The myth behind BDC's 4.7% return on equity

BDC Fact #13

BDC executives brief their political masters that the reason they can’t possibly achieve the Return on Equity (ROE) levels of the private sector is simple. BDC doesn’t have the same leverage as similar sized banks. I promised we’d look into that the other day, and I like keeping my promises (see prior post “BDC’s dismal 2008 financial results” July 22-08).

Canadian Western Bank has assets of about $10 billion, with loans of $7.9 billion.

Underpinning that $7.9 billion of loans is $390 million of sub debt, and $646 million of shareholders equity. Tangible common equity to risk-weighted assets was 7.9%; put another way, the value of risk-weighted assets was 12.7x the common equity. Dividend payout for the year will be about $25 million.

BDC has assets of about $10.6 billion.

Underpinning those assets is $1.038 billion of shareholders’ equity, and another $804 million of retained earnings. Assuming BDC doesn’t risk weight their assets, the multiple of assets to shareholders equity is 5.7x.

Simply put, Canadian Western Bank is levered 2.23x more than BDC is, all other things being equal.

From an ROE standpoint, let’s compare the two.

CWB is forecast to produce a cash ROE of 16.8%, which is 3.6x BDC’s 4.7% 2008 ROE.

For CWB to operate with the same leverage as BDC, it would need to have common equity of $1.44 billion. If it had that amount of equity, it wouldn’t need to carry any subdebt, which would reduce funding costs and increase dramatically profits, but I don’t have time to pull together a financial model. But you get the point — these are conservative figures.

Under that $1.44B back of the envelope, apples-to-apples senario, CWB’s return on equity would still exceed 7.5%, ~300 bps higher than BDC’s.

So, next time you hear that BDC’s ROE is on par with the banks, if not for the lack of leverage, remember these figures. And ask yourself the real question: why does the federal government let BDC pay only $21 million of annual dividends when it is carrying retained earnings of $804 million?

Those excess dollars could be drained tomorrow and be spent / invested in any number of worthy places to help grow the Canadian economy:

– tax cuts
– increased SR&ED tax credits
– increased job training for the manufacturing and automotive sectors
– commercialization of on-campus technologies
– the Windsor-Quebec City high speed rail line

If the $804 million of excess capital isn’t being well utilized at BDC HQ, there’s little sense in letting the funds stay moribund given the capital constrained economy.

Just a thought.

MRM