Mission, Money & Markets: A needed piece of community development infrastructure, the 'Guarantee Bank'
By Kimberlee Cornett
Unfunded guarantees have helped Kresge leverage its balance sheet, make financial commitments to reduce or mitigate risk, and drive social impact, all while keeping funds fully invested in our corpus earning an average of 7.5 percent each year.
Kresge’s CIO Rob Manilla recently wrote in our “Mission, Money & Markets” blog about the untapped potential of foundations to use guarantees to accelerate social change. As he noted, guarantees are not “free,” and we carefully evaluate and plan for future guarantee calls. We use a variety of structures to mitigate risk and ensure our investment partners are taking on appropriate amounts of risk of their own.
But we don’t shy away from the prospect of future guarantee calls. Those future payments are just another way of delivering our social mission – just like the grants we make today. But the opportunity to leave our funds fully invested – while catalyzing impact today – makes guarantees a highly efficient use of the foundation’s balance sheet (read Rob’s piece for a full breakdown). We hear consistently from partners in the field about the need for guarantees and experienced guarantors to help buffer risks that will allow organizations to grow, launch new products and guarantee value that does not yet exist.
Guarantees are not a new tool. What makes Kresge’s use of guarantees unique is perhaps the size of our commitment – the $150 million in guarantee capacity approved by our board in 2015 represents half of our impact investing pool. But the Bill and Melinda Gates Foundation, MacArthur Foundation, Ford Foundation, Annie E. Casey Foundation and others have used guarantees for years. U.S. AID has deployed 500 guarantees and technical assistance through the Development Credit Authority to Africa for a long time.
|Uses of Guarantees|
There are many examples of how Kresge has used guarantees to de-risk investments and bring in other investors. Here are a few:
Case study: Detroit Home Mortgage
Mission, Money & Markets: The power of the guarantee
Investment summary: Aura Mortgage Advisors
Investment summary: Invest Detroit
But guarantees are not yet as common as they should be. Despite the compelling capital efficiency and the positive social impact, only a small cohort of foundations employ guarantees. The Global Impact Investors Network released a report in 2017 discussing the need for guarantees in U.S. community development but found only a handful of active guarantors and a broad swath of investors and intermediaries needing guarantee capacity – but often the programmatic interests of guarantors and prospective beneficiaries didn’t line up. We began to ask: What would it take to reduce that friction, unlocking more guarantees and capital for communities?
As Rob alluded in his piece, Kresge is exploring the creation of a multi-investor guarantee pool, which would give foundations and other social investors the opportunity to leverage their balance sheets in an operationally efficient manner. We have tentatively called this effort the Community Investment Guarantee Facility – or just the Guarantee Bank for short. Despite the complexity of launching a new piece of community investment infrastructure, our energy has been bolstered as we continue to see evidence that we need to bring all tools to bear against increasingly complex and large problems to make more than incremental progress. This calls for innovation and new tools, which always come with the risk of failure or slow uptake, but which also raise the possibility of unlocking solutions that propel us forward with new velocity.
Kresge is working to organize the partners and structure that will ultimately stand up the first domestic, multi-investor guarantee facility. Investors would bring their guarantee commitments to the pool, which will make enterprise-level guarantees available to lenders and investors working in the areas of climate, small business and housing. You can find a schematic of this concept here.
Building this community investment infrastructure would:
Increase investment volume and create efficiency.
Reduce complexity for guarantors to make and manage guarantees.
Accelerate community investment without requiring current endowment liquidity.
Distribute risk across a pool of guarantors.
So far in 2018, Kresge has held three listening sessions with potential investment partners and prospective guarantors. In these conversations, we have heard a need for guarantees that provide liquidity, as well as downside risk protection and collateral substitution (or some combination of all three). These early conversations give us a good measure of confidence that a “Guarantee Bank” would accelerate the flow of capital for community investment.
We also believe there is much to be learned and discovered about how this new intermediary will best serve guarantors, investors and communities. Those discoveries will only come through time, experience and hands-on collaboration.
Stay tuned for more as we work with partners to make this much-needed piece of impact investing infrastructure a reality here in the U.S.
Reach out to us at firstname.lastname@example.org if you’d like to share your perspective or get more information.
|An Example of Pooled Risk|
How does pooled risk sharing work? Here’s one example, built on assumptions of how a proposed Guarantee Bank might work
Let’s say hypothetically that Kresge made a $10 million guarantee a new entity to do important community work. In this example, Kresge is fully and singularly liable for up to $10 million in losses.
Many foundations and social investors likely are interested in this type of transaction. However, few might have the resources or experienced staff capacity to make and manage this guarantee. For illustration purposes, we will assume that the fictional organization experiences a $3 million loss in the future. Kresge would be responsible for that $3 million.
But what if the hypothetical Guarantee Bank had made that $10 million guarantee and Kresge was just one investor in a pool of guarantors? For this example, let’s assume that Kresge has made a $15 million unfunded commitment to the Guarantee Bank – 15 percent of a $100 million pool. As in the earlier example, the bank makes a $10 million guarantee, and subsequently that organization experiences a $3 million loss.
Here’s what changes: Because Kresge is only 15 percent of the overall pool, our pro-rata share of the loss is only $450,000 – which we include in payout – not the full $3 million. Diversifying risk across investments and across investors is common practice in the capital markets. The Guarantee Bank is an attempt to replicate that for community development.
Kimberlee Cornett is Kresge’s managing director of the Social Investment Practice. Follow her on Twitter @kr_cornett.