Things take time, but with patience and sticktoitiveness, often you are rewarded. Another of those days has arrived as the C.D. Howe Institute has discovered what we’ve been preaching for years: the Business Development Bank of Canada is intentionally competing with private sector lenders on both price and terms, and needs better oversight and regulation.
Initially, it was with some intrepedation that I poured over the new 24 page report from the C.D. Howe Institute called “Reining in the Risks: Rethinking the Role of Crown Financial Corporations in Canada”. Based upon the list of interviews and documentary sources the authours (Philippe Bergevin and Fin Poschmann) relied upon, it wasn’t clear if they’d come across the treasure trove of research that we’ve been posting here for the past six years on Bruce The Mindless Eating Machine (aka The Business Development Bank of Canada’s lending arm).
Fortunately, the C.D. Howe researchers landed on the same sensible place that we’ve been recommending to the Federal government over the past number of years. Here are some highlights.
BDC competes with the private sector for loans, against its statutory mandate to “complement” and “round out” the offerings of private sector players (see representative prior posts “‘Bruce’ the mindless eating machine” May 31-08, “BDC Fact #4” Dec 5-07 and “BDC Fact #1” Dec. 3-07). This is what the report found:
“Author interviews with stakeholders have highlighted instances where the BDC has apparently been in direct competition with private lenders.”
“All Crown financial corporations should, in their governing legislation, have a clearly articulated mandate that focuses on the need to be complementary to private institutions.”
“The traditional ‘lender-of-last-resort’ role that [once] governed BDC’s lending should be considered for all Crown financial corporations. This former legislative role encapsulated well the concept that Crowns should not compete with private lenders and insurers. This would not necessarily lower the risk of the Crown lenders’ portfolios, but it would limit their size and the extent to which they crowd out private market activity.”
“The complementary mandates of all Crown financial corporations should also be better defined in guildelines and, more importantly, be better reflected in practice. An example would be to adopt a lending threshold of prime business rates plus 300 basis points, below which the Crowns would not offer financing.”
“Management compensation and the selection of directors should also reflect the complementary role.”
BDC uses its ultra-low cost of capital to win business. We’ve complained to a series of Cabinet Ministers about this over the years, starting with former Industry Minister Jim Prentice back in 2007. Here is the Report’s view:
“…if the BDC were to operate as a private institution and aim for returns on equity of 15 percent – consistent with those observed for private financial institutions – it would have to substantially increase the interest return on its loan portfolio. We calculate that for its 2012 budget year, the BDC would have to increase the rate on its loans by 1.4 percentage points – a 25 percent increase – to generate a 15 percent return. Recognizing that these numbers are indicative and hold many other factors constant, it is nonetheless clear that interest rate increases of this magnitude would affect the ability of any corporation to sell financial products and compete in the marketplace. Having lower capital costs therefore means that the aggregate portfolio of investments that the Crown undertakes can be riskier than the privately financed portfolio, even when selected from the same pool of investment (lending) opportunities because a Crown’s lending spread will be higher, even on a risk-adjusted basis.
“…comments from stakeholders indicate that the BDC, in some instances at least, competes on loan pricing and terms that bring its lending rates much closer to the prime rate, pricing other financial institutions out of the market. Evidence is anecdotal.
Last Fall, I found out that BDC was doing long term loans that the banking regulator OSFI had prohibited within the private sector (see prior post “BDC offside OSFI’s prudent lending guidelines” Sept. 17-12). Five years ago, for example, an Alberta-based manufacturer might be able to swing a 7 or 10 year term loan to buy some new equipment or acquire a business. Call the Canadian Western Bank today, and the longest they could give you was a five year deal – OSFI had determined that it was no longer prudent to go beyond five under Basel III capital rules.
Between 2008 and June 2012, BDC has added net $5.0 billion loans to its balance sheet with a maturity date in excess of 5 years. That’s almost 100% of the BDC’s $5.565 billion in loan growth during the entire period. This has pushed the overall percentage of long term loans on BDC’s balance sheet up dramatically, too: to 74% from 65%.
According to the C.D. Howe report, BDC isn’t being watched closely enough:
All Crown financial corporations should be regulated by OSFI, so that they are subject to the same capital standards and related prudential regulations as those of the federally regulated private financial institutions. This would help ensure that these institutions do not present undue risks for taxpayers, as evidence presented earlier tends to suggest.
It took a while, but to have three of my key complaints about the BDC validated by the C.D. Howe Institute is gratifying, and disproves what BDC CEO Jean-Rene Halde told his board and the former Senate Banking Committee Chairman about our experiences of BDC’s predatory competitive practices being unique in the loan marketplace. Let’s hope the C.D. Howe report finds its way into the hands of the right people in Ottawa.
(disclosure – this post, like all blogs, is an Opinion Piece. And, of course, reflects a personal view and opinion and is not meant to represent the views of the TPA, its Board/Staff or the federal government)