Jay Owen Community Development Solutions, SRI/ESG News, Advisors' Forum


The CARS rating service includes deep dive due diligence and analysis


By Ellie Winninghoff, award winning journalist and member of Ethical Markets Research Advisory Board


Local wind-farms that finance services for low-income people, microfinance for Indians, conservation easements that protect working waterfronts and the lobster industry in Maine. These are the types of activities financed by “community development finance institutions,” or CDFIs, most of which are revolving loan funds that serve minorities and low-income people. But while there is huge interest in them by impact investors, it can be baffling to analyze a nonprofit and understand the risk of investing in one.


Fortunately, there is a way. CARS (the CDFI Assessment Rating System) is the go-to rating service for these loan funds, most of which are nonprofit.  It also performs deep dive due diligence with respect to finances and how well a loan fund is achieving its own specific mission. Unlike conventional rating firms like Moody’s or S&P, CARS rates an entire institution rather than individual loans. And its research, which averages 120 hours per CDFI, is primarily financed by investor/subscribers.


“The heavy lifting is done by CARS,”‘ says Randy Rice, community impact investments portfolio manager at Boston-based Trillium Asset Management, whose firm supplements the rating firm’s 45-60 page reports with relationship building and site visits. “We know as investors that a [CDFI] does not have to have the highest CARS rating to still be doing good work and to be moderate risk.


 “For us, it is frankly more important that [a CDFI] is CARS-rated than what its’ CARS rating is,” he adds.  “That a loan fund has [been willing] to submit to a deep dive analysis shows to a level of maturity.”


CARS, like banking regulators, rates loan funds using the CAMEL (capitalization, asset quality, management, earnings, liquidity) analysis. It rates financial strength and performance on a scale of one to five, with one being the highest score. A rating of one, two, or three indicates that finances are sound. A rating of 4 or 5 indicates financial vulnerability.


Impact performance ratings include AAA (the highest), AA, A and B. But these letters do not indicate how impactful a loan fund is. “All these institutions have very different missions,” says CARS president and CEO Paige Chapel. “What’s really fun about CDFIs is the creativity of their business strategies. Literally, no two are alike.”


As such, CARS asks the CDFIs to identify the data-points that are meaningful with respect to assessing how well they achieve their missions and explain why. Ultimately, CARS assesses how well each CDFI is achieving its own mission based on the data it collects. The A ratings indicate relative degrees of success; a B may indicate lack of alignment of mission, strategies, activities and data.


With respect to making a social impact, CARS also recognizes that policy change is the way to affect the lives of millions of people. In that light, it awards CDFIs a “policy plus” if they can demonstrate that changing public policy is a critical part of their agenda and they have devoted staff and budget to it. CARS has rated 75 CDFIs representing about half the $11 billion in on-balance sheet assets for the industry’s loan funds. According to Chapel, about 45% of them have won the “policy plus” designation.


Driving financial standardization


As tax-exempt nonprofits, the IRS wants to be sure that CDFIs are true to their mission. But as financial institutions, they are unregulated. Although there are GAAP principles, the question is whether they should be presented as nonprofits or financial institutions. Beyond that, conventional capital ratios are not appropriate because an estimated 5% to 80% of revenues may derive from grants or government contracts and therefore be restricted.


“If you are looking at investing in them and you want to understand risk, you need much more nuance,” Chapel says. “You need to know how much money they are making from their financing activity, and you need to understand the restricted revenues and separate them out.”


Not only does CARS dig into the devil in the details, it is driving standardization of financial reporting in the industry. It requires standardized GAAP-compliant financials, which it drives through its reporting template. Even so, it has not been able to standardize how CDFIs account for portfolio performance.


“We rate organizations that have loans on their books that are 360 days delinquent and even 1000 days delinquent,” Chapel says. “They haven’t written [these loans] off because they know the borrower so well. They’re waiting for some event to happen, and they are confident it will happen.


“You look at their overall loan losses, and they’re right,” she points out. “But it’s just not good practice. You mask what the real risk is.”


The most complex–and most time-consuming–part of CARS’s analysis is assessing the asset quality of each CDFI’s portfolio. To see how the portfolio is performing over time, it takes a look at the types of borrowers and loans, as well as delinquencies, restructures and write-offs. It also examines how a CDFI conducts its due diligence, and how it risk/rates loans and monitors them. And if the CDFI is not 100% deployed in its own loan fund, it checks what those assets are invested in.


Even so, Trillium’s Rice points that the purpose of the CARS exercise is transparency–not to force CDFIs to write off loans.


“If they have a lending profile that’s the same as their local community bank, why bother?” he says. “We would rather see a loan fund work with its borrowers to restructure a loan if they can keep it performing rather than write it off. It’s better financially, and it’s part of the mission. But at the same time, we want the loan fund to measure it and manage it.”


Meaningful Datapoints


Although CARS also wants CDFIs to measure and manage their social impact, it realizes that standardized data isn’t appropriate because each CDFI has a different mission.  Instead, CARS asks each CDFI to identify what datapoints are most meaningful in terms of assessing how well it’s achieving its mission, and then to explain how it collects the data and uses it to monitor its own performance.


“We look hard at how the data lines up with what they are trying to do, and their programs and strategies, ” Chapel says. “And we go into the systems they use to collect and report the data.”


In this case, though, numbers don’t tell the whole story and can even be misleading. That’s because CDFIs often act as catalytic agents. For example, they may provide high risk gap financing to a business or development project, which can then attract funding from conventional lenders. Or a CDFI may finance a critical development of a major corner of a neighborhood that leverages other development.


“To say that one CDFI financed 3000 affordable homes versus another that financed 40,000 does not tell you anything because it’s out of context,” Chapel says. “There are so many groups that are thoughtful about how to monitor their social impact and do a good job. But in our experience, investors are not interested in the impact analysis we do. They care about financial risk. They want to know if they will get their money back.”


Ellie Winninghoff is a writer and consultant specializing in impact investing. More of her writing is linked at her blog,, and she can be reached at: ellie.winninghoff (at) gmail (dot) com.