unemployment figures and movements. They are the best indicators of underlying economic strength and direction.
Q: Do you agree that non-profit organizations are especially vulnerable in today's economy particularly if restricted funds are a high percentage of assets?
A: Absolutely. Not for profits fare in direct relationship to the state and trend in economic activity and the status and trends in the U.S. economy are hardly encouraging for either sustained or increased donations from the contributing public. Further, a not for profit in today’s environment with a high percentage of restricted funds will likely find its flexibility severely limited in responding to crises that require the immediate use of unrestricted resources.
Q: What is your recommendation in cases where the non-profit financial statements are not of high quality (small church, etc.) and there is no ability to get personal guarantees?
A: Follow the same process you would follow for any borrower, i.e., kick the tires, in effect, and ask all the tough financial and non-financial questions you feel are necessary to provide you with sufficient information to make a credit decision. If you fail to get the information you need, or fail to feel sufficiently comfortable with the information, then pass on the opportunity.
Q: Is a possible solution to a small church or YMCA loan request with no high quality financials to participate with other local banks if the credit decision is positive?
A: In theory it should be possible, but it would certainly depend on the quality of the credit assessment since a potential participant would look to the lead lender to assure the credit quality. There may be comfort in numbers, but if potential participants are skeptical about the quality of the asset they are asked to acquire, it may be very difficult to spread the risk.
Q: What causes or what enables restricted assets to be released? Is the original donor contacted for permission to release?
A: The restricted assets are released when they are used in accordance with the stipulations imposed by the donors. Management will judge whether it has, in fact, performed as required. It is very difficult to determine – from outside the organization – if the assets were used as intended. Audits presumably address this issue, but there are numerous levels of audit quality. Further, many not for profits do not provide audited statements, which makes it even more difficult to assure that contributions are used as intended.
Q: Doesn't the diocese have a responsibility, an obligation, to the donors of restricted funds to hold those funds for the designated purpose? Is the diocese allowed to essentially borrow those restricted funds?
A: A diocese or a not for profit organization does, indeed, have a responsibility to hold and use the restricted funds for their designated purposes. But, as crises arise, management will use all its resources to meet the most critical needs, which may result in borrowing funds for short or longer term. At the end of the day, whether management borrows restricted funds may depend upon a) the severity of a cash flow crisis, b) the expected duration of the borrowing need, and c) the prospects that such use of restricted funds would come to the attention of the donors in question.
Q: In an instance where the diocese spent restricted funds, could the donors of those restricted donations demand and that the diocese return their donations? And would the diocese be obligated to return the donations if the donors so demand?
A: Donors could indeed make such demands. Whether they would be successful in obtaining the funds is another question that would depend on the cash position of the not for profit organization. The not for profit has a moral obligation to return funds it has not used or has used improperly. Whether it has a legal obligation may depend on internal governance documents that establish its duties and responsibilities with respect to specific restricted funds.
Q: If you could kindly further explain the footnote #8 regarding interest rate swaps – that the derivative is held only for the purposes of hedging such risk and not for speculation? Does that mean it is an actual liability the org will have to pay?
A: The organization is obligated to pay the contractual fixed interest rate that is defined in the swap agreement. That is its year-by-year obligation. The derivative asset or liability balance on the balance sheet, which indicates that the not for profit is in or out of the money, is a score card that reflects the wisdom of the swap. If the not for profit organization is in the money, it means that the fixed rate is – up to this point in time – less than the variable rate. If the organization is out of the money and has a liability balance on its balance sheet, it means that – up to this point – the fixed rate is more than the variable rate. But the company is not obligated to pay a liability balance. Nor does it benefit from an asset balance. The balance sheet amounts are scorecards, not obligations or benefits.
Q: Is there really a borrowing need for Community Chapel if they are asking for short term financing (anything other than term debt)?
A: No, there is no borrowing need – certainly not in 2008 or in 2009. The organization has no short-term debt. It enjoyed a cash flow surplus for the past two years, which means it had no borrowing needs of any nature. It could encounter a cash flow deficit in 2010 if it fails to receive another $1,000,000 bequest, but it could likely fund any shortfall from unrestricted cash. The church does use long-term debt to support long-term assets, but it is paying down that long-term debt balance.
In effect, Community Chapel seems in very good financial shape, with quite decent back-up cash support. But the organization does need to repeat its 2009 revenue/donation performance in 2010 to ride out the storm without being compelled to use its balance sheet resources – or turn to additional interest-bearing debt.
