BDC offside OSFI's prudent lending guidelines

Don’t do as I do, do as you’re told.

If you are a Canadian lender, you might be forgiven for thinking there are two rule books. For the regulated banks, such as BMO, Canadian Western Bank, or RBC, the regulatory screws are tighter than they’ve ever been. But if the taxpayer is your shareholder cum safety net, however, you’re still living in the 90s.

As Basel III capital rules become the norm in Canada, one of the byproducts of these tougher criteria relates to the length of loans that OSFI believes are prudent for Canadian banks to be providing to their commercial clients. Five years ago, for example, an Ontario manufacturer might be able to swing a 7 or 10 year term loan to buy some new equipment or acquire a business.

Not any more.

According to the lenders I’ve spoken to, OSFI thinks 7 years is too long a loan term under Basel III, and that an average life of 5 years (per deal) should be the outer-limit for commercial bank loans going forward. The guideline is “enforced” via the amount of capital that a bank is required to set aside for loans where the term itself exceeds 5 years. The higher the capital reserve required by the regulators, the less profitable the loan is for the lender. That doesn’t mean a commercial mortgage can’t have a 15 or 20 year amortization period; just that the bank now finds it uneconomic to lock itself into a term beyond 5 or 5.5 years at a time.

Unlike residential mortgages, oddly, which are still available for terms of 10, and even 25, terms.

With rates at generational lows, you can imagine why an entrepreneur would want to lock in a business loan for 7 rather than 5 years. Certainty of funding, in terms of both cost and length, are integral elements in the analysis that any business owner brings to bear. Whether the investment is $100k or $5 million. Knowing that your bank loan won’t come due for an extra two years makes it much easier to sleep at night. The interest rate can be either floating or fixed, but it’s the loan’s due date that makes a CFO worry should the economy turn sour just when the loan comes up for renewal.

As the Federal government’s regulators move to “protect” shareholders, CDIC and the financial system by (essentially) reducing the length of commercial term loans, what is the government’s own bank doing? Just the opposite, according to the financial statements published by the Business Development Bank of Canada.

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:

BDC Loan Maturity date Over 5 Years:
2008: 65%
2012: 74%

What was going on at TD Bank you might ask? They’ve been putting out the small business loans, but with far shorter terms. Between 2009 and 2011, for example, TD’s small business loan book grew from $34 billion to $57 billion.

BDC is forever telling MPs they’re doing God’s Work out in SME Land, but TD’s small biz loan book grew 68% over two short years — far faster than BDC. Ironically, BDC’s loan growth entirely relies upon 5+ year term loans…a product the Canadian chartered banks no longer have access to under Basel III.

Last March, Finance Minister Jim Flaherty decided the time was nigh for OSFI to regulate the Crown’s mortgage bank, CMHC. From Bay Street’s perspective, this move was a reaction to CMHC’s newish habit of providing ultralong 35 year mortgage terms (see prior posts “Canada’s housing bubble – time to take away the punch bowl” Dec 23-09, “Canada’s housing punch bowl still serving, 12 months later” Dec 15-10 and “Ottawa tightening mortgage rules — better late than never” June 20-12). I guess the risk was just too much to take for the government benches.

And yet, compared to BDC, CMHC is a profit machine. Last year, for example, CMHC earned $1.5 billion of net profit, after $553 million of income taxes. BDC, on the other hand, spun a profit of $533 million, after paying no tax (but did send about $54 million in dividends to the treasury).

Since BDC is growing its loan book using loans terms that OSFI won’t allow at regulated banks, one has to wonder how long it will be before Ottawa shifts BDC under OSFI’s regulatory umbrella, just as it did with CMHC. BDC’s ultimate safety net is the taxpayer (as shareholder), of course, but so too is OSFI’s and the chartered banks, as we saw in 2008/09 (see prior post “Canadian bank bailout total touches $186 billion” Dec 2-10).

The freemarketers in Ottawa can’t feel good about their own bank dodging the very prudent lending rules that apply to the publicly-traded crowd. Given its relative size, CHMC was naturally the first one to be added to OSFI’s jurisdiction. But if BDC’s not following the rules, how long will it be before they join the list?

MRM
(disclosure – #1: this blog, as always, reflects a personal view and is not meant to represent the views of the TPA, its Board/Staff or the federal government; #2: we own shares of several Canadian banks in our household)