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November 11, 2003
As, Bs, and Cs: New Rating Tool Grades Community Development Financial Institutions
    by William Baue

The National Community Capital Association launches CARS: the CDFI Assessment and Ratings System.


As any student can attest, being graded is both intimidating and empowering: The evaluation process can be nerve-wracking, but the final result can testify to achievement or identify areas for improvement. Grades also help outsiders, such as future teachers or potential employers, assess and compare students. The same can be said for a new ratings system for community development financial institutions (CDFIs), which provide loans and financing to middle- and low-income individuals and small businesses that mainstream financial institutions do not serve.

Developed by the National Community Capital Association (NCCA), the CDFI Assessment and Ratings System (CARS) is a comprehensive rating tool that assesses CDFI’s investment risk and community impact for potential investors.

“A confluence of economic factors has made this the right time to launch CARS,” said Mark Pinsky, president and CEO of NCCA, which represents the industry of 800 CDFIs that manage over $8 billion in funds from 50,000 individual and institutional investors.

“While a few years ago both investors and CDFIs were interested in CARS but not motivated to participate, today both sides are eager to come to the ratings table,” Mr. Pinsky told SocialFunds.com.

NCCA committed to developing a rating system as early as October 1998, at its annual membership meeting. By late 2000, NCCA had created CARS, and two CDFIs volunteered as “guinea pigs” for testing the methodology. CARS assigns one letter grade on performance capacity and two sub-ratings on repayment capacity and community impact. The six possible letter grades fall into two categories: investment grade, which ranges from A+ (highest) through A (very strong) and B+ (good) to B (satisfactory), and below investment grade (C+, or constrained, and C, or severely constrained.) The sub-ratings each fall into one of three categorizations: very strong, good, and weak.

In late 2000, however, CDFIs were wary of ratings because the US Treasury Department’s CDFI Fund, which was created by Congress in 1994 to provide public capital to underserved and distressed communities, was pumping money into CDFIs. Then the economy turned and government spending slowed: CDFI Fund grants fell from $76 million in fiscal year (FY) 1999 to $42 million in FY 2002, according to the NCCA’s new report entitled Rating CDFIs: The CARS Guide.

"A rating system or process is necessary if CDFIs are going to access new sources of capital in any meaningful way,” said Mark Willis, executive vice president of the community development group for J.P. Morgan Chase, which underwrote the CARS guide.

Despite NCCA’s pleadings, none of the major rating firms (Standard & Poor’s, Fitch, and Moody’s) expressed interest in offering CDFI ratings, so the time is now ripe for NCCA to unveil CARS.

“We have identified more than 30 CDFIs that say they are ready, willing, and perhaps even eager to be rated,” said Mr. Pinsky. The number of CDFIs willing to be rated surpasses NCCA’s estimated baseline number of 30 CDFIs needed to create an economy of scale for CARS to work.

CARS will have some competition. The CDFI Fund plans to launch its own ratings, called PLUM: Performance effectiveness, Leverage, Underwriting, and Management. While PLUM and CARS overlap, NCCA maintains that CARS represents a more in-depth analysis, which includes a site visit. CARS also emphasizes qualitative over quantitative factors and proceeds from a cooperative approach as opposed to an adversarial one. For example, CDFIs review the information upon which the independent Ratings Committee makes its decision before the ratings are assigned.

NCCA does identify a number of shortfalls and challenges for CARS, including the untested nature of the CARS rating scale, the expense of rating (up to $15,000 per CDFI), and the challenge of maintaining the currency of ratings. Furthermore, accessibility to the ratings remains an issue, as some CDFIs may not want their rating to be publicly accessible on a fee basis on NCCA’s website, the dissemination method preferred by NCCA. Also, NCCA recognizes the potential conflict of interest in rating its own members and hopes to create a separate ratings entity when CARS reaches scale.

“Launching CARS is a big step into the unknown [and we] anticipate bumps along the way, changes in our strategy, and revisions to our methodology,” states NCCA in the CARS guide. “However, we are convinced that an effective rating system can help the CDFI industry become more efficient, grow to a significantly larger scale, attract new and larger sources of capital, and have a larger impact on disadvantaged communities.”

 

 
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