Our Foundation has made 103 Program Loans, about $20 million

By Wesley Matthews,2014-06-16 19:16
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Our Foundation has made 103 Program Loans, about $20 million ...

    PRIs at The Pearl M. & Julia J. Harmon Foundation

    Prepared by the Executive Director of the Pearl M. and Julia J. Harmon Foundation for use by PRI Makers

    Network members.

The Pearl M. & Julia J. Harmon Foundation was established in 1962 by Oklahoma pioneer oilman Claude C.

    Harmon and his wife Julia J. Harmon. Mr. Harmon named the Foundation for his late first wife, Pearl McCoy

    Harmon, and Julia, whom he married in 1948. A synopsis of the Foundation‟s history can be found at:

In 1981 the Foundation‟s Trustees decided to experiment with offering Program-Related Investments in the

    form of zero interest loans. It was a time of hyper-inflation and charities were having to borrow at high rates

    just to begin building so rising costs would not make their buildings more expensive faster than they could raise

    money. Our goal was to establish a revolving fund of loan principal which would enable the Foundation to

    support more and larger projects than it could with its normal distribution. Bringing this pool of charitable

    capital into existence was a significant aspect of the decision to make loans. In the 25+ years since, the Harmon

    Foundation has made 103 Program Loans, about $20 million.

Most of our loans are now low, not no, interest. Early in our experience we realized our prospective borrowers

    were quite intelligent and had figured out how easy it is to borrow at 0% and reinvest for enough earnings to

    pay back the loan and still have all the money. Now we charge what we intend to be “just enough” interest to

    preclude “arbitrage.”

Not one loan has defaulted. The purpose of this document is to summarize and share some of what we have

    learned about making Program Loans. We‟ve organized it as something of a checklist, in two Parts, with some lead-in topics in Part I and Loan Specific Comments in Part II.


1. What kind of entity are you?

The Harmon Foundation is a “private foundation.” We have and manage our own endowment. As a private

    foundation, we are required by law to distribute to other charities an amount equal to or greater than 5% of the

    fair market value (FMV) of that endowment. In our fiscal year 2004 (fye 5/31/05) the FMV of all our Assets

    was $42,635,840. Of that, $11 million was dedicated to charitable use, including $8.89 million of Program

    Loan Receivables.

Entities other than private foundations have very different considerations and are not subject to the mandate to

    make a minimum 5% distribution. If “you” are a “for profit,” you won‟t get any tax benefits from making loans

    or buying equity in a charitable effort. The IRS does not care if a for profit‟s goal is philanthropic.

    Community foundations are “public charities” which manage endowments as directed by donors. It would be perfectly logical for a community foundation to establish a Program Investment fund to help charities in its

    service area. If “you” are a community foundation, you should investigate the accounting and tax implications

    of PRIs in your context. Banks, regulated to avoid “red-lining,” can get some benefits from making loans which are not primarily intended for profit, but that‟s an entirely different topic . . .

2. Why make a loan?

If you do it right, you will get the money back. The $8.9 million in our PRI pool increases our ability to fund

    projects. On the other hand, loan repayments are paid from charity operating budgets. If your goal is to help a

    specific charity, maybe you should make a grant.


    We seek projects which save money and/or generate income. We‟ve funded construction of brand new community mental health centers with mortgage payments less than rent. We‟ve funded new group homes for

    the mentally retarded when income from the clients paid back the mortgage AND generated some operating

    profit for the charity. We‟ve insulated buildings. And roofed a theatre so it could open.

Grants would have done the same thing and left the charity with more money. But since our loans are

    structured so the project itself pays them back, from savings and/or income, we think the effect is to maximize

    social resources.

When word gets around (and it will) that you are making low interest loans, you‟re going to get lots of mail,

    much of it from individuals and businesses. Don‟t worry, be happy, recycle!

3. Don’t make a PRI to make money!

If you are charitable, you won‟t seek to profit from a PRI. If you‟re a private foundation, and you do, you can

    get in serious trouble! Several years ago we had a two-week IRS Exempt Organizations audit. The “charitable nature” of our Program Loans was examined very carefully – and passed. Our “return” on the roughly $8.9 million we had on loan 5/31/05 was about 1.8%.

    Here‟s the applicable standard lifted from the Instructions for IRS Form 990-PF. They‟re serious about it: “Section 4944(c) and corresponding regulations define a program-related investment

    as one that is made primarily to accomplish a charitable purpose of the foundation and no

    substantial purpose of which is to produce investment income or a capital gain from the sale of

    the investment.”

4. PRIs amount to a treadmill! Run! Run faster!

5/31/05, our 5% distribution requirement was $1,510,576. Program Loan repayments increased that by


When a private foundation makes a PRI, and the money comes back, whether loan repayments or sale of an

    “equity PRI,” the money has to go right back out, no later than the end of the subsequent tax year. That

    includes any “capital gains” on an equity PRI sale. But if a loan defaults or the equity investment “goes bad,”

    there‟s no additional deduction because the money was deducted when the PRI was made.

Even more complicated, the way PRI interest or dividends are reported results in their being offset against

    charitable expense. Again, this applies to private foundations, not community foundations.

5. Equity PRIs.

It is legally possible to make a PRI to a profit making entity. The PRI could be a loan or an equity investment.

    We don‟t do that. We only consider “charities.” Yes, a business can fulfill a social need. And there‟s surely a

    viable line separating an inner city grocery and Wal-Mart, but as we won‟t consider funding private ownership, we‟re pretty much excluded from equity PRIs.



