Q&A: Challenges and Strategies in Nonprofit Lending 

Navigating the complexities of lending to nonprofit organizations requires a nuanced understanding of the unique credit risks these entities present. Nonprofits, especially in sectors like healthcare and education, face challenges that differ significantly from their for-profit counterparts, with heightened sensitivities around reputation, regulatory scrutiny, and the absence of traditional financial safety nets. Naomi O’Dell, managing director of the debt restructuring group at Raymond James, has spent over two decades specializing in healthcare and not-for-profit finance. In this Q&A, O’Dell shares her expertise on nonprofit lending and loan restructuring, offering practical advice for banks. O’Dell will further explored these topics as a panelist in the RMA webcast, Mission Impossible: Restructuring and Workout of Nonprofit Borrowers, which you can watch below. 

In your experience, what are the most common credit risks associated with lending to nonprofit organizations, and how do these risks differ from those in the for-profit sector? 

I don’t necessarily view the credit risks associated with a not-for-profit borrower to be different than a for-profit borrower, but I do think of every risk category in the case of a not-for-profit as further escalated. Consider the “five C’s of credit”—character, capacity, capital, conditions, and collateral. 

The character of your borrower is important in both types of borrowers, but the higher calling of a nonprofit’s mission can tempt even the most pious of boards with visions of grandeur, driving tendencies to overspend for the sake of their constituents versus pursuing a solid business strategy. The capital category is strained from day one—by definition, a nonprofit doesn’t have the cushion of owner equity or a guarantor with deep pockets for a Plan B in the event distress occurs. The underlying collateral tends to be special purpose and often has zoning restrictions or grant exceptions associated with its use. And while services may be need based, not-for-profits are more sensitized to downturns in market conditions—donations are one of the first discretionary costs to be cut in a recession—and then one must layer on the risk of more regulatory oversight, particularly in the healthcare and education sectors. Meanwhile, exercising rights and remedies in the loan documents is subject to the risk of negative publicity for your organization (such as foreclosing on a defaulted hospital). In this lending “without a net” scenario, the initial underwriting and proposed terms are particularly key to confirm the capacity to repay your investment. 

When a nonprofit faces financial distress, what are the key challenges to restructuring their loans, and how do you balance the need for financial recovery with the reputational and political sensitivities involved? 

Lending to a not-for-profit places a bank in the unique situation of documenting its loan while knowing upfront that it has little appetite to exercise its full package of rights and remedies in an event of default due to the very real threat of poor PR. Without a secondary source of repayment (strong capital or collateral position), a lender is tied to making its primary source of repayment work—the operational success of its nonprofit borrower. Very often, you are negotiating with a volunteer board. It’s important to include in your restructuring cost estimates the need for industry consultants for your borrower to get you both to a long-term solution. Become familiar with financial advisors, legal counsel, and third-party managers that are sophisticated in this arena to supplement your borrower’s turnaround efforts and make sure your loan documents give you the ability to refer these engagements as covenants start to be tripped. 

What are some of the most frequent mistakes nonprofit organizations make when borrowing, and how can lenders better anticipate and mitigate these issues during the initial lending process to avoid complications down the line? 

The most frequent mistake I see is a not-for-profit overleveraging its organization—don’t take the money simply because someone is willing to let you borrow it! Lenders can help instill discipline by tightening the terms initially offered. Given the risk factors we’ve already discussed, more frequent reporting, more conservative advance rates, and higher coverage covenants can help protect both sides of the table. 

This interview has been edited for clarity.