INDY Committee Meeting

STANDING COMMITTEE ON INDUSTRY

COMITÉ PERMANENT DE L'INDUSTRIE

EVIDENCE

[Recorded by Electronic Apparatus]

Wednesday, October 28, 1998

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[English]

The Chair (Ms. Susan Whelan (Essex, Lib.)): I call the meeting to order.

Pursuant to an order of reference of the House dated Tuesday, October 6, 1998, this is consideration of Bill C-53, an act to increase the availability of financing for the establishment, expansion, modernization, and improvement of small businesses.

We're very pleased today to have with us the Canadian Finance & Leasing Association. We want to apologize to both Mr. Powell and Mr. Simmons for not commencing immediately at 3.15 p.m. We thought we would be able to do that, and now it's shortly after 3.30 p.m. and we're still waiting for a few members. But we do have a quorum and we can begin, so I would ask you to begin your presentation, and then we'll move to questions.

Mr. Tom A. Simmons (Chairman, Canadian Finance & Leasing Association): Thank you, Madam Chairman.

On behalf of the Canadian finance and leasing industry, I would like to thank the committee for this opportunity to present views on the Canada Small Business Financing Act, Bill C-53.

My name is Tom Simmons. I am chairman of CFLA and work with Newcourt Financial. I am accompanied today by David Powell, the president of CFLA.

With over 170 members, the CFLA represents the asset-based financing and equipment and vehicle leasing industry in Canada.

As you will see, our submission is presented in several parts. First there's a brief description of the asset-based financing and leasing industry, accompanied by some comparative numbers to illustrate its growing significance in Canada.

The second part addresses Bill C-53, in particular the proposal in clause 13 for a capital leasing pilot project for SMEs. This part concludes with some thoughts on how the government might meet its policy goals for SME financing in a way that combines SME needs, government constraints, and more modern financing techniques.

Finally, there are three appendices. Appendix A, entitled “The SBLA: Four Reality Checks”, summarizes the views of CFLA on the SBLA program in general. In brief, the SBLA is a program that was designed in the early 1960s and remains ill-equipped to accommodate the accelerating evolution in the delivery systems, products, and services of the financial services sector. The program fails to keep up with innovative financing alternatives for SMEs, it distorts SME business decision-making, it fails the new technology test, and it fails to reflect new funding techniques. That, however, is in the past. We want to look forward.

Appendix B is a backgrounder on the asset-based financing and equipment and vehicle leasing industry. The backgrounder outlines our industry, its products and services, and some of the unique advantages it offers to SMEs.

Appendix C is a list of members of CFLA.

First off, I want to briefly describe our industry, a growing financing partner for business and consumer customers. Today we estimate this industry to have a total of over $60 billion in financing in place with businesses and consumers in Canada. The best estimate is that about 60% of the industry's customers are small and medium-sized businesses.

To put these numbers in some perspective, last month the Task Force on the Future of the Canadian Financial Services Sector, in the MacKay report, reported that this industry had total assets of about $50 billion in Canada two years ago, in 1996. By way of comparison, the total assets of the property and casualty insurance industry were reported to be $53.3 billion.

The MacKay report is an important milestone for the CFLA. It is the first formal government report that recognizes the significance of this industry to the Canadian economy.

The last several years have been characterized by a boom in capital spending. In 1997 total expenditures by Canadian businesses on machinery and equipment reached $67.2 billion. We estimate that 20% to 25% of this business investment in machinery and equipment was financed by our industry. This is a significant advance, from 5% or less 15 years ago.

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The members of the CFLA are key partners of Canadian business in general and of SMEs in particular. A revealing analysis of the financing realities of the SME sector was brought to light in the Conference Board study published last fall, entitled What's New in Debt Financing for Small and Medium-Sized Enterprises?. The study highlights two major findings.

First, the size of the business debt financing market targeted at SMEs continues to be widely misunderstood, usually because analysts limit their review to term loans and lines of credit provided by the large deposit-taking institutions. In the process, they capture only about half the financing provided to SMEs. Sources of SME funding are much broader, and one of the main conclusions of the report is that SMEs are being funded by a wide variety of providers of financial services using various innovative products, services, and delivery channels.

The second major Conference Board finding was that while the total business debt financing market has grown, increasing 7% over the last two years to $271.6 billion, growth has been relatively uneven. The bulk of the growth has come from specialized finance companies, which experienced a 31% increase in total business debt financing. The study identifies the specialized finance institutions as heavily represented in the asset-based financing and leasing industry.

These Conference Board findings underline a significant point: the inability of traditional means of gathering statistics and analyzing financial service activity to provide a comprehensive picture of what is actually going on. This phenomenon raises the question of whether the government policy planning process is adequately informed. We wonder whether the government mindset surrounding the SBLA program has been shaped by incomplete information. The program is designed around a set of assumptions that are less and less reflective of today's financing realities.

Turning to the SBLA, CFLA has had a long-standing interest in this program. The association has had the honour of appearing five times before parliamentary committees on the issue since 1994, once before the industry committee in May 1994. On each occasion, CFLA raised concerns about the SBLA program.

CFLA has long been on record as being in disagreement with the SBLA program. If, however, government intends to continue providing an SME financial assistance program, we are here to try to make it better. The position of CFLA should not be misunderstood. Our industry does not seek any form of government financial assistance. Rather, the marketplace offers new ways of structuring financing for SMEs and new, previously untapped sources of financing for SMEs. If governments decide to pursue programs of financial assistance to SMEs, it only makes sense to explore these new structures and sources.

It serves little purpose to rehash the past. For those who are interested, appendix A to our submission presents the deficiencies our industry has identified in the SBLA.

More important, going forward, how do we develop a workable capital leasing pilot project as proposed in clause 13 of Bill C-53? We understand that the program must remain relevant to the needs of small business, move toward cost recovery, and have an adequate accountability framework. We also understand Industry Canada's criteria for success. A pilot project would be successful if it could demonstrate incremental impact on financing and ensure delivery on a cost recovery basis.

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For us, incremental impact on financing means more SMEs getting financing, SMEs getting more financing, SMEs getting access to different financing terms, and more added-value features for SMEs.

From a government risk perspective, a capital or finance lease is virtually identical to a term loan or a conditional sale contract, both of which are currently eligible under the program. Anticipated credit losses on leases are certainly no more than, and are likely lower than, current default rates for loans under the program.

For an SME customer, however, a lease is very different from a loan. We have set out in our submission some of the features that combine to make leasing an attractive business choice for SMEs.

As a first principle, it is essential that a pilot project accommodate the key features that make leasing attractive to SMEs in the first place. As a second principle, a pilot project must also reflect the legal and economic framework of leasing in order for it to be attractive to lessors.

Leasing is structurally different from traditional bank lending. From the perspective of those active in administering lease contracts, a pilot project cannot simply superimpose a bank model on a very different financing product. The pilot project must reflect a rethinking in light of the new realities, not an attempt to force capital leases into an outdated program designed for something quite different.

The industry would have very great difficulty in making a pilot project work without key elements for success being built in. What are some of those key elements?

The flexibility of leasing is a key difference from traditional lending. It allows for payments and payment schedules tailored to SME lessee needs. Leasing often permits technology upgrading to manage obsolescence.

Speed is an essential ingredient of leasing. Leasing systems permit credit decisions to be made in a matter of minutes, often at the point of sale. An electronically based registration, payment, balance tracking, and reporting system is needed to optimize the cost efficiency of the leasing process.

A broad range of permitted assets should be eligible. Limiting the pilot project to certain types of assets is no service to SMEs. At the end of the five-year pilot term, it would be difficult to properly measure success.

A broad range of lessors should be eligible. It has been suggested that manufacturers' finance companies and vehicle lessors be excluded from the pilot project. That would significantly reduce the new capital and credit available to SMEs. At the end of the five-year pilot term, it would be difficult to properly measure success.

Flexible rate formulas are necessary. While SBLA loans are generally tied to the prime rate, most leases are written as fixed-rate transactions. The fixed spread will have to exceed the 3% currently used under the SBLA, because the lessor's real transaction cost is normally greater than that.

Government guarantee transferability will be necessary. Lessors frequently obtain the funding for their leases through asset-backed securities. Government guarantees will have to be compatible with these practices.

Again I stress, leasing is not lending. Developing a capital leasing pilot project is not simply an exercise in substituting the word “lease” for the word “loan” in the legislation and the appropriate regulations. Our industry has the expertise to help policymakers understand how to structure and administer such a program. I would respectfully suggest that our know-how is essential to making it work. In the end, the program has to make business sense for our members. If not, will they use it?

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Again I emphasize, our position should not be misunderstood. Our industry does not seek any form of government financial assistance.

Without the SBLA, it is presumed that SMEs currently qualifying under the program would not otherwise obtain a bank loan. Similarly, in the absence of a satisfactory program, such SMEs would remain unable to obtain asset-based or lease financing.

Our members offer new ways of structuring financing for SMEs and new, previously untapped sources of financing for SMEs. If governments decide to pursue programs of financial assistance to SMEs, it only makes sense to explore these new structures and sources. In this context, the need to level the playing field between loans and leases has to do with creating new opportunities for SMEs.

The leasing industry has demonstrated a remarkable agility in recent years, and a great capacity for creativity, imagination, and custom-designed solutions. In the development, administration, and monitoring of a capital leasing pilot project, this committee and Industry Canada can count on the interest and technical support of the CFLA.

Thank you very much, Madam Chair.

The Chair: Thank you very much, Mr. Simmons.

Mr. Powell, did you have anything to add?

Mr. David Powell (President, Canadian Finance & Leasing Association): No.

The Chair: Okay. Then we'll move right to questions. We'll begin with Mr. Pankiw.

Mr. Jim Pankiw (Saskatoon—Humboldt, Ref.): You said you have long been opposed to the SBLA, the reason being that essentially, if I am understanding you correctly, you're suggesting that the SBLA prevents businesses from leasing. In other words, they could have got access to capital through leasing instead of a loan, but they took the loan because the taxpayer guarantee was there.

Mr. Tom Simmons: One perspective is that—and we have said this in the past—often the borrower or the prospective lessee goes to one of our members before they go to a bank for a loan. If a new start-up business has been in business less than three years, based on our credit adjudication, they're going to be turned down under a capital lease program. So subsequently, if they're turned down, then they would go to a bank to try to obtain a loan for the same asset. So currently the program is biased in favour of lending rather than the capital lease.

