BDC pitches Senate on lending in Mexico and England

There “Bruce” goes again.

There may be times when you think I’m a bit tough on the Business Development Bank of Canada. I see the role as simply one of shining a light on the daily grind of one of Canada’s most visible Crown Corporations, using information garnered from their financial statements and public utterances.

Today’s post is merely another in that series, with the BDC’s own testimony at the Senate of Canada Banking, Trade and Commerce Committee serving as the exhibit. It seems Canadian entrepreneurs can’t get enough financing for their offshore operations, despite the excellent work being done by Export Development Canada. In particular, firms that are trying to build plants in Mexico or hotels in England sometimes find it inconvenient to borrow in Canada, and put that money to work in their foreign subsidiaries.

You might ask yourself: what is surprising about that?

A Canadian business doing a greenfield start-up via a new subsidiary in a foreign country may well have problems raising local debt capital to get things started. Although there are plenty of banks to call on in England or Mexico, it may well be that the lack of operating history in those jurisdictions makes it hard for a local bank to provide even a few million dollars, in the hopes the new venture works out.

Obviously, if the Canadian company has incremental debt capacity at home, it can raise additional capital and fund the foreign growth that way. After all, it is the business acccumen and experience of the Canadian entrepreneur that provides any lender the comfort they need that the new foreign venture is a viable idea.

In the eyes of the BDC, this is a hassle for SME entrepreneurs and should be fixed. At the present time, BDC’s legislation is written in such a way that it can’t lend directly to a Mexican subsidiary of a Canadian company; it can only lend to the Canadian company, which would then redeploy that capital to the foreign sub. Nor can BDC provide new direct debt capital in exchange for security via a direct commercial mortgage on a property based in Mexico or England, for example.

This is something BDC’s CEO Jean Rene Halde would like to change, according to his October 20, 2010 testimony at the Senate of Canada:

Mr. Halde: In global supply chains today, larger companies like to have their suppliers close by. Think of a company that is manufacturing bearings in Canada. They are being asked to open a plant close by to this enormous Magna facility so it can provide bearings quickly. That Canadian company comes to us, and we can help them to finance the subsidiary, but technically we can finance it only through their Canadian corporation and not the subsidiary.

Senator Moore: You are talking about a subsidiary and this bearing company you talk about is a free standing company, not a subsidiary.

Mr. Halde: That is correct. It is not a subsidiary.

Senator Moore: You can deal with them but if the supplier, the bearing company, is a subsidiary of Magna, then you have to go through Magna. Otherwise, you can deal with that company directly.

Mr. Halde: Let me try again. In my example, the supplier has nothing to do with Magna. It is a Canadian company that manufactures bearings. They want to establish a premise in Mexico so that they are close to their large order giver. They want to create a subsidiary and to buy a plant so they want some real estate to be financed in Mexico. Under the existing act, BDC cannot take a mortgage on the facility in Mexico and provide them money directly for their plant in Mexico. BDC can provide money only to their operation in Canada because that is the only way to do it under the act. Their Canadian company then becomes leveraged, and they basically funnel the money down for the plant in Mexico.

Senator Moore: BDC can provide funding to the Canadian supplier but not to its subsidiary.

Mr. Halde: That is correct. You have said it perfectly. Thank you.

Senator Moore: Thank you.

Senator Massicotte: I believe we understand. You can do it with a Canadian corporation but not with a foreign corporation. I suspect that the only reason the Canadian company would not want the loan directly is that it does not want to guarantee the loan. It wants the loan to go directly to the subsidiary so that it can avoid the risk of guaranteeing the loan. If that is so, why is it good for the BDC? If the bearing company does not want to take the risk, why would BDC want to take the risk?

Mr. Halde: In this example, we are happy to take the real estate in Mexico as part of the guarantee. We might ask the parent company in Canada to provide additional guarantees until we are satisfied that we are properly covered. Currently, we cannot consider anything.

Senator Massicotte: Why would the Canadian company object to that if it’s prepared to give the guarantee wholly? It must do it directly.

Mr. Halde: Every circumstance is different, and in some cases it is simpler. I will give another example. Not long ago, there was a relatively large hotel chain in Canada that wanted to open a hotel in England. We would have been happy to help them directly to deal with that piece of real estate in England but instead of that, we had to get them to more or less remortgage some of their property in Canada so they could access the funds. They then transferred those funds to the European facility. In some cases, we have to take unnecessary extra steps.

Senator Massicotte: Are you allowed to provide a loan to a Canadian company with offshore security?

Mr. Halde: We cannot take it offshore.

Senator Massicotte: You cannot take it offshore.

Mr. Halde: That is what I am talking about.

Senator Kochhar: Is that not a function of EDC, or you are trying to compete with EDC to put them out of business?