    PROLOG: EVERY LOAN IS DIFFERENT! Given that every loan is different, we see no use for elaborate form sets, though our procedure is standard. Here's how we go about making PRI Loans.

1. On Initial Contact

Our initial contact is more likely to be a grant request than a request for a Program Loan. Most of our initial

    contacts end after we inform the applicant that we make loans, not grants, and don‟t even process grant applications. When a charity does express interest in a loan, we refer it to a simple form posted on our Internet

    site, It can be found by clicking the Programs Link and then the link under Program

    Related Investments to "More Information and Application Form." If the charity does not have internet access,

    we will mail a paper copy. In 2006 it seems everyone can get to the „net. Our form asks for a copy of the IRS 501(c)(3) recognition letter. Without that letter, we won‟t consider the application.

2. Be Skeptical

Our standard is that the loan is intended to (1) generate revenue sufficient to repay the loan over time, or (2)

    cost savings to do the same, or (3) possibly a combination of both. This standard weeds out a lot of stuff which

    makes no sense whatsoever. We're also careful not to consider applications from organizations which, e.g., want

    to put on a private landowner's property a "horse petting stable" for disadvantaged youth.

3. Verify Charitable Status

If the project looks like something our Board would be interested in funding, we verify the charity's status on

    IRS Publication 78. and pull its recent 990s from

4. Review Financial Status

Next, we ask for audited financial statements, current documentation of cash and income/expense. We can get

    pretty deeply into an organization's finances trying to confirm the group's goal isn't to borrow money to directly

    pay operating expenses, or to invest in a "financial" instrument, like a bond, stock, or CD. We want to be sure

    the organization is well managed and can pay back the loan! We also would like to be sure our money isn‟t off

    for a tour of the Cayman Islands.

5. Collateral

We take what we fund as collateral, so we're either taking real estate mortgages, filing UCC statements on items

    like office furniture, or putting a lien on motor vehicles. Everything our money goes to buy has a fairly certain

    value, though as anyone who's dealt in real estate knows, that can be difficult to determine. Get a third party

    appraisal if valuation is important. In terms of collateral, we have also accepted standby bank letters of credit

    and/or pledges by third party trustees to pay off loans from endowment income. WE DO NOT CONSIDER


    collect money from such a charitably minded person? WE WILL NOT ACCEPT A MORTGAGE ON A

    CHURCH BUILDING. Who would want to be known as the entity that foreclosed the “Little Chapel in the

    Woods?” Sometimes, especially for small loans, we have simply taken a Note without collateral.


6. Evaluating Creditworthiness

If you are new to making loans, get a loan officer‟s help. When we started making Program Loans we had

    several loan officers among our Trustees. There is no substitute for experience. Don‟t settle for a new, young,

    bank employee, either. Ask for help from someone with some years at the job. If you don‟t have a loan officer

    on your Board, recruit one to serve as a consultant.

    7. Legalities, like Mortgages and Notes

We've standardized loan documents as much as possible, but it is key to have a good lawyer! If you‟re making

    a loan, you will at least need a Note. You may want to take a Mortgage, or to make a UCC filing on items like

    furniture or computers. The documents we use are standard boilerplate, straight from lawyer formbooks. With


    A) We include a clause affirming the charitable nature of the loan, that it is indeed below commercial interest


    B) We restrict when charities can make “prepayments.” One charity had an opportunity to roll the project we

    funded into a complete refinancing which was larger than we could carry. The new lender insisted on

    closing on what happened to be the last day of our fiscal year, when a $478,000 outstanding PR Loan was

    paid off. Getting the money on that day put it on our tax return for redistribution within 12 months, on top

    of the money we already had to distribute. Thus the treadmill sped up that year, a lot! As a result, we limit

    prepayments to the first two months of our fiscal year, unless we agree to take them later. This gives us

    some control over when the money returns.

    8. Your Lawyer Will Be Worth the Money

You need a lawyer familiar with the laws of the state in which any collateral is located, or if there‟s no collateral,

    in which the loan is made. Once your lawyer modifies boilerplate Note, Mortgage, Financing Statement, using

    the same forms later should be less expensive. If the loan starts to “go bad,” usually a letter from your lawyer

    will get it right back on track. Though we‟ve had to resort to threatening legal action only a few times.

    9. Remember: BE CHARITABLE

    If you make a PRI (loan or equity), you‟re doing so to be charitable, not to make money. You want the money to come back because the credibility of your program depends on people understanding you‟re serious. But,

    especially if you‟re a private foundation, the money that does come back is “found money,” money you had to

    give away anyway. It should never be a matter of life or death to your foundation that it come back. Don‟t loan

    or invest endowment you can‟t afford to lose, then sleep very well. Look at it this way: is the loan you‟re

    considering something you would support with a grant? If yes, yes. If no, no!

    10. A Word About the Federal Reserve

Most of our loans are 15 year mortgages which recalculate the rate of interest at year 5 and 10. Up or down,

    based on US Treasury Rates. We simply weren‟t prepared when the Federal Reserve forced U.S. interest rates

    to historically low levels. A PRI which was several “points” below the going rate when made was suddenly

    higher than prevailing house mortgages. We did not want to redraft all those documents so our outstanding

    loans would still be charitable, nor did we want all the charities to refinance. So we made “grants” to our

    interest-paying borrowers, rebating interest to them, and advising we were doing so because rates had fallen so

    far, and that they should not count on our doing so in the future.


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