Mr. Jim Pankiw: So that's the basis of your opposition to it?

Mr. David Powell: Our opposition early on was based in large measure on the fact that we regarded this as being a government subsidy program of a competing product. The government has since moved to increase the fees.

We have, from day one of our involvement in this, been in favour of a self-financing program. We don't believe a subsidized program is necessary.

It's interesting to note that in the minister's press release of November 1997, when he announced the extension of the program for one year to allow for this period of deeper discussion on the future of the program, the minister said the three considerations for the program's continuation would be that it must be relevant to the needs of small business, it must be financially self-sustaining, and it must have an adequate accountability framework. I think I'm right in quoting him as saying that.

Now, when I look at the backgrounder that accompanied the minister's statement of 23 September introducing this particular bill, I notice that two of the three criteria remain critical objectives, but when it comes to cost recovery, he says the program will move toward cost recovery. So for me and for us, that begs the question as to whether the department believes that the program is being operated on a cost recovery basis. That is a concern to us and remains a concern to us, because we don't believe a government subsidy program is appropriate.

Mr. Jim Pankiw: Neither do I.

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Would you agree with me that access to debt is far less of a problem? In other words, in some cases, businesses have far too much debt. The problem is much more their equity. A far greater, more effective, and direct way to improve their access to financing is to allow them to retain more of their earnings by lowering their taxes.

Mr. David Powell: I'm not sure that we necessarily have an opinion, as an association, on that. Everybody is in favour of lower taxes, as a general rule.

In looking at this specific program, we feel there are a growing number of alternatives. What we tried to show in both our submission and our remarks is that we wonder to what extent the policymakers are fully aware of what's really happening in the marketplace and how new sources of funding and financing are becoming available.

We quoted the Conference Board study, which was co-sponsored by Industry Canada, the Canadian Bankers Association, and us, but there are other indicators that traditional means of finding out what is actually going on are not doing the job.

Anecdotally, the Financial Post comes out once a year with the 100 most important companies in Canada, and they have a listing of financial institutions. Well, in the list of the top 100 financial institutions in Canada in 1987—that is, 10 years ago—six of our members were on that list. In the list in 1997, five of our members were on that list. By our estimation, just in about 12 members, they were probably missing close to $20 billion in financing in Canada today. In fact those members would be in the top 50, but there's no way of tracking and knowing.

I'll give the example of the manufacturers' sales finance companies, such as IBM Financing, Xerox Leasing, and John Deere. These are companies that have major financing programs and are providing credit and capital to small businesses across Canada, and nobody knows about it.

Our annual conference was in Quebec City a month ago. One of our members from Vancouver is a very aggressive young group, and they were looking at acquisitions, so they hired some students to do a survey. They took the Bell CD-ROMs and identified all companies in Canada that had the word “leasing” in their name, in the 15 top markets in Canada. Then they eliminated from that list vehicle leasing, because they were only interested in acquiring equipment leasing companies. Then they looked at companies with portfolios of $100 million of assets and less.

They came up with 232 companies. When I asked him for the list, he said, “Well, all I can tell you is that fewer than 10 are members of your association.” They thought this was intriguing, that there were all these companies out there providing financing.

They then asked the students to do a survey, and they called these companies to ask what they were doing, what business they were in, how much they were lending, and so on. The conclusion was that the average portfolio was between $20 million and 40 million and that the total portfolio of these companies was $4.5 billion. And these companies are nowhere on the radar scope. Nobody knows they're out there. We didn't even know they were out there, and we're in the business.

So when you look at developing a program such as the SBLA, you have to say to yourself, in 1961, when the program was first introduced, it was introduced because of the environment that existed in 1961. Does that environment still exist in 1998?

Mr. Jim Pankiw: That concludes my questions.

One thing you did say, though, that really puts my mind at ease is that everybody is in favour of lower taxes, because if that includes the finance minister, I guess the EI premiums will go down to $1.90 and capital gains taxes will be cut.

The Chair: Thank you, Mr. Pankiw, for your commercial.

Voices: Oh, oh!

The Chair: Mr. Bonwick, please.

Mr. Paul Bonwick (Simcoe—Grey, Lib.): Thank you, Madam Chair.

I have a couple of comments. I agree with you that there are a lot of new, innovative ways to access financing, and I certainly commend your organization for partnering with the financial community in offering more selection to small and medium-sized enterprises.

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Mr. Pankiw has made the statement that there's certainly not a problem in accessing debt for small business. One needs to be a little bit more specific than that. On the issue of accessing debt, one could talk about leases, leasehold improvements, SBLA loans, or any form of financing, but more specifically to SBLA loans, one would have to be extremely naive or completely out of touch with the demands of small business in particular to not recognize that one of their demands is certainly access to capital.

In my riding and as I had an opportunity to travel across the country with the financial review task force, it came through loud and clear on many occasions that there is a certain difficulty inherent to small business accessing capital, both new business and existing business.

Coming back to the need for government intervention or assistance in that regard, small and medium-sized business represents likely one of the most important sections of our economy and is singly, as a sector, one of the largest employers. They're having difficulty accessing capital, given that the mandate of a leasing company or the mandate of a bank is significantly different from that of a government. A bank's single mandate and a leasing company's single mandate is to produce the highest return possible for their shareholders, while we're here to stimulate small and medium-sized business.

So my question to you is, how do you envision a small business loan of, say, $40,000 for a new business start-up or for an existing small mama-papa business in rural Canada competing against your organization, if the track records there do not traditionally qualify for that?

Mr. Tom Simmons: You're suggesting a new small business seeking $40,000 of capital—

Mr. Paul Bonwick: I'm picking a number. They have some requirement for financing.

Mr. Tom Simmons: As I mentioned earlier, the financing could come from a number of sources. You obviously need some seed capital or equity capital to start any business, whether you call that working capital or loans, and you have to secure that from either family members or a venture capital company. There are many venture capital companies across Canada where seed capital can be acquired.

For specific assets, if a new business needs computers, equipment, trucks, etc., our industry certainly tries to satisfy that need. But unfortunately, a lot of our credit scoring systems, for many of our members, will look at a new business start-up, and based on their past experience, in trying to maintain their loss ratios at a certain percentage, they will turn down a start-up type of business.

Having said that, the banks traditionally are not risk-based lenders. Normally, if you meet their criteria, you get a loan from the bank.

However, as David was referring to, we have many emerging members, both Canadian-based and U.S. new entrants, that are in what I call non-conventional funding. Some people call it sub-prime, but sub-prime I relate to people who had debt, defaulted, and are trying to start again—who have a bad credit history. A lot of members who are in non-conventional lending are going to charge a much higher rate in order to finance a computer, a truck, etc., but financing is available, and it's a matter of what price.

Mr. Paul Bonwick: If I might build on that, first of all, you spoke about the many options that are available, and I encourage your organization to continue to offer new and creative ways of accessing capital or financing.

But let's go to rural Canada, to, say, a community of 35,000 or less, or perhaps a community in my riding of 20,000 or 15,000. When they're trying to start up a small or medium-sized business, they're used to traditional main street lenders, schedule A banks perhaps, not so much leasing companies, although it's certainly something for them to investigate and look forward to.

But when they're trying to access capital from traditional main street lenders and they don't qualify, based on some very cautionary lending practices—whether it be the equity that a particular bank might require to start up something or whatever—that's where I see and have witnessed a very important role for the SBLA to play a part. I'm not suggesting for a moment that there's not a similar role for you to play in assisting them to purchase that truck or that computer.

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Secondly, you've said there are alternatives with respect to high-ratio lending if there is a greater risk, based on the fact that there's not enough equity perhaps, or based on the fact that they're not lucky enough to have a large family to draw finances from. By the very fact that you make the statement that these high-interest or high-ratio loans are available, that flies right in the face of a successful small or medium-sized business, because one of the greatest deterrents they might face is excessive cost of capital.

Mr. Tom Simmons: Yes, I agree with you.

If a small businesses is starting, obviously he needs legal and accounting advice, and one of the things we've found in our industry, particularly for small business, is that an outside accountant may say to him, “Try to get as much off the balance sheet as possible. You need a certain amount of debt when you have to go to your bank. But on hard assets, whether it be manufacturing or processing equipment, try to put that in a lease or an operating lease so it doesn't appear on your balance sheet, so then when you go to your bank to get a loan, your debt-to-equity ratio is in better shape.”

So we do provide a role, because we look at the underlying collateral, and if the business has been around, usually for a three-year timeframe, or if we have a personal guarantee, we try to put a deal together. In our industry, which is asset-based, we have the underlying collateral as security for our loan or lease.

Mr. Paul Bonwick: So if I'm understanding you correctly, then, you could in fact see a role for SBLs for capital expenditures if they were for leasehold improvements or a new roof—things that traditional lenders or even leasing companies may not provide—and if they didn't qualify, based on an equity ratio, through traditional main street lenders.

Mr. Tom Simmons: Absolutely. If our members had the guarantee from the SBLA program, capital leasing to start-up business would grow. I don't think there's any question about that.

Does that answer your question?

Mr. Paul Bonwick: Sort of, but it....

Mr. Tom Simmons: But keep in mind, we're not working capital lenders in our industry; we're asset-based lenders. Consequently, if it's a start-up business—

Mr. Paul Bonwick: As with an SBL.

Mr. Tom Simmons: —and if we have an SBL guarantee, we will certainly extend financing, either on a loan or a lease basis, looking at the underlying collateral.

Having said that, the added service that our members provide to start-up business and business that hasn't been around for long is more of an asset management service. We help the small business acquire the assets. We deal with service-vendor relationships, whether it be an equipment or a truck vendor, etc. We help the user specify what the asset should be, what has the best resale value, and what has the lower operating cost.

We work very closely with the user and the vendor of that particular equipment to help manage the asset so that we can realize a higher resale value at the end of the given term of the lease, whether it be three years, four years, etc., which translates into a lower monthly payment.

The Chair: Thank you very much, Mr. Bonwick.

[Translation]

Madam Lalonde, please.

Mrs. Francine Lalonde (Mercier, BQ): This is very interesting. It would have been easier for me to understand if I had a French version, but I know you do not often attend such hearings. I hope a French version will be available next time.

This is my first question. What exactly do you want? Do you wish there was no Act on small business financing and that any pilot project integrate leasing arrangements?