Mr. Halde: EDC is a capable organization, and we work them. Both have areas of expertise and we collaborate well. In cases where they are more equipped to handle something, we are happy to make the referral and vice versa. What we care about is that the entrepreneur gets what he needs.

This new foreign mandate angle raises many Public Policy and risk management questions which should matter to every taxpayer in Canada, since BDC is, after all, working with our money:

– with Canadian banks already operating on the ground in Mexico, why is BDC particularly focused on that country? Didn’t Scotiabank and others invest billions and build alliances with local Mexican banks for the specific purpose of taking advantage of the increased southbound Canadian business trade that would result from NAFTA?

– what expertise does BDC have with taking collateral and perfecting security in a foreign land, such as Mexico? When doing so, how do they comply with Canada’s Financial Administration Act? Under Part X of the Act, BDC is required to “Maintain financial and management control and information systems and management practices that provide reasonable assurance that its assets are safeguarded and controlled.” Given the evolving maturity of local commercial law in most Mexican regional jurisdictions, how can BDC assure the Auditor General of Canada that lending in Chihuahua is the same as Chicoutimi?

– in our experience, and we’ve witnessed this first hand, most small Canadian businesses that open a plant or factory in Mexico do so with a local joint venture partner. To take make a loan and receive direct security over the foreign subsidiary, BDC would need the written and enforceable consent of the local Mexican entrepreneur — whether he’s a minority or majority shareholder in the JV. That’s a very different circumstance then BDC’s traditional lending standards in Chicoutimi or Calgary.

– why exactly, since Mr. Halde raised the example in his Senate testimony, is BDC helping a Canadian “hotel chain” build sites in England? Does a hotel chain sound like a “Small and Medium Enterprise” to you, which is supposed to be the focus of BDC’s efforts? Not that I’m against growing the British tourism industry or creating jobs in Liverpool, but one has to wonder what’s that got to do with growing the Canadian economy? As Senator Kochhar asked himself: isn’t that the proper role of Export Development Canada, if anyone at all?

– why does BDC want to use the Canadian Business Youth Foundation to lend to entrepreneurs on its behalf? According to Mr. Halde’s testimony, the current BDC Act prevents BDC from lending to a not-for-profit organization, which would then in turn, re-lend that money to Canadian businesses itself:

“it would be useful for us to be able to lend money to the Canadian Business Youth Foundation. They are very close to small, young entrepreneurs, and they are very efficient. We would love to be able to lend them the money so they can lend them themselves, versus having to deal one on one with each very small loan that they do. Currently, we have to do it that way. It is not an efficient way of doing this. With changes to the act, we could help entrepreneurs to get their money faster and it would be more efficient.”

Mr. Halde, in essense, admits that BDC is now too big and chasing too many whales to “efficiently” lend to many small companies, which confirms the intentional growth of their average deal sizes going back to the beginning of Mr. Halde’s tenure as CEO (see prior post “BDC Fact #4” Dec 12-07). Moreover, taxpayers have to ask themselves what suitable collateral a non-profit can provide BDC for the loans they receive. Which is exactly what’s required under the Financial Administration Act.

– In Mr. Halde’s testimony, one of his arguments for allowing BDC to initiate this new lending strategy was so that Canadian businesses wouldn’t become overlevered:

They want to establish a premise in Mexico so that they are close to their large order giver. They want to create a subsidiary and to buy a plant so they want some real estate to be financed in Mexico. Under the existing act, BDC cannot take a mortgage on the facility in Mexico and provide them money directly for their plant in Mexico. BDC can provide money only to their operation in Canada because that is the only way to do it under the act. Their Canadian company then becomes leveraged, and they basically funnel the money down for the plant in Mexico.

From what I know about lending, if the parent company becomes over-levered due to debt being raised for use by a subsidiary, then that’s something to be avoided. Simply, if the overall business can’t support the debt, it doesn’t matter where the debt is held — there’s only so much free cash flow available to service and reduce that debt, regardless of where the debt is parked. Putting debt in offshore subsidiaries, provided by Canadian taxpayers via the BDC, can only make sense if the collateral and business plan supports the concept. The jurisdiction is a red herring, at least to those of us in the private sector.

– the last obvious question about providing commercial morgage money in Mexico is how BDC intends to deal with the environmental issues that may invariably come from the land that the building is situated on. According to BDC’s 2010 Annual Report, “since 2006, we have also complied with the Canadian Environmental Assessment Act, to ensure we do not fund projects that might have a significant adverse impact on the environment. We also have a monitoring process to ensure we continue to identify and appropriately manage environmental risk.” That’s hard enough to do in Canada, but what about the developing world?

Lots of questions, as there always are. But more evidence of the imperialistic and competitive trend underway at BDC. More on the BDC’s Senate Testimony to come….

MRM