One person’s charity is another person’s loss-absorbing capital –
Earlier this month, we pointed to an emerging American trend where philanthropists provide “first loss” capital for private investments.
The idea works as follows. Investment ideas that pursue political outcomes — such as education, or environmental sustainability — don’t usually achieve high enough returns to entice private capital. But if philanthropic capital takes the bulk of the risk, then private money will flow in.
Here’s the latest example of the emerging complexity of philanthropic capital structures, in an article earlier this week from Impact Alpha. It describes a new fund, backed by the Chan Zuckerberg Initiative, to provide affordable housing in San Francisco.
The Facebook-linked organisation will provide $40m, which effectively “serves as equity”, and is “given with no expectation of a financial return”. Here’s the key line:
The big slug of concessionary capital — effectively a grant — makes it possible for the new fund to both provide affordable housing developers with lower-cost loans and other attractive terms — and attract additional investors with competitive returns.
The investment fund has raised $260m out of a total of $500m. It has attracted capital from Morgan Stanley, according to a press release last week. That release also mentions the Ford Foundation, which we pointed to in our last post, as well as a host of other foundations that are involved in the broader project, including the San Francisco foundation and the William and Flora Hewlett Foundation.
For US foundations, losses themselves have a kind of value, because they count towards requirements to distribute (or “lose”) 5 per cent of their holdings each year, so as to remain tax-exempt. At a high level, you can see a conceptual substitution between tax “losses” on the one hand and charitable “first losses” on the other.
The investment fund is already lending $6.5m to the East Bay Asian Local Development Corporation. The ultimate logic is that the concessionary capital (also known as “catalytic capital”, also known, as above, as “first-loss capital”) allows the loans provided by the fund to be cheaper than the market would provide. These loans, to developers, will allow them in turn to provide more affordable housing in developments that “also include market-rate units”.
As you may have noticed, the entire principle is analogous to what a range of government subsidies aim to do. As the Impact Alpha article notes, those earning 60 per cent of the average median income are eligible for federal Low Income Housing Tax Credits. The philanthropic approach targets those who earn more, but are still struggling to find affordable housing.
When the government provides subsidies, it potentially benefits private businesses or investors as much as it benefits the targeted political demographic which it intends to subsidise in some way. This is why private interests try to influence or capture the government’s decision-making process.
The same thing is also true of charity. Or, as we should now start referring to it, “loss-absorbing capital”. We’ll be closely following the development of these new capital structures.