Mr. David Powell: First, please accept my apologies because I did not bring any French material. I fully understand your comments on this matter. Unfortunately, we are only a small organization.

Mme Francine Lalonde: This is exactly why I am not making too much of a fuss about it. Otherwise, I would have.

Mr. David Powell: We still ask you to accept our apologies.

As for the position of the Association on the bill, we have already indicated it in our comments. This is the fifth or the sixth time that we are talking about it to a parliamentary committee. Governments know why, but they did not agree with us.

This is why we decided that, in the future, if the government still wanted to pursue such a program, we would try to ensure that it is offering SMEs financial services dealing with today's requirements, not those of 1961, when the program was first introduced.

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In Quebec—where once again the approach is progressive—the equivalent program includes leasing since at least two years, if I remember well, thanks to initiatives taken in Quebec and by our Quebec members.

Thus, we are saying that if the government thinks it is a good idea to implement a pilot projet at the federal level, we should help ensure that such a project is useful and effective for SMEs and therefore for our members, because if it does not work for our members, then they are not going to offer it to SMEs.

Mrs. Francine Lalonde: Can you tell us more about the Quebec program? It may be helpful for us to know the details.

Mr. David Powell: I do not think the parameters of the Quebec program are very well defined. It relies more on decision-making. You have to submit your case to the SDI or Société de développement industriel du Québec, which will decide if the risk is acceptable to the government. For the time being, it is like the election of the Pope, you do not know what happens when the SDI debates the matter. Up until now, a few applications were approved. But it is clear that the Quebec government is more concerned with the different options available to SMEs.

Mrs. Francine Lalonde: I take it that you favour the implementation of a pilot project.

Mr. David Powell: Yes.

Mrs. Francine Lalonde: Then, I think it would be helpful if you could explain to us how this pilot projet should work.

Mr. David Powell: What we tried to do in our comments as well as our brief, which unfortunately is only available in English, is to draw a list of key elements that the program should include, i.e., the elements that decision-makers should consider when designing the program. Because this is such a complex industry, we are offering our expertise to the Department to help them design an effective program.

Mrs. Francine Lalonde: I would like to know more about that. Of course, officials pull the strings, but they are still accountable to elected representatives here. Thus, we would appreciate having a little more detail.

Mr. David Powell: If I had a copy of a draft regulation or of a draft bill in my briefcase, I would table it, but I think—

Mrs. Francine Lalonde: Do you have one?

Mr. David Powell: No, not yet. It is only in September that we learned of a change of attitude in the federal government. Until then, the message we had was that they were not interested in including leasing in a program made under the SBLA.

The impression one gets is that they are ready to work within the existing rules relating to loans and to try and adjust them in order to include leasing. I know the Conference Board tried to do it as a simple word processing exercise, substituting the term "lease" for the term "loan". This does not work because these are two completely different matters.

Mrs. Francine Lalonde: It is a different rationale.

Mr. David Powell: Exactly. In our brief, we have tried to identify certain elements that we consider essential, such as the flexibility available today with leasing arrangements and the fact that, as a lessor, you can almost draft custom contracts each reflecting the actual needs of the customer. It is not the same with a traditional loan, where there is little manoeuvring space within the loan structure.

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With leasing, if you are the owner of a ski resort and you only earn income six months every year, we can structure the transaction so that you only make payments when you have revenues. We can also match payments to your revenues. Flexibility takes many forms.

Also, if your product is a high technology one, we can, during the term of a lease, allow you to replace your equipment with a new one. For instance, computers often have a useful life of, say, three years. In a five-year lease, you would be able to replace the equipment before the end of the term. You therefore have greater flexibility, which should be included in the federal program, if you want both our members and lessees to find it attractive.

[English]

Mr. Tom Simmons: I have one other point.

The advantage of leasing, particularly when you're projecting a residual value at the end of a four-year term, is that a small business can budget more appropriately in looking at how they are going to deploy that asset in their business. They're going to create an incremental revenue by purchasing and utilizing that asset in their business. By setting a residual in a lease, you can then translate that into a lower monthly payment than you would otherwise have if you were purchasing it and had to pay it down to a zero residual after a four-year term.

Consequently it makes the budgeting for the small business easier. It's almost like a building-block situation, where they're adding another asset and they can forecast the marginal revenue, look at the marginal cost, and then see the marginal gross profit to their business.

Once again, the other advantage, if it's an operating lease—even though we're just talking about capital leases—is that for a new business, most accountants would tell small business to try to structure a lease off the balance sheet so that it improves their debt-to-equity situation. But even apart from that, it's being able to project their cashflow better.

So you're creating an asset at the end of a given term, and members of our industry will make sure that asset reflects the appropriate market value at the end of the given term. Consequently, they can purchase it or we can re-market that asset on behalf of the borrower, and if it's worth more, that money goes back to the lessee or the small business borrower, and they acquire another asset. Many businesses are run that way.

My history is in the automotive and leasing business. Particularly with commercial trucks, a lot of businesses start off with one truck, then they get a bigger territory and add a second truck, a third truck, and they manage their business on an incremental cost revenue compared to the incremental revenue from a new customer, a new territory, etc.

That might give you some perspective as to why leasing is so attractive to small business in managing their business.

[Translation]

Mrs. Francine Lalonde: One last question. In your opinion, would a pilot project help establish that leasing is less costly? The present perception is that leasing costs more in terms of rate and fees than a loan obtained from a bank and guaranteed under the SBLA. Would you be ready to accept a capped rate?

Mr. David Powell: Leasing does not necessarily cost more than a loan. It depends. The real cost to the lessee does not only reflect equipment financing costs, it also includes the services chosen by the lessee, which are added to financing costs. Thus, it is not necessarily costlier.

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Obviously, though, it is not often less costly. It depends on the choice of services and on the choices an SME makes regarding business financing. For instance, if you take a $50,000 loan at the bank, you are told that you have to pay back a certain amount every month for five years. In the case of leasing, this depends on a number of factors. If you wish, you can only pay 10% of the real value during the first year, because you are willing to pay the residual value at the end of the term.

Mr. Simmons mentioned residual value. There is a balloon payment at the end. If, during a period of five years, you only pay half of what you would pay for a bank loan, you should expect a "ballooning effect" at the end of the term. During the first five years, you would have reduced the current costs of your business, expecting you would be capable of making a larger outlay of money at the end of the lease.

Therefore, you are absolutely right, it can be costlier than a loan at the end. This is not necessarily the goal of a small business during its start-up years. If it is, then it would better off getting a loan than taking a lease. Leasing is not for everybody all the time.

The Chair: Thank you, Madam Lalonde.

[English]

Mr. Lastewka.

Mr. Walt Lastewka (St. Catharines, Lib.): Thank you, Madam Chair.

I just wanted to clarify a couple of items. When Mr. Pankiw said you're not in favour of the SBLA legislation as presented, my understanding is that you answered in the affirmative.

Mr. David Powell: Our objection was rather more based on the historical situation with the SBLA. Our principal concern lay in the fact that as long as it was seen to be a government-subsidized program for a competing product that we did not have access to, we felt that was inappropriate.

The government then indicated that they were establishing a self-financing program. That was the indication last year. That went some way to reassuring us that at the very least, the subsidy argument was no longer there.

However, when I look at the backgrounder accompanying the minister's news release of September, instead of saying the program will be self-sustaining, it says it will move towards cost recovery. That raises again the concern that this is a subsidized program. The nature of the subsidy by the government of a competing product is of deepest concern to our members.

Mr. Walt Lastewka: At the same time, the legislation has introduced a pilot program in leasing in order to better understand it and so forth. So you're disagreeing with the pilot program in leasing also?

Mr. David Powell: No, I don't think so. If you can't beat them, you join them.

We have come forward four of five times now to parliamentary committees to express our views on the SBLA. For reasons we don't quite understand, the government has chosen not to follow our point of view. Therefore, we recognize that there will be a program, and if that's the case, we're here to say we believe capital leasing will add to what you have to offer to small businesses, and we're willing to roll up our sleeves and help make it work the best possible.

Mr. Walt Lastewka: One of my colleagues mentioned leasing in the rural areas, and I think he used the example of a town of 30,000. I think it's more far-reaching than that. Leasing beyond financial service areas such as Hamilton and Toronto.... I'll use examples. If you go into parts of the Niagara area, it gets thinner and thinner, and we have to deal with people at central office. One of my problems with leasing institutions is that they're too centred in large cities and not out in the rural areas.

• 1620

Mr. David Powell: All I can say to that is this. First of all, increasingly leasing is tied to the point of sale, as Tom said—vendor financing. That means if you are, say, in a farming community and you want to buy a John Deere product, chances are you will go to a John Deere dealership, look at the equipment, and decide what you want. At that point of sale, the John Deere dealership will offer you financing offered by John Deere Credit, along with the other sources of financing that you might have available to you through your local bank or through other sources. But clearly there is a centralized office somewhere, to which that John Deere credit distributor will report and electronically send the application, and from which it will get a response.

The other thing I would tell you is anecdotal and goes back to our earlier point that we may not be fully aware of what's going on on the ground. You absolutely do know, as members of Parliament. You're in your constituencies every week and you're listening to people on the ground. But this same person from Vancouver who told us about this large number of companies in the leasing business said that the previous week, he had someone in from North Battleford who had a $40 million portfolio, and he was interested in teaming up with them, as well as someone from Kamloops. A lot is happening in smaller communities too, and it's partially incumbent on the customers to start looking around and asking questions.

We're doing the best we can as an association. We're going out and talking up our industry. Part of what we're trying to do today with you is make people more aware of it. But there are a growing number of opportunities, both inside and outside the SBLA.

Mr. Walt Lastewka: I've been a member for five years, and to this point I've had no one come to my office and talk to me about leasing in the constituency area.

Mr. Tom Simmons: I would suggest to you that wherever there is a vendor of equipment throughout Canada, whatever the equipment is, there might not be somebody in your office, but I can assure you that one of the sales representatives of one of our members services every vendor of any type of equipment sold in Canada.

As David said, they may not be there every day, but there's electronic origination out of the high-technology. All car dealerships, wherever they're located, all computer vendors, all heavy equipment vendors, all truck vendors are serviced and are able to provide financing to any customer in their geographic area.

