Political expediency trumps free market

I’m starting to figure out how hard it is to grow a business – at least on a level playing field; that sinking feeling that entrepreneurs get sometimes when they worry that their fill-in-the-blank product is going to have growth challenges that weren’t initially forseen.

You’d think that this is an easy time to be in the lending business. Your assumption is half right. There is little new business credit flowing in Canada, at least anecdotally, and firms such as ours are sitting on enough dry powder that we could capitalize several firms in the space of the next few weeks. And if we put out all of our remaining capital, plus re-circulate the capital that comes back via exits, we can still go back to our limited partners for another $125-$150 million recirculating Fund IV and keeping going.

The oh so tricky part is predicting where the economy is going. With huge swings in the currency, some domestic tech firms may be insulated from the recession more than initially thought, but it is very difficult right now to get a handle on just how hard it will be for the entrepreneurial world to meet their 2009 forecasts:

– will the G2000 corporate buyers rebuff signing P.O.’s for the next few months, as we saw in 2001-03?
– will it be harder to convert Lab trials into product roll-outs?
– will soft consumer behaviour put the brakes on industrial capex plans currently on the drawing board?

The other part of the equation, at least for those of us in the private sector lending world, is the unfair advantage that policy makers are giving Canadian chartered banks with this effort to bolster their balance sheets via the Canadian Mortgage and Housing Corporation, guaranteeing new medium term debt, and putting a safety net under interbank lending.

These moves make sense on several levels, of course, as Canadians appeared to cry out during the election campaign for “someone to do something”; even though what they really wanted was for the stock market to stop falling. Hard for Prime Minister Harper to do anything about that.

But reinforce the health of the Canadian banking system? That was achievable. It didn’t seem to matter to Canadians that their banks were, at least according to a World Economic Forum study, the healthiest in the world. If other nations were taking major actions to help their economies, where was the Canadian government? So high was the anxiety that it didn’t matter there was no connection between what was up at Wachovia and TD Bank.

At first we learned of a $25 billion CMHC mortgage program (exactly 10% of the US$250 billion U.S. bank capital injection announced the week earlier), which is designed to give banks capital relief so that they can put more money back into the Canadian economy.

Poppycock, of course. There was no guarantee from these grateful banks that they’d open up the doors again to new business loans (see prior post “‘Thawing Credit Market Should Ease Concerns’ – NFW part 2” October 30-08), although it would certainly be easier to write more mortgages if they could off-load some paper into the secondary market. With home sales and prices dropping, there’s no question that banks need to be able to provide mortgages if the residential market is going to recover. The lending patterns of the 1991-93 recession speak to one simple truth: “mortgages are good assets”, as former Bank of Montreal CEO Matt Barrett was fond to say.

The first $5 billion mortgage purchase by CMHC was done around 4.2% according to rumour, which highlights the michief of this Canadian bank bailout plan. The last large round of preferred share issuances were done at 5%, which gives you a sense of what the private sector is prepared to charge the domestic banks for 5 year capital.

For CMHC, one will assume they turn around and sell these packaged mortgages into the marketplace at, say 4%, keeping the 20 bps for their effort. With the five year Government of Canada bond trading at 2.84%, investors looking for a Crown-backed bond will love the yield.

The federal government has the opportunity to increase the capital flowing out of the Business Development Bank of Canada (“BDC”), and it will be interesting to see how they respond to the difficult climate for business credit. Will new loan volumes drop, as they have at other institutions, or will BDC fill the holes left by other capital providers with increased deal volume?

But where does that leave the rest of the non-bank private sector?

U.S. Representative Barney Frank was on CNBC last week, reminding U.S. bankers that their U.S. Government-provided capital was to be used solely to lend into the marketplace. Politicians in Canada will be returning to the House of Commons on November 18th, and you can expect to hear a similar refrain. “We freed-up all of this capital, now get to work.”

If policy makers are trying to stimulate the economy, they shouldn’t ignore the rest of the private sector lending universe. If you reduce our cost of capital as well, we will have a chance to put more money out than we otherwise would. But to grease the skids solely at the banks is a market-distorting event.

And Canadians wonder why their banks have a lock on the marketplace….

MRM