Recently the MacArthur Foundation announced news of a new collaboration with the Chicago Community Trust and the Calvert Foundation: Benefit Chicago, a community-investment vehicle that, on one side, loans money at low interest rates to people and projects that have trouble getting it from other types of financial institutions, and on the other, returns money to investors.
From the investor's end, it's pretty simple: you can buy fixed-income securities called Community Investment Notes from one to 15 years, which return one to four percent annually. You can do it online, directly, for as little as $20; you can do it through a CCT donor-advised fund or through a financial adviser at higher minimums. That's it. The return isn't enormous, but a five-year note returns two percent, while my bank is offering 0.5 percent APY on a CD. It's unsecured debt, but the returned promise is decent, and the Calvert Foundation has returned all its investors' money during its existence.
The difference is that in this case, your money is loaned to nonprofits and social enterprises that, according to Benefit Chicago, "bolster families and communities and pave the way to a more sustainable future."
Plenty of people think it's a good idea. So why don't we see more like this?
To begin with, there's a fear factor. If traditional financial institutions aren't making these kinds of loans… there must be a reason, right? For instance:
Pinsky (2012) conducted research in which investors were presented with an investment opportunity in a CDFI [Community Development Financial Institution]. While the investors initially perceived that the opportunity was market-rate investment grade, if “community development” was added to the description of the opportunity, the investors raised their pricing by 600 basis points, an amount that Pinsky labels the “community development premium.”
So the first step for CDFIs is to build trust in the sector.
"We did a study that looked at performance data of CDFIs [Community Development Financial Institutions] over a long period of time, starting from before the recession, going through the recession, and after the recession, and compared them to conventional banks," says Michael Swack, director for the Center for Impact Finance at the University of New Hampshire, who's worked in the United States and overseas in the field. "And what we found was the performance rate was very high."
As might be expected, he adds, "Delinquencies and defaults did go up a little bit during the recession, but were essentially well managed. Very few CDFIs went out of business during the recession; none of them got bailouts from the federal government. One of the things it suggests is that if you carefully underwrite your loans, you can effectively manage risk… Being relatively poor doesn't mean you don't repay your loans."
One of the things that's key in here: if you carefully underwrite your loans, you can effectively manage risk. To succeed, CDFIs have to do substantial qualitative and quantitative research on potential loan recipients; some offer assistance and guidance after the loan is made.
"The way we do the risk assessment—we're philanthropic, so we don't have the same constraints on us as a profit-driven investor would," says Debra Schwartz, MacArthur Foundation's managing director, who oversees its $500 million portfolio. "We can take the time to look at each organization, one by one, and really spend the time to understand what their mission is, who they're trying to serve, the problems they're trying to solve in the community, whether that's providing job training, bringing access to vegetables in a food desert, spurring development on a disinvested block."
So CDFIs have a more time- and labor-intensive model. And the projects they invest in can require that time and labor. "We can make sure that we have the right timeframe for repayment, because their margins are slim, and they need a few extra years, because they're only going to generate so much free cash flow," Schwartz says.
CDFIs also manage the risks on the back end. "They are not as highly leveraged as banks, so they have balance sheets where they have 15, 20 percent capital," Swack says. "You hear arguments about banks these days, should they strengthen, should regulators require them to have more capital. These CDFIs do. They build in that risk calculation by having stronger balance sheets, meaning less leverage."
That, of course, requires additional money. "Many of them have some philanthropic support to support their operating budget," Swack says.
Safety of investment is one thing, but ease of investment is another. In a report from the Global Impact Investing Network co-authored by Swack, an "industry stakeholder" told them that CDFI portfolios are "so small, so hand crafted and specific—kind of artisanal in nature—that trying to find buyers on the other end has been difficult. There is always something about how the loan has been done that will not meet an investor threshold."
Artisanal, in this context, isn't a selling point. What Benefit Chicago does is take the intensive, complex community investment end and translate it into something comparatively frictionless for investors. "From an investment standpoint, all the investor is relying on and looking to is Calvert Foundation. That's who's responsible for paying back their principal and interest. The risk profile for the investor starts and ends with the Calvert Foundation," Schwartz says.
Beyond that, the Community Investment Notes are registered securities, so they can be easily purchased on the electronic market by a broker. The Calvert Foundation is somewhat unusual in this regard. It also offers a broker commission—typical for investment products, atypical for CDFIs—as a sales incentive. "There are quite a few barriers [to investment]. This new Chicago fund has addressed many of them," Swack says. "I think it's a really great idea, and a terrific idea of overcoming some of those barriers."
MacArthur is putting $50 million into the Benefit Chicago fund; the Chicago Community Trust is buying a $15 million note from Calvert. The goal is to raise another $35 million in investments—which will then be loaned by Calvert to Benefit Chicago—for a total of $100 million over 15 years. It's a lot of money by philanthropic standards, but Schwartz puts it in perspective.
"There's a lot that needs to come from the public sector. The scale is just not possible—when you look at the budget of an agency, whether it's our state's department of human services, or child welfare, or education, when you look at what the annual budgets are of those agencies, those are way beyond what any of our private foundations have on their balance sheets, let alone their grant budgets," Schwartz says. "Those resources need to be flowing too, and as we know, they're not."