BDC Fact #8

In response to a prior post (“BDC Fact #6“, December 7-07), one reader posted a series of insightful questions:

I’ve enjoyed your series on the BDC. Investigations of such government entitities can always be an eye-opener.

The BDC can probably grow its business faster than the RBC since it is backed by the full faith of the federal government, and thereby is blessed with cheaper financing costs than private entities. It can pass these costs on to borrowing customers, undercutting the folks at RBC. No?

Are there numbers showing the cost that RBC would have to pay for issued debt relative to the BDC? Does the BDC indeed offer customers better rates?

To state the obvious, it is impossible for me to know what the average interest rate The Royal Bank of Canada might offer for a loan, and what The Business Development Bank of Canada would do in the same situation. With fees, term and covenants, no two loan proposals are precisely the same. All we have are anecdotes, although I learned from politics that anecdotes confirm what polling firms will ultimately find, and I don’t doubt that the raft of anecdotes we’ve heard about BDC’s lending pricing strategies reflect a broad swath of their book of business.

There is a curious FAQ on BDC’s website that suggests a client should use BDC, even if the BDC charges more for a loan that the private sector:

“Why should I borrow from BDC when I can get lower rates elsewhere?

If you look at your total financing package, and not just the interest rate, BDC is very competitive and offers flexible repayment terms as well as increased levels of financing.”

The first thing that popped into my mind was: if you say you don’t compete with the private sector, why does your website advocate leaving a lower rate private loan for a government-sponsored version?

BDC would say that their term loan book is priced higher than an average bank given what they believe to be a higher risk profile; prime plus 250 is their figure. What that means is that with Canadian prime at 6%, each of their normal term loans will be at 8.50% (they generally don’t price much differently between fixed and floating deals). We lost a deal to them last month, for example, where their loan quote was prime plus 1.25% – half of the spread they claim to be their target.

According to the BDC 2007 Annual Report (March 31st FYE; prime was 6% at the time), the effective yield of BDC’s entire loan portfolio with a term of 4-12 months, the average rate was 7.76%; 1-5 years came in at 7.53%; for loans longer than 5 years it was 7.2%. First determination one needs to make is when these loans were booked, given the prime has been increasing, on average, over the past couple of years.

For the twelve months prior to BDC’s fiscal year end, prime averaged 5.94%. For the two years prior to March 31st, prime averaged 5.29%.

With about $2 billion of loan authorizations a year, and a book of about $8.8 billion, one could assume that close to one quarter of BDC’s book was added in the one year prior to March 31st. But one can’t deduce from the annual report where exactly that loan volume would be allocated without knowing the average life of the group.

It appear clear, from what we see in the market and what you can glean from the financial statements, that the theory that BDC’s book is priced above market is a bunch of hooey.

Your other question surrounded what BDC pays for its debt. With the full backing of the federal government, BDC essentially issues at the same rate that the federal government would: a 3 month T-Bill is issued at 3.92%, where the 3 month US$ LIBOR rate is 5.15% and the Sterling rate is 6.65%. As the best RBC would borrow at right now would be the London Interbank-Offer Rate, there’s an example of the short term cost-of-funds spread between the two organizations. RBC has the benefit of being a deposit-taking institution, so they are able to use the overnight free cash balances of their clients to reduce their overall cost of funds, unlike BDC.

BDC is smaller, as well, so there would be in theory higher technology and similar costs per head. But they also have the wonderful benefit of a lower targeted return at 7.2% versus 15-20% at RBC; but with a lower use of leverage in their financing model the ROE figure should be lower as well.

All-in-all, it has been our experience this year on four different live transactions that BDC’s lending team uses the Government of Canada’s borrowing power to beat the private sector – when they choose to – on price and terms.

That might be great for the borrower in question, as the cost of their loan is reduced. But BDC’s Act prevents it from competing with the private sector, and who among us is a fan of the government crowding out the private sector.

If anyone in Ottawa thinks this is a good idea, a bunch of us would like the government to get into the ATM, car parts, home renovations and gas stations. If the feds intend to compete with the private sector in the lending arena, why not roll-out thousands of government-owned automated teller machines? Canadians have been complaining about those fees, as well. And I wouldn’t mind a break on tires. Why does the government subsidize loans but not tires? ‘Cause one creates jobs while the other is a disposable consumer product? But if someone can’t get to work without tires, they they can’t dream up the next new venture that’ll create those new jobs for the government to finance via the BDC.

More than a few Canadians would like cheaper gas, too. But the government got out of that business in the late 80s when it privatized Petro Canada. More on that later.

MRM