Could it be that the Banks and Flaherty are both right?

The worst global financial crisis since 1932 was born out of loose lending practices in the subprime market, but that’s not going to stop Canadian politicians from demanding that Canada’s banking fraternity open up the lending tap to the small and medium-sized (SME) portion of the economy as Canada trudges through a global recession.

For their part, Canada’s largest banks retort that they are already doing what they can to do business with “credit worthy” clients. For our own part, I can report that this appears to be true. Our bank (BMO Bank of Montreal) couldn’t be more supportive of us, and our two dozen or so portfolio companies don’t appear to be experiencing attitudes from the Canadian chartered banks that are different than pre-recession 2007.

To be honest, many of us in the SME market have been waiting for the past 18 months for the shoe to drop (via reduced credit for good SME borrowers) and it has yet to happen. To the contrary, some will say. Some of the 6 large Canadian banks appear to still be fighting for market share among many of the SME-type businesses that we interface with.

As a firm, Wellington Financial provides growth capital to expanding firms with (generally) between $10 million and $100 million of revenue. For a commercial lender at a Canadian bank, this is their bread-and-butter. Which is not to say that getting the size of your operating line bumped right now isn’t going to cost you another 100 bps. But with prime rate at 3.5%, and the all-in cost of commercial borrowing at levels I haven’t seen since my career began in 1993, I don’t fault any institution for pricing a deal to suit the times.

Debt has been too cheap for too long. With that now changing, people are whining to their politicians. M.P.s in minority parliaments can’t be faulted for responding to the whining of their constituents, even if there’s a disconnect between the cause and the actual complaint.

The banks have both shareholders, depositors and OFSI to report to, after all, and they plan to still be in business long after we all are dead and gone. Just as the Big 5 banks were in business before any of us were born. Not many commercial borrowers can make that statement.

The great Canadian political sport of “beat up on the banks” might be in full swing, but Finance Minister Jim Flaherty is right to put the heat on them nevertheless. It was just a few months ago when he led the charge to free up their balance sheets by $100 billion (see prior posts “Political expediency trumps free market” November 3-08 and “‘Thawing Credit Market Should Ease Concerns’ – NFW part 2” October 30-08).

And that might have been the problem. Government officials may well have thought they were bending over backwards to help the economy, but in reality they were “just” giving the banks some low cost financing to replace what had begun to be cut off in the summer of 2007 (see prior post “‘Panic’ sets in to the debt markets” July 29-07).

We’ve led $160 million and added 26 new SME clients over the past 26 months or so (100% increase over the prior period), and our cost of capital is no where near as low as the banks enjoy via their CMHC-subsidized balance sheets and overnight “free” cash balances that slosh around in everyone’s chequing accounts. But, rather than moan about their unfair advantage, why not tap into their support network?

Here are two solutions to Minister Flaherty’s challenge. First, make the banks earn your ongoing financial support. Second, develop a program for specialty firms such as ours to be able to access lower cost of capital, just as you’ve done for the chartered banks. Firms such as ours could put out hundreds of millions of new loans in 2009 if you lowered our cost of capital, just as you’ve done for the banking oligarchy.

The banks (particularly BMO and TD) say they’ve experienced loan growth in the SME market over 2004-2008; they’ve even bought ads in the DTM. OFSI can easily test the growth figures, although the claim that they are making credit available to “worthy” clients is obviously a subjective one. I believe them, for what it’s worth, but most voters don’t.

The Canadian Bankers Association blames the captive auto finance firms, the foreign banks and the specialty lenders for whatever “tightness” is currently being felt by would-be borrowers. And the crisis in the start-up and venture capital market only adds to the aura of an absence of capital (see prior posts “Venture Capital Crisis in Canada? ” March 12-08 and “Solving the Start-up & VC malaise part 2 ” February 6-08 and “Deloitte’s study on Canadian VC Crisis is well-timed” December 6-07) in Canada.

The easiest thing for our Finance Minister to do is to tie his ongoing support for the $100 billion emergency CHMC bank relief program to specific targets: demonstrated SME loan growth in 2009 and beyond. The banks have all raised billions of equity and preferred shares over the past few months, so solvency is no longer an issue. If Bank X wants to sell more mortgages to CMHC, and access the cheap ~4% financing that flows from that program, put some conditions on the money.

As for the specialty finance firms that the CBA blames for part of the current capital shortfall, let’s design a program that works for our corner of the market. If Minister Flaherty would like another $500 million of new loans to be put into the SME part of the market in 2009, focus some of the Department’s attention and capital on the very providers that benefit the most from adding new SME loan clients; each new clients means alot more to us than a 100 year old bank with thousands of existing customers.

And with almost 2% of our $125 million fund capital coming from management’s own pockets, we have more incentive to focus on credit quality than any of our friends in the banking industry. As my Dad has written in the past, “the banks spill that over lunch”.

MRM
(disclosure – we own BMO, BNS and TD in our household)