Community development is a capital-intensive undertaking, and foundations have always wrestled with how to take on this challenge at scale. Grants alone don’t pack enough of a financial punch to move the needle on big issues like housing affordability or small business development in communities that have suffered from decades of chronic disinvestment.
Impact investments are one way for community development funders to magnify the effect of their work. And lately, as more funders embrace these tools, there’s been a lot of new action in this space.
Usually, when we think of impact investing, we think of actual capital investments like loans or equity. But there are other ways for organizations with strong balance sheets to leverage financial resources for social good. And the need is great. Even when philanthropy lends a hand, accessing traditional capital can be a tricky prospect for community development actors like CDFIs, affordable housing developers and local entrepreneurs. As it stands, big institutional lenders often take a pass on community development projects given the level of risk involved.
That’s the challenge the Kresge Foundation and 10 other organizations are taking on with a new and innovative tool, the Community Investment Guarantee Pool. Through the pool, Kresge and its partners hope to catalyze a stream of new investment in affordable housing, climate projects and small businesses. Using guarantees may let them unlock hundreds of millions in capital while only spending a small fraction of that—or maybe even nothing at all.
An Underutilized Tool
The transactions involved may be complex, but the basic concept of a guarantee is simple. Picture a college student’s parents cosigning an apartment lease. The guarantor organization—for our purposes, a philanthropic funder—uses its financial heft to enhance the credit of a fiscally shaky enterprise, smoothing the way for mainstream institutional investors to come on board. Ideally, the investee will cover its obligations and the guarantor won’t actually have to pay a dime.
Guarantees aren’t new on the philanthropic scene. Several major funders like Gates, Ford and MacArthur have used them for a while to backstop development projects, in many cases overseas. Kresge got into the guarantee game in 2011, four years after it debuted its Social Investment Practice. In 2015, the foundation doubled down on its commitment to social investing with a plan to deploy $350 million of its assets toward impact-oriented loans, deposits, equity and guarantees through 2020. To date, Kresge has made around $70 million in guarantee commitments, unlocking an impressive $780 million in additional investor capital—all of that without requiring Kresge to pay anything at all, according to a 2018 post by Chief Investment Officer Rob Manilla.
“The balance sheet is one of the most underutilized assets foundations have to support their missions,” Manilla wrote. “Why can a balance sheet be so powerful? Because most foundations, if rated by a credit rating agency, would receive the highest possible rating of AAA. This is a unique advantage; there are only two U.S. corporations still rated AAA.” Few organizations besides foundations, after all, have assets that so dwarf their annual liabilities. That’s the promise of philanthropic guarantees: In Kresge’s case, close to $1 billion in capital opened up for restorative community development by an unfunded commitment of $70 million. Since Manilla’s post, Kresge has had to pay on one of its guarantees, but only for a modest amount.
So what’s the catch? Why haven’t more funders gravitated toward guarantees? According to Kresge Portfolio Manager Joe Evans, novelty is one factor. After all, the slow-moving foundation world is just dipping its toes into impact investing. Guarantees are an even more unconventional step. On top of that, guarantees tend to come with lots of moving parts and priorities. “Each actor tends to have specific program strategies they’re aiming at,” Evans said. Deal requirements can vary widely, both in terms of the type and scope of impact sought and the financial risks and incentives packaged into the deal.
Essentially, when you combine a program officer’s tendency to micromanage impact with an investor’s desire to micromanage risk, you’re left with a recipe for frustration.
Collaborative Credit Enhancement
The Community Investment Guarantee Pool was designed to smooth over many of those challenges. “It’s a centralized place to access credit enhancement from a group of foundations, instead of having to meet one particular foundation’s program goals,” Evans said. The pool requires all participants to “step back up to their higher-level program priorities and let go of the very specific targeting that happens a lot when you’re matching one foundation with one project,” he said.
In 2017, Kresge funded a Global Impact Investing Network study on the philanthropic use of guarantees that teases out the challenges involved and provides an excellent overall primer on the subject. Subsequent focus groups pointed to the possible gains from creating a centralized credit enhancement instrument that could speed community investments without actually locking down capital.