Mr. Walt Lastewka: I'm just making the point—and I want it make it stronger now, after your remarks—that I'm very involved with small business in the Niagara area, and in five years, I have not had anybody from leasing come to talk to me. I'm making that point, and I'm making it strongly, because I work with small business and trying to help small business. There's a problem that needs to be corrected. It behooves the leasing people to be more active with small businesses in communities outside the larger area.

Mr. Tom Simmons: But sir, are you a vendor of equipment? What I just said is that the sales representatives of our industry would be servicing all the vendors of any type of equipment across Canada. They may not in fact be contacting the users of that equipment.

The Chair: Thank you.

Mr. Jones, please.

Mr. Jim Jones (Markham, PC): I have a few questions.

Can you explain something to me? Let's say I want to repair and upgrade my restaurant and I'm paying 10%, which is 3% above prime. Why, from my standpoint, is this not self-financing? You're saying this is not self-financing. If I want to borrow money and I have to pay 10% and I pay my bills, why isn't that self-financing?

Mr. David Powell: I'm not sure what you mean.

Mr. Jim Jones: You're saying the SBLA is not self-financing. I'm saying if I go out and borrow money—

Mr. Tom Simmons: Oh, on a cost recovery basis.

Mr. Jim Jones: Yes. What other costs should be included in there? I am assuming that everybody pays their loans.

Mr. Tom Simmons: Currently, if you're getting a loan from the bank at 3% over prime—and they're also probably charging you the 2% registration fee and the 1.25% administration fee—it would be on a cost recovery basis. But the government is not saying it is full cost recovery at this point.

• 1625

Mr. David Powell: All I was alluding to was being somewhat surprised at the different choice of words. Last year I was reassured by the fact that the minister said one of the three criteria for the program going forward was that the program be self-sustaining. When I look at the news release of September, last month, it says the program will move towards cost recovery. The other two criteria identified are identical in wording, and it just raised a flag to me that maybe what we have understood for the last 12 months—that the program was in fact self-sustaining—is somehow not accurate. That bothers us, so that's why we're putting it on the table.

But I'm not saying necessarily.... I haven't done an analysis of it to know. I'm just relying upon the government's own representations.

Mr. Jim Jones: The other thing is that the small business loans have been around for about 35 years. Let's say we were just going to do a new program. Say it hadn't been around and we were just doing it today. Why would we need it? It appears to me that a lot of product is available and there are a lot of different ways of accessing capital, whether it's a bank or a financial institution, leasing, or foreign or Internet banking. Aren't these areas able to provide this marketplace today? Why do we have to have this type of program?

Mr. Tom Simmons: I agree with you, sir. There is certainly a wide variety of diverse providers of funding for whatever your needs might be. It really comes down to a matter of cost. If someone is in a start-up mode and either a bank or a lessor is going to provide him with financing for certain assets or leaseholds, etc., they're taking a risk, but you can do risk-based pricing. Today you may pay 10% if you've only been in business for six months. Somebody else may charge you 15% or 20%.

So capital is available at a price. To your point, I agree with you.

But it's a matter of what price, as public policy, the government wants new, entrepreneurial businesses and knowledge-based industries to pay. One of the risks of that is obviously the counterpoint that the higher cost you have in a start-up business, the greater the risk of failure. I heard this gentleman refer to that. That's the counter-argument to that.

But money is available for all your needs, whether it be venture capital, seed capital, or long-term financing. Many of our members are in what I call non-conventional funding—lending both in conditional sale contracts and in leasing—on a full range of products. And that's not only for start-ups, but also for what I call the non-prime or sub-prime business, where people have had failures in their business and they're starting up again, and they don't have a good track record. But funding is available to those people at a price.

Mr. Jim Jones: Where is your capital coming from?

Mr. Tom Simmons: For our industry, a lot of it comes through the securitization of loans and leases, so the capital providers in the main come from insurance companies, pension funds, etc. By the same token, many of our members fund from the schedule A banks, the captives, etc. But securitization represents a new source of capital for an industry.

Mr. David Powell: I just want to emphasize the fact that our funding does not come from the public, unlike deposit-taking institutions or insurance companies, which collect premiums from the public. Our funding comes either from banks or from the capital markets, through the issuance of commercial paper or, as Tom says, through securitization.

That has meant that this creation of a new form of funding has tapped into new sources of funding and has made available, all of a sudden, large amounts of capital through our industry to the marketplace. The banks too now are moving towards securitization for the same reason, so that they're not entirely dependent upon the deposit base for sourcing their funds that they pass through.

So we are effectively unlocking a lot of capital that otherwise hadn't previously been available.

Mr. Tom Simmons: Could I just add one point? Securitization is a good source of funds for small business when you have a bank that limits the amount of lending going to any one business, based on a debt-to-equity parameter or whatever else the case may be.

• 1630

When you have a large number of lenders that are like members of our industry—in other words, they lend money and lease assets to small business, and then pool the assets and securitize them—that same bank that may not lend any more money to that small business will in fact invest in the pool of securitized assets, because they've spread their risk.

So primarily insurance companies but also banks with surplus funds have invested in securitizations. It does create more capital available to small business, both in Canada and in the United States.

The Chair: Thank you very much, Mr. Jones.

I want to thank you, Mr. Simmons and Mr. Powell, for being with us today. We appreciate your very detailed presentation. It was a very interesting discussion.

I'm going to suspend for about three minutes while the witnesses exchange places. We have another group of witnesses joining us from the Canadian Bankers Association.

• 1631

• 1634

The Chair: We're going to resume hearings.

We're pleased to have with us from the Canadian Bankers Association Mr. Alan Young, vice-president of policy; Mr. Gareth Powell, senior manager of Scotiabusiness products at the Bank of Nova Scotia; and Mr. Robert Heisz, vice-president of financing products at the Royal Bank of Canada.

We would appreciate it if you would give us your presentation first, and then we'll ask questions, I'm sure.

So I'll turn it over to you, Mr. Young.

Mr. Alan Young (Vice-President, Policy, Canadian Bankers Association): Madam Chair and members of the committee, thank you for inviting us to appear before you this afternoon. Our opening remarks are quite brief.

We appreciate the opportunity to discuss with you our views regarding the proposed replacement for the Small Business Loans Act, the Canada Small Business Financing Act.

• 1635

Through the SBLA, in partnership with the Government of Canada, Canada's banks have been able to lend to small businesses that have risk profiles above the level to which a low-risk lending institution such as a bank can lend. Ultimately this program is about risk-sharing for those small businesses that would be less likely to qualify for bank debt financing.

It is important to remember, however, that irrespective of a higher-risk profile, policy guidelines at the banks require lenders to underwrite SBLA loans with the same standard of care and due diligence that is applicable to other underwriting.

Throughout the comprehensive SBLA review process that has taken place over the past year, Canada's major banks have consulted with Industry Canada officials on major issues concerning the existing program and its future. In principle, Canada's major banks support the provisions in the new proposed Canada Small Business Financing Act. As the members of this committee may be aware, many provisions that currently exist in the SBLA statute itself have been moved to the regulations under the proposed CSBFA. The draft regulations were tabled with this committee on October 22 and were at the same time distributed to other stakeholders, such as us.

Although we had a limited opportunity to study and really analyze and assess the impact of the regulations, we will briefly highlight some areas of concern that we do have. However, the main focus of our discussion with you today is on the statute, as we're aware that you have to report back to the House on the statute itself. We have provided you with some proposed amendments to the statute, which I would like to go through with you momentarily.

Over the coming days, Canada's banks will be working with Industry Canada officials to clarify and hopefully to change some of the aspects of the regulations under the CSBFA. We'd like to highlight for you four potential areas of concern that may adversely impact on the ability of small business to obtain financing under the proposed legislation or restrict the ability of lenders to provide CSBFA financing.

The four issues are as follows: the prohibition of financing for existing leasehold improvements, issues concerning related borrowers, borrower security requirements and due diligence requirements, and reporting requirements.

Madam Chair, those were our very brief formal opening remarks, but I wonder if it would be helpful to committee members if we briefly looked at the proposed amendments we have provided to you so that we can provide you with a brief explanation as to the proposed changes. Following that, we'd of course be delighted to respond to any questions that members of the committee might have. Should we do that?

The Chair: Sure.

Mr. Alan Young: Okay. Please turn to the page that's headed, “Proposed Amendments to Bill C-53”. It's a document attached to my opening remarks.

The first is under heading A, “Liability of Minister”, subclause 5(1).

In all of these proposed amendments, you'll see lines through words. What that means is we're proposing that those words be deleted from the bill. You'll also see in some cases words that are highlighted in bold-face type. Those are words that we have proposed adding to the bill.

With respect to subclause 5(1), the deletion and the addition here are simply for clarity and transparency. We believe the phrase we've added, “made under this Act”, is all-encompassing. Therefore it's just a way of shortening it. We're taking a stab at drafting, to help make it clearer.

With respect to subclause 5(3), we've proposed extending the notice period from 24 hours to seven days. The rationale behind this is to make sure the banks have adequate notice to implement any new provisions that may arise. We understand the intent of the subclause, but we recommend that the 24-hour notice period be extended to seven days. This is a logistical issue. It would give time for our members to instruct their thousands of employees who are in thousands of branches and communities across the country to cease lending under the program. We don't think 24 hours is a sufficient length of time to ensure that operations will cease under the statute.

With respect to subclause 7(1), here the change is designed to reflect our belief that the borrower should disclose to lenders any exposure that they have under the program.

• 1640

This particular subclause is linked very closely to the draft regulations, because when we talk about the regulations with Industry Canada officials next week, we'll be recommending that the regulations provide for a signed declaration from the borrower so that the lender under the program will know, from a signed declaration, whether or not the borrower has existing liabilities or exposure under the statute. That's the purpose there. It's a common commercial practice in a commercial transaction to require officers of a company to sign a declaration or a statement attesting to the operations of their organization.

With respect to the next proposed amendment to subclause 9(2), the rationale here is that subclause 9(2) is simply redundant. The language in paragraph 9(1)(b) captures the language in subclause 9(2), so it's our suggestion that you don't need to have subclause 9(2).

Turning now to heading B, “Pilot Projects”, we're proposing an amendment that would indicate that lender participation in the CSBFA does not necessitate participation in the pilot projects. This is simply because the pilot projects have yet to be designed. We don't know what they're going to look like, so we're somewhat hesitant to fully endorse the concepts until we see what the pilot projects are like.

