Take the Business Development Bank of Canada public

Ten Ideas for 2025 - post #5

Early in their careers, entrepreneurs are invariably too busy to focus on public policy.

When you’re trying to raise Seed capital, hire a team, prove-out your first product and win that pilot customer — all while covering your own rent and maybe raising a family — you’ve got zero bandwidth to attend political fundraisers or ponder how to “fix” the role of government in society. Later, as age and success/failure take hold, you’re likely to be quite animated about all the ways in which you experienced some version of government policy/program failure during that formative life phase.

It could be healthcare delivery, tax policy (see prior post “How Freeland’s capital gains tax changes will harm Canada’s economic future” Apr 30-24), Open Banking (see prior post “What is "Open Banking," and why should we care?” Jan 16-24), government procurement, ineffective Start-up incubators, capital formation, “rent-seeking oligopolies” (a fav complaint of many), risk adverse commercial banks (see prior post “Taking risk can be rewarding, even for a bank” Jan 4-24), the cost of SRED paperwork, bike lanes (see prior post “The Final Word on Toronto's Bike Lane Debate (as if) Dec 1-24) and so forth. Even all of the above!

Is it possible to kill (Ed. note: instead of “kill,” how about “nick” instead?) several of those birds with a single stone if we shook-up our banking sector just a bit?

A lot of politicians yearn for more competition in the Canadian personal and commercial banking space, without ever taking it one step further. Unless these MPs and MPPs can convince JP Morgan (JPM:NYSE) to roll-out Chase Canada, despite HSBC’s recent exit, the only way to boost competition is to create one or more meaningful new domestic banking institutions. Ironically, the opposite trend is underway, as one of the few larger independent banks (Canadian Western Bank {CWB:TSX}) will be acquired by National Bank (NA:TSX) on February 5th (see prior post “Does ‘Courage’ create shareholder value?” Apr 22-24).

No matter how successful fintechs might be, they’re likely just going to nip around the edges over the next decade.

If Canada’s bank regulator OSFI wanted more competition, it could always approve a few de novo bank proposals, as America’s regulators do with much frequency. Between 2021-23, the FDIC approved 29 different applications for deposit insurance — a necessary component of executing a P&C lending strategy. I can’t find similar data from CDIC, but I’m unaware of any new Schedule I Canadian bank approvals over the last four years.

OSFI sure isn’t going to do it without some pressure from on-high, as I learned after just a single meeting with some of their officials in July 2011. As Finance Minister, Chrystia Freeland had every opportunity to encourage would-be bank entrepreneurs to tackle the space, whether they wanted to start a new institution, or acquire an under-utilized existing bank charter (see prior post Careful what you wish for, Tony Feb 13-24). And don’t come at me with stories of regulatory comfort with Telecoms or retail / grocery store chains using bank charters to facilitate branded credit cards — that’s not the point.

The only data point we have about Ottawa’s mood on this topic is that Freeland resigned her post without approving the takeover of Wealth One Bank by Globalive’s investor syndicate, more than two years after she ordered its sale due to “national security concerns.”

How much of that multi-year process is due to unnecessary regulatory burden vs. the necessary optimization of Globalive’s proposed cyber security, business plan or risk management practices isn’t known. What is clear is that CWB was started back in 1998, and it’s a rare occasion when Ottawa approves such business plans. Gone are the days when the Second Bishop of Montreal could pull together 15 investors in 1846 and start what ultimately became Laurentian Bank (LB:TSX).

There are plenty of reasons why the U.S. saw labour productivity grow at more than twice the Canadian rate between 2001 — 2021 (see prior post “Only entrepreneurs can get Canada out of its economic funk” Jan 8-25), but I know that access to capital is part of the equation.

My suggestion to take the Business Development Bank of Canada public on the TSX isn’t a reflection of a grudge (see representative prior posts “BDC snows the Senate” Mar 14-11 “BDC snows the Senate part 5” Mar 18-11), and I know that long-suffering blog readers have heard it all before (see prior post “Time to spinoff the BDC?” Apr 9-07). Simply put, if you want more agile players, BDC just so happens to be the only obvious vehicle available to spur the right type of private sector-owned competition within our P&C banking sector.

Nor can one ignore the compelling argument that governments shouldn’t be in these types of businesses. Some of you may be too young to know the names Bricklin, Massey Ferguson or Curragh Resources, but I’m confident that Petro-Canada, CN Rail and Air Canada will be familiar as former arms of the Crown. Those who were on staff during the Mulroney-era privatization push (circa 1987-92) recall that the only reason why BDC wasn’t cut lose then was because Canada was in a recession by the time we finally got around to the small fry items during the second mandate.

The taxpayers of Canada currently have $15 billion of shareholder’s equity tied-up in a business that produced “core net income” of just $215.2 million for the six months ending Sept/24. Which means that taxpayers borrow $15 billion on a rolling basis to keep BDC in business, and pay maybe 3.3% per annum in interest payments to do so. The price tag on that is $495 million of additional annual federal interest expense (using the 10 yr CDAs), less whatever dividends we get to help defray those costs.

No investor would pay 3.3% in margin interest to earn a gross return of 4.2%.

If BDC focused merely on “filling the gaps,” as required by its 1995 Act, outstanding loan balances wouldn’t have grown five fold — to >$41 billion — over the past 15 years. That’s the good news…the team knows what a normal commercial loan looks like and how to win the deal. To put the size of the bloated balance sheet in context, National Bank had an average business & gov’t loan book of ~$70B as of the end of fiscal 2023; CWB’s was actually smaller, at just $29B.

The Bank of Canada is even open to the concept, so there’s that!

“When services and infrastructure projects are privatized, it is expected that more efficient private sector management will reduce government expenditures. For example, a private consortium may be better able to manage the financial risks involved in building an infrastructure facility, such as cost overruns or the withdrawal of contractors, than the public sector. The key to raising efficiency and lowering costs, however, is competition, not privatization per se. Therefore, the cost savings arising from the privatization of services or public works depend crucially on the terms of the contract. Overall, when structured to improve economic efficiency, privatization is likely to enhance the economy’s performance, thereby producing long-term economic and budgetary gains.”

I know it won’t be easy to turn a fat public agency into something that investors will want to back with new equity. BDC’s 74% expense ratio is too high for a public company, but that can be fixed. Adding a retail business platform is easy now that everyone’s smartphone serves as a branch.

If I was a young and enterprising investment banker, I might pitch Power Corp. on vending WealthSimple into BDC, post-IPO. NewBankCo would benefit from the younger retail clientele base, a differentiated asset management strategy plus a new strategic shareholder. I’m sure there could be pros in taking over Laurentian, even if BDC already has 100 offices across Canada; the age of that tech stack would be high on the list of concerns.

There are clear policy benefits of bringing public funding to private markets, but the under-appreciated corners of the market that BDC puts energy into can be tackled with other government tools. VCAP need not sit on BDC’s balance sheet, for example. What’s worse, BDC has been the most active (direct) venture capital in Canada for far too long. That hasn’t fixed anything — it’s time to try something different. And I don’t mean giving senior staff the keys to any more of BDC’s existing captive VC funds.

At some point, BDC Execs decided to label the institution as “The Bank for Canadian Entrepreneurs.” That’s the right mindset, but just the first step in this journey. The best way for the institution to grow and prosper, and be free to compete with the Big 6 on market terms, is to take it public. The strategy worked when we privatized Air Canada and CN Rail, and there are plenty of ways a government can support early stage firms without owning a bank.

MRM

(this post, like all blogs, is an Opinion Piece)

(photo credit: Bricklayer (A), London, 1950, by Irving Penn)