Shadow banking lenders, borrowers left out in cold

TORONTO • Criteria for delivering federal government-backed loans to small and medium-sized businesses during the coronavirus pandemic is excluding a number of non-bank financial firms, potentially cutting off a group of borrowers from support as the economy plunges into recession.

Lending outside the traditional banking sector has surged in Canada over the past decade, yet some private lenders and digital upstarts that have been part of the shadow-banking boom have been shut out of federal partnerships that traditional financial institutions have been granted to help avoid a wave of corporate bankruptcies.

The Canadian Finance and Leasing Association, which represents the assetbased financing, vehicle and equipment leasing industry, has pushed the Department of Finance to “remove the last hurdles for independent finance companies to utilize the Business Credit Availability Program,” according to a recent letter to the group’s members from its CEO, Michael Rothe.

The Business Credit Availability Program (BCAP) is a key element of Ottawa’s attempt to keep smaller companies from disappearing during the COVID-19 crisis, and it uses Crown corporations Export Development Canada and the Business Development Bank of Canada to help do so.

EDC, for example, will guarantee 80 per cent of a new loan or operating line of credit extended to a business up to $6.25 million, leaving financial institutions on the hook for only the remaining 20 per cent.

However, EDC’s terms are not doable for some lenders, which could keep businesses without a relationship with a traditional financial institution from accessing the program. To take part, lenders must have a minimum senior secured portfolio of $100 million in Canada and at least seven years of loan-portfolio results that EDC can review, according to an application form seen by the Financial Post.

Lenders must also reasonably anticipate submitting at least 20 eligible deals a year, be able to pay guarantee-related fees directly to EDC and have a commitment to the principles of corporate social responsibility, according to the form. Furthermore, lenders must be subject to oversight by the Financial Transactions and Reports Analysis Centre of Canada, the federal anti-money laundering watchdog.

So even though Vancouver-based Maynbridge Capital Inc. in February was a beneficiary of a $100-million credit deal with British Columbia Investment Management Corp., a provincial Crown agency, and the assetbased lender has its own anti-money laundering policies, it can’t access the $20-billion loan-guarantee program because it isn’t required to report to FINTRAC.

“If you want to rapidly deploy $20 billion, this is an all-hands-on-deck exercise,” said Stephen Davies, chief risk officer of Maynbridge, which specializes in financing equipment and industrial assets.

The Department of Finance did not answer questions from the Post, but a spokesperson for EDC said the guarantee program currently is open to 112 Canadian financial institutions (FIs).

To deliver it quickly, the Crown corporation began by working with lenders it knew, and has been adding to that list since. “We are following a set list of criteria including the application of our standard due diligence process for all FIs and thus need to ensure that the partnering institution has a soundtrack record,” Shelley Maclean said in an email. “There are no current plans to reduce these requirements.”

The lack of familiarity by government and regulators could be the key sticking point for non-bank financial intermediaries, or shadow banks.

“The big banks and credit unions face tons of regulation, and as a result typically have more access to emergency facilities in crisis times,” said Jeremy Kronick, associate director of research at the C.D. Howe Institute. “Shadow banks do not typically face this same level of regulation and are thus often excluded.”

But the decision on whether to involve shadow banks in the BCAP could boil down to a cost-benefit analysis of not doing so, said Kronick.

Non-bank lending has become a popular source of funding for would-be homebuyers and firms denied loans by big banks or prefer an alternative form of financing.

DBRS Morningstar, the debt-rating agency, said last month that shadow banking in Canada rose to US$1.5 trillion in 2018, compared with US$600 billion in 2010, growth that was mostly driven by money pouring into investment funds that help to bankroll borrowers.

Canada’s shadow-banking system now controls assets worth about half of those owned by regulated banks, compared with about a third in 2010, the agency said. Nonbank financing also “provides an important funding source for the economy and is a valuable alternative to traditional banking,” a discussion paper by Bank of Canada staff observed last year.

To be sure, at least part of that growth has happened outside the watchful eyes of regulators, creating a source of possible risk for the financial system. “Especially in the current uncertain environment,” DBRS said, as “disruptions from nonbank financial institutions could have a widespread impact on the financial system at large.”

One alternative that has sprung up in recent years is funding provided by Canadian financial-technology lenders, which have been left out of participating in the BCAP. Those lenders would like to join the federal credit-support efforts, as fintechs have been allowed to assist relief plans in the United States, the United Kingdom and Australia.

The Canadian Lenders Association, which represents fintech lenders, teamed with Kilgour Williams Capital, a regulated investment manager focused on fintech-originated loans, to propose a $2-billion emergency loan program that would partner with and receive funding from Ottawa. Loans would go to smaller businesses hit hard by COVID-19, but that may not qualify for the BCAP, lack an existing relationship with a traditional financial institution or need more than the Canada Emergency Business Account, which provides interest-free loans of up to $40,000.

“Absent timely financial support, many viable businesses will fail, and those failures will ultimately delay Canada’s overall recovery once the pandemic has cleared,” the proposal warned.

The federal government announced Monday it will expand the Business Credit Availability Program to “midsized companies with larger financing needs,” which will include loans of up to $60 million per company and guarantees of up to $80 million.

But recent small-business surveys done by Lending Loop, a CLA member and peer-to-peer lending platform for smaller firms, found an average revenue decline of 68 per cent, and that 34 per cent of respondents had been rejected or were ineligible for BCAP loans. Only two per cent of respondents said they were approved for BCAP funding.

Lending Loop CEO Cato Pastoll hopes the government will look both at the fact that some businesses may not be well-served right now by the existing support programs and the fact that other countries are using companies similar to Lending Loop to deliver that support.

“Now is the perfect time for government to leverage us,” he said.