Turning to heading C, “Audit and Examination”, we have a series of proposed changes to make to clause 15, as you can see. In subclause 15(1), we are adding “45 days” of notice, and we're also recommending the deletion of a number of words in this subclause.

Let me clarify right up front that we're not opposing the requirement for an audit and examination. What we are suggesting is that a specified notice period be put in the statute, and we're suggesting that that notice period be 45 days. It's simply a case of wanting to make sure we have adequate notice to comply with an audit or an examination. It's again here largely a logistical issue. SBLA loans might be spread across the country in various branches, and it's a question of the time required to pull together all of the material.

As for the words that we're suggesting be deleted, the phraseology here is simply repetitive.

With respect to the proposed change to subclause 15(2), we're recommending that the words “relating to the loan” be added. This is because of the concern over client confidentiality. We want to ensure that the audit or examination only extends to a customer's CSBFA loan. This proposed amendment would give that added degree of certainty to the statute.

Turning now to subclause 15(3), again here, for reasons of client confidentiality, we want to ensure that all client records remain at the site of inspection. Secondly, in the interest of ensuring that the program requirements are being met and in order to improve performance under the program, we think it would be advantageous if lenders who have been audited or examined receive a report from the minister, detailing the findings of the audit or the examination, so that we'll have an opportunity to understand how things can be done better or differently. So we're proposing that lenders receive the results of the examination or the audit from the minister. We're recommending 45 days.

With respect to subclause 15(4), the banks feel that failing to submit to an audit or an examination is clear and reasonable grounds to deny payment to a lender under the statute. Again, the language that we propose be deleted is, we think, just not necessary.

Turning to our last two recommendations under heading D, “General”, we'd like to see a clause added to the bill that would provide lenders with regular reporting of lenders' positions with respect to the liability ceiling. It's a new concept being introduced in the statute, the concept of a ceiling. As each lender has a separate account under the program, this reporting provision would facilitate better lender monitoring of their activity in relation to their CSBFA portfolio. I understand that the technology exists today in the SBLA program office to provide this, so we're recommending that it be done in the statute.

In conclusion, we'd like to see a clause added that would provide lenders with 90 days' notice to implement changes under the act and the regulations. The reason for this is that many of the provisions in the current statute have been moved out of statute and into regulation, to make it easier and more flexible for the government to amend certain parts of the program and to respond to developments as they might arise. We're simply wanting to ensure that we have adequate notice to implement any changes to the program that might emerge from the government. A 90-day implementation or notice period would suffice. We think it's a reasonable period for notice.

• 1645

Madam Chair, those are our proposed amendments to the statute. We'd be pleased now to respond to any questions you may have.

The Chair: Thank you very much, Mr. Young.

We'll begin questions with Mr. Pankiw.

Mr. Jim Pankiw: Thank you.

The eligible loss of a lender, what is that amount? There's a maximum, right? Do you know what it is?

Mr. Alan Young: Do you mean the portion that the government is responsible for?

Mr. Jim Pankiw: Yes.

Mr. Gareth Powell (Senior Manager, Scotiabusiness Products, Bank of Nova Scotia; Canadian Bankers Association): It's presently 85%.

Mr. Jim Pankiw: Oh, but there's a dollar number that's capped, isn't there?

Mr. Alan Young: The maximum amount of the loan that can be underwritten is $250,000.

Mr. Jim Pankiw: That's the maximum amount of the loan.

Mr. Alan Young: Yes.

Mr. Jim Pankiw: But is there not a ceiling on the amount of liability that the government has to an individual lender?

Mr. Gareth Powell: Yes. It's approximately 10% of the total loans registered within any given period.

Mr. Jim Pankiw: There's not a dollar amount cap? It's just 10% of the total loan value?

Mr. Gareth Powell: Yes.

Mr. Jim Pankiw: In other words, they're responsible for 85%?

Mr. Gareth Powell: Yes.

Mr. Jim Pankiw: What percentage of loans can go bad on you before you reach that 10%, then?

Mr. Gareth Powell: We're having trouble understanding the question; I'm sorry.

The Chair: I think Mr. Pankiw is referring to paragraph 6(2)(c), which refers to the liability of the minister to pay any lender. I think it's, as Mr. Young already spelled out—or maybe it was Mr. Powell—10% or any prescribed lesser percentage.

Mr. Jim Pankiw: Of the total value of the loans.

The Chair: Did you want to try to clarify your question?

Mr. Jim Pankiw: Okay. I haven't thought this out, but if the maximum amount that is guaranteed to you is 10% of the total value of loans outstanding, and the guarantee on each loan is 85%, then what percentage of loans that you give...?

You know what? Just come back to me. I'll figure it out myself.

The Chair: Mr. Pankiw, just to clarify, the government is responsible for 85% of the loan.

Mr. Jim Pankiw: Of individual loans.

The Chair: Right.

Mr. Gareth Powell: I think I know where he's going.

The Chair: Go ahead, Mr. Powell, if you'd like.

Mr. Gareth Powell: When we advance loans, every loan is registered with the government, and the government keeps track of the total amount of each loan that's registered. Those amounts get aggregated. Over a year, we may register, say, just for argument's sake, $10 million worth of loans. The government will pay out claims totalling 10% of that $10 million. Individual claims will get processed and the government will pay up to 85% of the amount of the claim, and those claim amounts get aggregated and deducted from that 10% of the total loans registered.

So if we have a portfolio of $100 million, 10% of that portfolio is $10 million. So all the claims, at 85%, get totalled up, and the maximum that the bank can claim is up to that $10 million amount.

The Chair: Does that answer your question, Mr. Pankiw?

Mr. Jim Pankiw: Well, sort of, but I understand all that.

I'll tell you what. Let me try to think of how to phrase this, if you'd come back to me.

The Chair: In awhile.

Mr. Bellemare, please.

• 1650

[Translation]

Mr. Eugène Bellemare (Carleton—Gloucester, Lib.): Thank you, Madam Chair. The last group represented leasing organizations.

[English]

They appeared to be absolutely against this project, and they were suggesting that this was a subsidy. Do you feel the banks are being subsidized?

Mr. Alan Young: The program is an effective partnership between lending institutions, the government, and small business. The fact is, many small start-up businesses simply would not be launched without this type of program.

Mr. Eugène Bellemare: Do you feel the banks are being subsidized?

Mr. Alan Young: No, this is not a subsidy program. This is a partnership program.

Mr. Eugène Bellemare: Do you feel the small businesses are being subsdized?

Mr. Robert Heisz (Vice-President, Financing Products, Royal Bank of Canada; Canadian Bankers Association): I can answer that.

I wouldn't classify it as a subsidy. This program is a partnership to encourage new businesses to start up. At the time that many new businesses start up, there are unusual risks in that business, and what the program allows us to do is finance individuals who have other than normal borrowing requirements. Therefore they have the opportunity to set up their business.

Mr. Eugène Bellemare: Do you have any feeling as to why the leasing people may have suggested that this is a subsidy program?

Mr. Robert Heisz: No, sir, I can't speak on their behalf at all as to why they would view it as a subsidy program.

Mr. Alan Young: We walked in part-way through their presentation, and just in listening, it sounded as if their concern was that the program was not a cost recovery program. I think that was lying at the bottom of the concern. But as I understand it, the program is to be a cost recovery program, so that should alleviate their concern.

In addition, I understand their concern was that they had heretofore not been participants in it. As you know, the new statute would set up pilot projects that would incorporate or include lease financing.

That's the best I can do; I'm sorry.

Mr. Eugène Bellemare: On the topic of cost recovery, do you have data on the number of defaults that have taken place, let's say in the last year, in 1997?

Mr. Alan Young: I don't know whether we have it specifically for that, but I do know that the default rate I have seen for Canada compares quite favourably with similar programs in the United States and in the U.K. Our default rate, as I understand it, is about 6%. In the United States, under a similar program, the default rate is 20%, and in the United Kingdom the default rate is around 40%. So our program is functioning quite favourably relative to similar programs in other countries.

Mr. Eugène Bellemare: It appears to be quite a positive record. Tell me, has a study ever been made as to whether or not the defaults come from the same banks, say the Toronto Dominion Bank, for example, or the Royal Bank or the Bank of Montreal or the Banque Nationale? Has the Canadian Bankers Association ever made a list of where the defaults are located, at which banks?

Mr. Alan Young: No, we haven't. I'd be surprised if there were any particular pattern. But no, in answer to your question, we have not done that sort of analysis.

Mr. Eugène Bellemare: Then my next question would be superfluous if I asked which branches.

Voices: Oh, oh!

Mr. Eugène Bellemare: With small businesses, you get the local businessman. For all we know, he could be a local mechanic or restauranteur. When we meet him in our offices, he's a small business person, a one-man show, but often he has up to 10 or 11 businesses going strong. He may own the magasin de patates frites and he may own the rental shop. I suppose everything is incorporated. Do you feel that when a person like this takes a loan for operation number eight or number seven, this is really a bona fide start-up program?

Mr. Robert Heisz: Generally the act is intended to allow up to $250,000 to one borrower. If the associated companies are under the ownership of the same borrower, the act is intending to set out a maximum of $250,000.

• 1655

About the regs, we were saying that the regs qualify this as the borrower or anyone related to the borrower. We couldn't abide by having a maximum for anyone related to the borrower, because the borrower and the borrower's wife may have independent businesses, and the fact that they're related should not restrict one from borrowing for their business when the other person is borrowing for their business. The intent of the act is to help people up a maximum of $250,000 per individual borrower.

Mr. Eugène Bellemare: Per individual, but that person who has seven or eight small businesses and has no loans on any of them could get a small business loan on, let's say, operation number nine that he wants to start up?

Mr. Robert Heisz: He could, yes.

Mr. Eugène Bellemare: Okay, and my last question—

The Chair: Thank you, Mr. Bellemare.

Mr. Eugène Bellemare: Do you think the Business Development Bank of Canada should have the opportunity to get into the small business loans program, and if not, why not?

Mr. Alan Young: The BDC basically exists as a bank for small business; that's their statutory rationale, their raison d'être. The government's policy is that there will be some potential borrowers out there who simply do not qualify for a loan from a low-risk institution such as a bank. Therefore the government has seen fit to provide those particular borrowers, the higher-risk borrowers, with opportunities through the Business Development Bank.

Mr. Eugène Bellemare: My question was very specific; it wasn't that. My question was, do you think the Business Development Bank of Canada should have action in the Small Business Loans Act program?

