BDC's stellar loan loss improvement

Talk about great timing! BDC has reported its best financial results in history, just as MPs are about to consider renewing the Crown Corp.’s mandate.

I have just started to pour through the 2011 BDC annual report, and the one thing that immediately jumps out is the record net profit: $346 million as compared to $6 million in fiscal 2010. How did this happen, you may ask.

Loans grew the usual 9% year-over-year, and the venture side didn’t lose as much as in previous years, but it was a huge drop in loan loss provisions that manufactured generated this record profit figure. Nicely timed to coincide with Parliament’s 10 Year Statutory Review of BDC’s mandate.

As you may recall, BDC’s claim to fame is that they take “more risk” on the loan side of their business than the Chartered banks; the theme is littered throughout every annual report. What’s interesting about these current financial statements is that BDC’s loan book is performing better than many in the chartered banking sector. According to the BDC annual report, the huge drop in loan loss provisions is due to “improved market conditions, the resilience of Canadian businesses and BDC’s rigourous monitoring of its portfolio.” Compare these BDC and RBC results (BDC’s fiscal year comes 7 months earlier than RBC’s but I believe BDC’s 2011 results are comparable to RBC’s 2011 version):

Decrease in loan provisions between 2010 and 2011:

BDC: 62.7% (fiscal Mar. 2011)
RBC: 21.4% (fiscal Oct. 2011)

That’s right. BDC’s portfolio is so healthy that it cut loan loss provisions from $260.7 million in 2010 to just $97.1 million in fiscal 2011. RBC’s view on the economy isn’t as rosy, obviously. The big drop in loan loss provisions, despite the increased size of the total loan book, is where BDC generated most of its 2011 profit. But let’s look at another angle.

Losses as a % of outstanding loans:

2011
BDC: 0.67% (fiscal 2011)
RBC: 0.34% (fiscal 2011)

2010
BDC: 1.96%
RBC: 0.45%

2009
BDC: 2.00%
RBC: 0.72%

As the recession receded, RBC’s annual loan loss provision dropped 52.8%, while BDC’s fell by 66.5%. Got that? BDC’s loan portfolio either: i) improved faster during and post the recession, ii) has become of such high quality (because they are poaching business from private sector lenders) that losses are no longer occurring as they once were, or iii) BDC has guessed wrong on the improvement of their loan book and the economic health of Canadian businesses compared to the Royal Bank of Canada; which means they didn’t reserve enough in fiscal 2011.

Total gross impaired loans as a percentage of the loan portfolio:

Fiscal 2011
BDC: 4.0%
RBC: 0.78%

Fiscal 2010
BDC: 4.7%
RBC: 0.95%

Fiscal 2009
BDC: 4.6%
RBC: 1.02%

What’s interesting about these figures is they show the reverse dynamic. RBC’s total gross impaired loans improved by 23.5% during the period, while BDC’s improved just 13%. Put another way, the number of loans that were in trouble in some way shape or form at the Royal shrank from 1.02% to 0.78% over a two year period, versus 4.6% to 4.0% at the BDC. Which means that RBC’s actual troubled loan book retreated to a greater extent than that of the BDC, and yet BDC’s loan loss provisions in March 2011 had improved faster than RBC’s as of October 2011.

BDC’s actual losses as a percentage of loans improved so much more than the Royal’s between 2009-11, despite the fact that the RBC impaired loan portfolio dropped further than BDC’s. It doesn’t usually work like that. The difference in the figures can’t be explained by the five month lag between their reporting cycles.

BDC’s 2010 annual report claimed that the agency stepped in when the Canadian banking fraternity backed away from the lending market: “we acted as a shock absorber” was one tag line. That they took on deals no one else wanted to do. Had BDC done their usual loan loss provision of 1.96% or 2% as in previous years, reported profits would have been reduced by more than half for fiscal 2011. But that’s not what happened, despite picking up all that allegedly high risk loan business during the credit crisis.

As the economy treads water this year, it won’t be too long before we find out who made the right credit provision call: RBC or BDC. And, perhaps, it may well be that both are right. In that case, BDC will have a hard time claiming that they were doing higher risk loans during difficult economic conditions, while writing off less bad debt (as a % of their loan book) than ever before.

MRM
(disclosure – we own RBC in our household)