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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.
SocialFunds.com --
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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