Mr. Alan Young: Oh, I see. I misunderstood your question. You're asking if they should be permitted to be lenders under the statute?

Mr. Eugène Bellemare: Yes.

Mr. Alan Young: The issue we have there is that the Business Development Bank is a crown corporation, and it's receiving, as I understand, about $50 million per year.

Mr. Eugène Bellemare: So?

Mr. Alan Young: So they're already being provided for by government to provide small business loans. That's one concern we have.

Mr. Eugène Bellemare: You're not in favour, in other words.

The Chair: Mr. Bellemare, thank you.

[Translation]

Madam Lalonde, please.

Mrs. Francine Lalonde: I sent a survey to the SMEs in my riding, as I know other members did. One of the questions asked was whether they thought the SBLA should apply to working capital when there is management advice. Many said yes.

I know we cannot make this change without altering the very nature of the legislation, but my question is this: do you think a pilot project can help us identify the conditions under which working capital loans could be guaranteed though monitoring, giving management advice and helping start-up companies?

[English]

Mr. Robert Heisz: It's a very valid point. If we could design the mechanism from this program to provide working capital loans, there certainly may be a demand for such a loan. The program is fundamentally structured as a term loan facility, centred on financing fixed assets of the business. If you moved from that to current assets, it fundamentally would probably require a completely different set of regulations, it is so different.

So it may be an opportunity to look at it as a separate program, but because this program is built as a term loan program, it would be very difficult to accommodate it under the program, and to administer it fairly.

• 1700

[Translation]

Mrs. Francine Lalonde: This is why I am asking if we can use a pilot project to determine whether we should design a new program and under what conditions. The SBLA, which will have a new designation, provides loans to purchase capital equipment and permanent buildings which are a kind of collateral. As a matter of fact, it should be easier for businesses to get unsecured loans to purchase equipment or buildings than for working capital.

My purpose is not to cause losses but to help SMEs that really need it. So I will continue to press for a pilot project with appropriate controls in this area.

You are not opposed to the idea, but you are saying it takes a completely different program, is that right?

[English]

Mr. Robert Heisz: That's right; it could give rise to a completely different program.

[Translation]

Mrs. Francine Lalonde: Okay. I have several other little questions, Madam Chair.

When you mentioned you wanted to amend clause 5 by striking out the words "in respect of which the requirements set out in the Act and the regulations have been satisfied", you said this was a minor change. However, the regulations are part of the Act, which means that if the minister were to take the regulations out of the legislation, he would be able to change them at will. Are you not trying to keep some negotiating room with the minister by eliminating the words "and the regulations" from clause 5?

[English]

Mr. Alan Young: That's certainly not the intent here. The intent is that the loan in fact would be made under the act—

[Translation]

Mrs. Francine Lalonde: Of course.

[English]

Mr. Alan Young: —because the act creates the ability to have the loan. We're simply saying you could shorten this language quite considerably by saying that the loan is made under the act, because that in effect is how it would work.

In a word, there's no secret agenda here.

[Translation]

Mrs. Francine Lalonde: Oh, but there may be secret outcomes.

About the regulations, you are raising four very interesting points on the first page. You say these are areas of concern. This is why I asked the question, which may have seemed improper to you. I have worked a lot on bills and in negotiations.

When you mention the prohibition of financing for existing leasehold improvements, you are in fact supporting the claims made by restaurant owners, who were testifying yesterday. Is that right?

[English]

Mr. Alan Young: That is a particular concern that we do have under the regulations, and we're meeting next week with Industry Canada officials to try to address those concerns.

Maybe one of my colleagues can explain what the particular concern is.

Mr. Gareth Powell: The issue here is that for a small business that acquires a business as a going concern—say, for example, it's a restaurant—a good proportion, upwards of 50% or more, of the total purchase price of the business is usually in leasehold improvements. By not allowing existing leasehold improvements to be eligible under the program, it now precludes many entrepreneurs from buying existing going concerns, because they will not be able to cover the purchase price of the leasehold improvements under the SBLA financing.

The end result is that we do recognize that leasehold improvements have limited assets in a situation where we have to claim and realize on them, but it's very important that businesses be able to continue to finance all fixed assets of the business under the SBLA program, and not just capital assets, as in equipment.

• 1705

The Chair: Thank you, Madame Lalonde.

[Translation]

Mrs. Francine Lalonde: Is that all?

The Chair: Yes, that is all.

Mrs. Francine Lalonde: You are hard, Madam Chair.

[English]

Voices: Oh, oh!

The Chair: For now, for now.

I just want to let everyone know that a copy of a letter from the CRFA, the Canadian Restaurant and Foodservices Association, based on their testimony yesterday, has been circulated. It's in both official languages now.

Mr. Shepherd.

Mr. Alex Shepherd (Durham, Lib.): Thank you.

Going through some of your recommendations for so-called improvements to this bill, you seem to want to have a 45-day notice in writing regarding an audit. This does away with the concept of what's known in the trade as a surprise audit. Where I come from, the reason people want notice is so that they can put in order their files that may not be in order. Is that one of the intents of this proposed amendment?

Mr. Gareth Powell: No, not at all. In fact when Industry Canada and the Auditor General were reviewing the program this past year, we did have two audits, and the way they conducted themselves was that they gave us a list of the files they wanted to review. They were spread all over the country, and we pulled them together in one location so that they could come and look at them and see the level of underwriting that was done.

We don't really have the ability to preview those files and have customers come in and make corrections to documentations and things like that. They were just looking to confirm the level of due diligence and the level of care that was used to underwrite loans using the SBLA program.

The reason we ask for 45 days is that, in the first instance, we were given just over two weeks, and it took huge amounts of time and resources to be able to pull all those files together, to notify the branches, and to get the files to a certain location so that the OAG or Ernst & Young could come in and look at the files.

Mr. Alex Shepherd: But simplistically put, if I had a list of the outstanding loans and I said I wanted to see your documentation on this particular loan, presumably it's at one of your branches. Why do you need 45 days? Why can't I go and look at it tomorrow?

Mr. Gareth Powell: Well, first of all, loans get transferred amongst different branches and branches get merged, so the branch under which the loan was originally written may not be in existence any more. Secondly, we have centralized locations where we keep security documentation, so we split the security documentation from the credit file and things like that. So it's not as simple a matter as just walking into a branch and expecting everything to be there.

Mr. Alex Shepherd: If the loan went into default, I suspect you could get your hands on the file within a day, couldn't you?

Mr. Gareth Powell: We have credit files that we can look at, but to review the security documentation, we have to go to centralized areas to pull that information.

Mr. Alex Shepherd: Another recommendation you're asking for is to drop a part of subclause 15(4). The stroked-out provision is “under this section or refuses or knowingly fails to comply with any other requirement of this section”. This says, in other words, that the minister may not be liable under the loan if you had not undertaken certain provisions in the regulation. Why would you want to strike out a part that says you knowingly failed to comply?

Mr. Alan Young: We think the subclause stands on its own, without the added language, because if a lender doesn't submit to an audit or an examination, that in and of itself is solid grounds for the minister not to be liable under the act.

Mr. Alex Shepherd: I'm sorry; what does the additional strike-out do, then?

Mr. Alan Young: It simply makes the subclause clearer, that if a lender doesn't submit to an audit or an examination, the minister isn't liable.

Mr. Alex Shepherd: Doesn't it say “or”? The reality is, it says:

Where a lender does not submit to an audit or examination under this section or refuses or knowingly fails to comply...

So you could submit to the audit but in fact knowingly fail to comply with other regulations. Is that what you're asking us to do?

Mr. Alan Young: No, that's not the intent.

Mr. Alex Shepherd: Well, am I reading it wrong?

Mr. Alan Young: No, I don't think you are.

Mr. Alex Shepherd: But it basically allows you to be knowingly in violation of the act, but the minister would still be liable for payments on the loan. Is that correct?

• 1710

Mr. Alan Young: But failing to submit to the audit or the exam is quite clear and reasonable grounds.

Mr. Alex Shepherd: It says “or”, though. It doesn't say “and”; it says “or”.

Mr. Gareth Powell: If you look at subclause 15(3) right above it, it clearly outlines the requirements, the information, and how the financial institution or the lender is supposed to respond in the case of an audit. So subclause 15(3) clearly states what the requirements of an audit would be and what the obligation is on the part of the lender in order to comply with the audit.

Since subclause 15(3) sets out what an audit is and what we're supposed to do, in subclause 15(4) that deletion can be made. If we haven't been able to fulfil the requirements of an audit as they're outlined in subclause 15(3), then we haven't complied with the audit.

Mr. Alex Shepherd: Well, my idea of submitting to an audit is simply that you open your books for examination.

Mr. Gareth Powell: It goes on to say—

Mr. Alex Shepherd: But what if part of the examination were to discover that you knowingly, almost fraudulently, failed to comply with the requirements of this section? You stroked that out.

Mr. Alan Young: Subclause 15(3) requires not just that you open your books; it also requires you to respond to all questions that relate to the audit or the examination. There's a lot of follow-up. It's not just a question of saying, “Here's our file. Go to it.” There is an obligation, under subclause 15(3), for the lender to respond to questions that might be asked by the person doing the audit or the examination, and to provide additional information and documentation to the person doing the audit.

Mr. Alex Shepherd: So if you knowingly failed to—

The Chair: Mr. Shepherd, make this your last question, please.

Mr. Alex Shepherd: I only asked one question.

Getting back to the whole program, there's some concern that the total revenue provision of $2 million to $5 million is unnecessary. In other words, that range of authorization is for people who could get normal bank financing in any case. In other words, the people with $2 million to $5 million of gross revenue are really not small business operators, and they probably could get financing without using SBLA. Do you think that's true?

Mr. Robert Heisz: No, I don't necessarily think that's true. Many small businesses today grow very rapidly in their early years. In their first year, they grow very rapidly, and that is a section of the business that the program is trying to support. With this rapid growth in the first year, even if your projections demonstrated that you were going to do $4.5 million in sales, you would still need the fundamental financing to get your business started. That's what the program helps to do.

Mr. Alex Shepherd: How old would a business be that was generating $5 million in sales—one year old?

Mr. Robert Heisz: I have been granting these loans for 30 years, and I've seen many businesses that go past $5 million in sales in the first year.

Mr. Alex Shepherd: It's an unlikely event.