The pool debuted with guarantee commitments totaling $33.1 million, which its members expect to unlock more than $150 million in new community investment capital. It rejects bespoke targeting for a broad focus on small business, affordable housing and climate solutions. So far, Kresge has committed $10 million to the pool alongside average commitments of $3.3 million apiece from the Annie E. Casey Foundation, the California Endowment, the Chan Zuckerberg Initiative, CommonSpirit Health, Gary Community Investments, the Jessie Ball duPont Fund, the Phillips Foundation, the Seattle Foundation, Virginia Community Capital and the Weingart Foundation.
Each of those guarantors is on an advisory council that collectively signs off on any rule changes. Managing the pool’s day-to-day operations is LOCUS Impact Investing, a subsidiary of Virginia Community Capital that has partnered with a number of philanthropic organizations including the United Philanthropy Forum, Confluence Philanthropy, BALLE (now Common Future) and the Democracy Collaborative. The Rockefeller Foundation is expected to support the pool with funds for operational support, rather than joining as a guarantor.
Taking Risks—and Managing Them, Too
The pool’s guarantors have agreed to limit their individual commitments to under 2% of assets, a ceiling meant to reassure institutional investors that the guarantors won’t get swamped if borrowers fall through. Two percent sounds pretty low, but the initial plan called for an even less risky ceiling of 1%. The pool upped its limit when one guarantor expressed an interest in coming in higher.
Despite a number of steps taken to mitigate risk, Kresge wants to take some risk through the pool. “One message we heard was that you cannot create some kind of facility where you expect zero losses. We anticipate seeing losses through the pool,” Evans said. “Given a five-to-one leverage, even if we lose 15% of that dollar, that’s a small price to pay for the economic impact. And the loss counts as a charitable expenditure.”
Evans also noted that even while losses tend to show up later in the process, many community development efforts are a decent bet. For instance, you’d think the 2008 housing crisis would have wiped out CDFIs lending to low-income borrowers, but in fact, many fared quite well through the downturn. With credit enhancement tools like guarantees, “you often cover the perception of risk as much as you cover a real risk,” Evans said.
Shifting the Status Quo
Perception of risk—whether it exists or not—is one factor that has consistently denied capital to low-income neighborhoods, communities of color, rural areas and other places far removed from Wall Street’s usual haunts. While some of the nation’s biggest financial institutions have taken steps to address chronic community disinvestment, especially through their philanthropy, precedent and privilege are powerful counterweights.
The Community Investment Guarantee Pool is meant to act as an example to institutional lenders. Kresge has positioned its commitment to social investing in that light, arguing that traditional philanthropic grants don’t always make the same case to big capital as performing loans do. And even through foundations can accomplish a lot with their own impact investments, philanthropies are still minuscule next to the JPMorgan Chases and Citis of the world. “Bank of America now has a billion dollar commitment to CDFIs, and that probably won’t have existed without foundation investments in CDFIs over the decades,” Evans said.
Going forward, Kresge and the other guarantors hope to secure over $75 million in commitments to the pool. Multiplied by a factor of five, the resulting potential investment rises into the ballpark of the Partnership for the Bay’s Future, a joint effort of Bay Area power players that has secured $500 million in affordable housing investments for the region.
CZI is leading the charge on that front, and it’s unsurprising to see it step forward as a guarantor for the pool. West coast-based organizations make a strong showing overall, among them the California Endowment, the Weingart Foundation and the Seattle Foundation. That reflects the pool’s loose geographic preference for a number of states where guarantors are located (and where community development challenges like affordable housing are acute). That list includes California, Colorado, Delaware, Florida, Georgia, Maryland, New Mexico, North Carolina, Texas, Virginia and Washington.
We’ll be interested to see how well the pool’s promise to catalyze big investment pays off. In a time of deepening crisis around housing and the environment, this instrument unites collaboration and impact investing—commonly cited as ways to expand philanthropic potential—with a semi-novel tactic, the guarantee. That makes it an intriguing way for funders to magnify impact and shift the status quo without delving directly into policy advocacy.