Mr. Robert Heisz: Well, today, particularly in high-tech businesses, it's not unusual at all. For a young business owner with a new software design who needs financing to set up a business, it's not unusual for the sales to exceed $5 million in the first year.

The Chair: Thank you very much, Mr. Shepherd.

Mr. Jones, please.

Mr. Jim Jones: Thank you.

I tend to agree with the member just before me; 45 days seems excessive to provide the documentation. Maybe 15 days would be reasonable, but 45 days seems excessive.

What is your loss ratio on small businesses that are not covered under this act?

Mr. Robert Heisz: Probably the best answer to that is it depends on the kind of loan program, because programs and portfolios are different. But as reported, losses on small business loans can often average about 2.5% to 3%.

Mr. Jim Jones: And you're averaging 6% on this, right?

You were giving the example of 10% on $100 million. Let's say we write off the 10% in year one and we still have those loans. Those ones that were included in that $100 million are now excluded from any losses in the future?

• 1715

Mr. Gareth Powell: Yes, if we fail to underwrite any more loans going forward. It's a rolling number that moves forward, based on the total volume of loans you underwrite in any given period. So if in year one we underwrote $100 million and we had over $10 million in claims in that period, yes, all other loans, assuming we didn't underwrite any further loans, would not have the benefit of the government guarantee behind them.

Mr. Jim Jones: That's my question.

The Chair: Thank you very much, Mr. Jones.

Mr. Bonwick, please.

Mr. Paul Bonwick: First of all, I'd like to commend and encourage CBA membership for partnering with small business and government. However, I'd encourage the CBA membership to become a little bit more aggressive in small business lending outside of the SBLs. But I certainly recognize that there's a very important role for SBLs in communities, and certainly in rural communities.

I want to touch on a couple of topics, first on the Reform position and secondly on access to capital in rural areas.

It was suggested yesterday and touched on again today that my Reform colleague felt that perhaps this was a way of subsidizing the banks to maintain a presence in small to medium-sized lending for small and medium-sized business. Although certainly there's no evidence to suggest that, I've taken the time to chat with some of the bank managers in my riding, both prior to becoming a member of Parliament and certainly afterwards as well. They suggest that the level of scrutiny the government places on prudent lending practices, to make sure they take place, is such that they don't tinker or embellish the records in order to get something to qualify for SBLA. For the size of the loans they're dealing with, and if you look at the industry in total and the amount of loans, it's just simply not something a bank manager is prepared to toy around with. I'd like you to touch on that and tell us if in fact that's a consensus throughout your membership.

Secondly, in rural areas, do you see the SBLA as a more useful tool perhaps than even in urban areas? There's certainly a lack of access to all these new initiatives, these new sources of capital, which tend to be more concentrated in larger urban centres.

Would you answer those two? And then I'd like to go to a couple of others, if I have time.

Mr. Gareth Powell: In regard to your first question, it's important to note that the banks that the CBA represents utilize the same risk management model and the same decision tools whether the loan is government-guaranteed or not.

What the government guarantee allows us to do for small businesses is push the envelope a little bit in terms of the type, the industry, and the amount of financing perhaps, and to cover off the entrepreneur's lack of experience or the fact that it may be a totally new industry to them. That's what the government guarantee allows us to do.

But in terms of the actual decision, we utilize the same due diligence and the same decision models as we do for the non-government-guaranteed loans.

Mr. Paul Bonwick: Which is quite evident in your reported losses. It's commendable, as we compare ourselves to other models internationally, to see that we're sitting at around a 6% or 7% default ratio, versus your 3%. The differential is not substantial, as in the U.K. at 40%, or to the south. I'm pleased to hear that. And I don't believe for a moment that local bank managers are going to embellish files and create risk for themselves or for their larger umbrella organization, whether it be the bank or otherwise, to compromise a $25,000 or $50,000 SBL.

Mr. Gareth Powell: Actually, the requirements under the program are quite specific. When we go for a claim under the government-guaranteed program, we have to be able to confirm to Industry Canada that, first, the business was eligible, and secondly, the loan requirements met all eligibility of the program. And the files and papers are such that we actually have to have and provide to them the invoices, the assets, that we financed under the program.

• 1720

So there's no real way we can embellish information we receive from a customer in order to provide them financing under the program. And if we were to do that, it certainly wouldn't be in our best interest, nor would it be in the best interest of the small business.

Mr. Paul Bonwick: Could you touch on the question of access to capital, especially in rural areas in Canada?

Mr. Robert Heisz: Sure, I'd be glad to answer that.

You're absolutely right. It is more difficult to access capital in rural areas, particularly in purchasing fixed assets, because very often there's a limited resale for the fixed assets, or else a very specific knowledge within a rural community is required to understand the ongoing value of those assets. With a small business in a small town, for example, you have to have a local knowledge to understand the continuing value of the business.

On government-guaranteed small business loans, I'd like to explain that you're financing a business and you're financing the opportunity to be in business. You're not just financing assets. You're not making a loan against an asset and saying, “The loan will move down more quickly than the value of the asset, and in the end I'm always going to get my money back, because the asset will still be worth more than the loan.” That's not the intent of the act.

The intent of the act is to finance a businessman going into business and to set up a repayment structure that fits the building of the cashflow of the business. In many of the rural areas, that's only available through this kind of program, and you need that local understanding and judgment.

Mr. Paul Bonwick: Okay.

Just to conclude, as I mentioned at the outset, I see it as an extremely successful partnership between your membership, the government, and small business.

I can't speak on behalf of the government, obviously, but I see the rationale for 45 days, based on the splitting of the files and the fact that you might be asked to go down a list and pull together 20 or 25 files from various branches. There's also the level of service that's being delivered on the ground. Do I expect my account manager to drop what he's doing to try to source out other things within 10 days?

The last message I send is that I would still like to see your membership become much more aggressive and raise the bar in small to medium-sized lending, without actually taking advantage of SBLs.

Thank you very much for your submissions.

The Chair: Thank you very much, Mr. Bonwick.

Mr. Pankiw.

Mr. Jim Pankiw: Thanks.

First of all, what I was trying to establish before is, as you had explained to Mr. Powell, the 10% of the total loans value. Of individual loans, 85%—and I was trying to get the number—and therefore more than 10% of your loans, can default before you reach that limit. It's actually 11.7% or 12%.

The point I wanted to make from that, then, is that with respect to prudent lending practices, banks can become somewhat imprudent, because they have such a large availability of loans to default before they reach their ceiling. It's my suggestion to the committee members that that 10% is perhaps too high.

Also, I'm not sure if I heard my honourable colleague correctly or not. When he said “embellishing files”, I'm not sure if he said that I suggested banks are doing that.

Mr. Paul Bonwick: No.

Mr. Jim Pankiw: Okay, good. That's fine then; I won't even go there.

My last question then is, with respect to that 10% cap that you're eligible to get, if you are the Bank of Montreal, does that apply to the entire banking operation—in other words, every branch of that bank in Canada—and therefore, do you as a bank have to pool all this information from every branch? Or does it apply to regions or individual branches or...?

• 1725

Mr. Gareth Powell: The 10% limit, or the 11.7% or whatever it actually works out to be, is on a national basis for a bank. So it's based on the total loans registered for a financial institution—Bank of Nova Scotia, Royal Bank, or whoever.

As for the reason we wouldn't want to see that ceiling drop, well, first of all, we don't make loans to anticipate that they'll ever go bad. If we knew at the outset that a loan was going to go bad, we wouldn't make the loan. And secondly, every time a claim goes through, the bank is, after all assets have been liquidated, still responsible for the 15% that the government doesn't pay us on.

So that's incentive enough for us to first of all make sure we are using the best judgment we can to make the loans correctly in the first place, and then, when the loans do go bad, we do our damnedest to recover whatever we can from the assets of the business so that we reduce the amount of claim that flows through to the government and hence also reduce the 15% that we're responsible for.

The reason that ceiling is reasonable is that it does give some buffer there. As you can see from the industry numbers, we aren't anywhere near that 10%. Depending on the institution, we're at about 4% to 6%. So it's not as if we would ever expect to go up that high, but we certainly need that sort of comfort there. It's just a standard formula based on the total loans that are registered. And I don't think Industry Canada has a problem with that formula either.

Mr. Alan Young: Can I respond to the statement about banks being imprudent lenders under the statute? I'd just like to say that's not the case. Banks are prudent lenders under SBLA. The same procedures and the same due diligence apply to the evaluation of an SBLA loan as would to others. So I just wanted to—

Mr. Jim Pankiw: What I said, or at least what I meant to say, is that because that ceiling is far higher than what's even being used, there's an opportunity to alter the bank's view of a risk-benefit ratio. There seems to me to be some incentive there, possibly, to allow banks to say, “Well, we're not reaching that”....

It's obviously not happening, but if it's not happening and the ceiling is not being reached, why is the ceiling that high? That's all I'm saying.

Mr. Alan Young: A bank wouldn't lend to a small business in order to see that small business fail. That's not what a banker has in mind when he or she lends money.

Mr. Jim Pankiw: Well, now hold on a minute. Because that program is there, you're lending to businesses with a higher risk-benefit ratio than you would have had the program not been there.

Mr. Alan Young: Yes. That's the purpose of the program.

Mr. Gareth Powell: There's another point you should keep in mind too. When we do lend to a small business, let's say in the case of my financial institution, the SBLA loan represents one of a number of facilities we have granted to that company or business. In the vast majority of cases they'll also have an operating line of credit and maybe some kind of leasing product with us or whatever. So when a business goes belly-up and we're forced to claim on the government-guaranteed facility, there are also other facilities that the bank is at risk for.

Obviously we don't want to see businesses fail, but it's nice to have that buffer in situations where we perceive, when we initially underwrite that loan, that that added comfort is required.

The Chair: Thank you.

Thank you very much, Mr. Pankiw.

Mr. Lastewka, please.

Mr. Walt Lastewka: Thank you, Madam Chair.

I appreciate some of the comments you made and the amendments you made on the bill, and of course that's what this procedure is for. Except a couple of the items you wanted to change are accountability items, in my view.

Why did you decide to delete subclause 9(2)?

Mr. Alan Young: Our reading of subclause 9(2) is that the intent is picked up in paragraph 9(1)(b).

• 1730

Mr. Gareth Powell: Part of the problem too under subclause 9(2) is that it states, “in respect of all loans made by it”. In full, the subclause reads:

The Minister is not liable to make any payment to a lender in respect of any loss sustained by it as a result of a loan made by it unless a lender has, in respect of all loans made by it, paid to the Minister the annual administration fee in accordance with section 12.

What that means is if we miss paying the fee on one loan, we've eliminated the government guarantee on our whole portfolio.

Mr. Walt Lastewka: Oh, I could understand that change, but I think the message there was, if you haven't reported and you haven't paid a fee on a loan, you shouldn't be able to make a claim on it.

Mr. Gareth Powell: And that's covered off in paragraphs 9(1)(a) and 9(1)(b).

Mr. Alan Young: Paragraph 9(1)(b) requires compliance with the act and with the regulations, so it's covered off already. That's our interpretation of it.

Mr. Walt Lastewka: Okay.

Mr. Alan Young: We've had some lawyers have a look at it, and our lawyers and your lawyers will look at it, and they may agree or they may not.

Mr. Walt Lastewka: Yes, too many lawyers.

Voices: Oh, oh!

Mr. Walt Lastewka: I want to go back to the 45 days in subclause 15(1). I think that's very unreasonable. I understand that one or two days is not enough, and I understand having to retrieve files and so forth, but I, for the life of me, can't understand why it should be more than seven days.

Mr. Gareth Powell: On behalf of my financial institution, I handled both the Auditor General audit and the one that was commissioned through Industry Canada and conducted by Ernst & Young.

For the Auditor General audit we were given two weeks. From the time I received the list, I had to get communications out to branches right from B.C. to eastern Canada; the files had to be brought in to me, because they wanted them all centralized in one location; I had to review the files to make sure that I had the right files and to make sure they were the SBLA files; and some couldn't be located, so we had to scramble. Really, we had two weeks, and it took all of two weeks, 100% of my time, and intense cooperation on behalf of our branch network in order to get together the information that the Auditor General had requested. So maybe 45 days is too much, but certainly two weeks was too tight, because it just required too much effort to pull so much information together in such a short period of time.

We have a vast branch network. It's right across Canada. It's not like I could walk down the stairs to a branch and access that information.

Mr. Walt Lastewka: I suppose it could vary depending on whether the audit was to be all-encompassing or for two or three files.

Mr. Gareth Powell: Our bank had the most of any bank that was asked in the Ernst & Young audit. I think it was 24 files that they asked for. The nature of them being spread right across Canada and how we separate our security and have our credit files, and we have to make sure that we have all the information.... They wanted to see everything, so we had fire insurance registrations, all the security documentation, etc. Everything was there.

We came through the audit well. We're not afraid of an audit by any means. We just need some time to pull the information together so that the audit is useful and meaningful for whoever is conducting it.

Mr. Walt Lastewka: So 21 days would be much more reasonable, right?

Mr. Alan Young: It would be more reasonable than no notice.

Mr. Walt Lastewka: So if you had a choice between no notice and 21, you'd probably pick 21?

Mr. Alan Young: Absolutely.

Mr. Gareth Powell: Yes, sir.

The Chair: We need to hear what the department has to say about 45 days, Mr. Lastewka. I think that's a wonderful suggestion, but I can't wait to hear the department's response.

Mr. Walt Lastewka: This is for questions and answers, not final changes.

The Chair: I just can't wait to hear the other side.

Mr. Walt Lastewka: Could you go back and explain something under your section D? You say the banks would like a clause added to the act that would provide lenders with 90 days after receipt and so forth. You refer to subclauses 5(3) and 15(1), and I just can't follow what you're saying about subclause 15(1).

Mr. Gareth Powell: Okay. The issue here is that this document sets out various terms for what notice is. What we've proposed as notice for an audit or examination is 45 days. For when the minister is advising a financial institution that they're no longer able to grant SBLA loans, we're saying that would be seven days.

• 1735

We're referring back to those subclauses because those are the two other spots in this bill where a timeframe is related to notice. That's why we have that mapping back to subclause 15(1) and and the other subclause that outlines when the minister can eliminate his liability.

Mr. Walt Lastewka: Thank you, Madam Chair—before you cut me off.

The Chair: Thank you very much, Mr. Lastewka. I wasn't going to cut you off.

[Translation]

Madam Lalonde, please.

Mrs. Francine Lalonde: Thank you. I have more questions about the areas of concern that you have regarding the regulations.

Your second point deals with security requirements. Would you explain to us what exactly concerns you in the regulations? And, as a subsidiary question, do you think it is better to have a 25% limit or to leave things as they are now?

[English]

Mr. Gareth Powell: Are you referring to where we raise comments about the regulations?

Ms. Francine Lalonde: Yes.

Mr. Gareth Powell: Okay.

[Translation]

Mrs. Francine Lalonde: You mention the CSBFA regulations. These are the four points on the first page of your brief. I have already asked a question about the first point, and I would now like to turn to the next three.

[English]

Mr. Gareth Powell: On the issue of borrowers' security requirements, we aren't questioning whether the guarantee from the individual should be 25% or some other amount. The issue here really is that this program is being broadened, in that whenever we finance assets outside the SBLA program or under the SBLA program, the security should be of equal ranking and the same security. That can cause a problem for us.

The original SBLA program actually did require us to take what we finance as collateral, and the reason it didn't stipulate whether we should take additional collateral or all assets of the borrower was so that the borrower and small business could leverage the remaining assets they needed for other such credit facilities, such as operating lines and things like that.

[Translation]

Mrs. Francine Lalonde: This is important, Mr. Lastewka.

[English]

Mr. Gareth Powell: We have run into situations in the past where branches have taken all assets of the small business to support the SBLA loan, and then six months, eight months, or a year down the road, the small business person comes back and asks for an operating line. If we have all business assets supporting the SBLA loan or this facility, it really restricts the business in leveraging those assets to get those other lines of credit that they need to continue financing accounts receivable or to acquire additional inventory.

[Translation]

Mrs. Francine Lalonde: I think this is an extremely important aspect because instead of making it easier to access capital, this provision makes it more difficult to get other loans at the same bank or it forces a small business to go to another institution which will charge a much higher rate. I think we will have to talk more about that.

My third question deals with due diligence requirements and the issues concerning related borrowers. This is your third point.

[English]

Mr. Robert Heisz: In the borrowers' security requirements, there have been some changes in the regulation that would make it prohibitive for many borrowers to borrow to finance leasehold improvements. We already covered the existing leasehold improvements, but there is a section in the regulations that requires that the lender obtain a waiver from the landlord and take security on leasehold improvements.

This is almost impossible. Most of the leaseholds are attached to the property, and landlords refuse to provide a bank with this release to have the security that would allow it to, in the event of liquidation, go in and remove those particular leaseholds. Very often it's carpet, or it could be anything attached to the walls. It would be impossible for businesses.

• 1740

Interestingly, one of the areas where the program helps small business to a great degree is in financing leasehold improvements. This would remove the ability of the act to finance leasehold improvements.

[Translation]

Mrs. Francine Lalonde: What about your third point? What does "due diligence" mean?

[English]

Mr. Gareth Powell: It was actually a very big surprise to me that this change came through in this bill.

If we were to finance this glass under the program or if we were to finance this glass under a bank-risk, non-government-guaranteed program, we agree that the same due diligence should be applied in terms of assessing the risk, assessing whether it's a good asset to finance, and assessing whether the business itself is a good risk.

The advantage of financing it under the SBLA program in the past has been that if the borrower required a higher level of finance than we were willing to do if the bank financed it, if they wanted a period of interest-only to permit them to build up their cashflow for a start-up operation, we were able to do that under the SBLA program. This bill now says that we have to apply the same rules that we would if we financed it under the bank's non-government-guaranteed program, which are tighter and more restrictive.

In the past, the benefits for small business were that the SBLA program was able to give them financing on this glass if they had not been able to get it in the past, and they were able to get it on more favourable terms.

Under the SBLA program, we can finance up to 90% of the purchase cost of this glass. Given the value of the glass in terms of residual value or ability for us to realize on it in a claim situation, under the non-risk or the non-government-guaranteed loan, the bank may only be willing to advance 75%. So it allows businesses that require higher levels of financing to actually get them under the SBLA program, whereas they would not be given such generous terms under a non-government-guaranteed facility.

In the clause here, our concern is that when you say the parameters have to be the same whether it's government-guaranteed or not, it removes a lot of the strength and the guts of Bill C-53 in terms of small businesses being able to get slightly more generous terms than they would otherwise be able to get if it were not a government-guaranteed loan.

[Translation]

Mrs. Francine Lalonde: This is very important.

[English]

Mr. Gareth Powell: Absolutely.

[Translation]

Mrs. Francine Lalonde: What about issues concerning related borrowers?

[English]

Mr. Robert Heisz: Yes, I covered that before. The definition in the regulations of a related borrower is far too restrictive.

Generally in banking, you view who owns the assets and you restrict the lending to the person who owns the assets. We track it through the assets. In this there's an added element that relates it to family. We don't agree that you should ever relate lending to families, because the family unit may contain three different business people who are very closely related, and this would restrict those businesses from operating independently and financing themselves.

Mr. Gareth Powell: There's also another issue here. If you look at this clause in the bill, it's actually almost two pages. That makes it complex for our branch network to decipher and really understand what is meant by “related business”. In the process of trying to determine whether something is related or not, there's a whole lot of criteria, such as the business style, whether it's incorporated or a partnership or a proprietorship, and so on. So the lender really has to look at things such as ownership, whether they share in the profits, and whether they share in the decision-making.

Then you have a few sentences at the end of it saying, notwithstanding what you've read above, if the business is in a separate geographical location or if it's a separate entity, it's okay.

So part of the problem we have is that the rules are very complex and difficult for us to interpret, and then we have to turn around and write policies and guidance for our branch network across Canada. It really makes it onerous for the branch network to understand whether they're within the parameters of the act or outside them.

• 1745

We've found that where we can't make things simple and easy to understand, you don't get lending under a program. That's the bottom line.

The Chair: Thank you.

[Translation]

Thank you very much, Madam Lalonde.

[English]

Mr. Bellemare.

Mr. Eugène Bellemare: The list of people who can participate in this small business loans program includes banks and banking institutions. It doesn't seem to include the Business Development Bank of Canada. Should it include that particular bank? Just a yes or a no.

Mr. Gareth Powell: It's difficult to give a yes or no answer to it. My feeling is that the BDC has a lot of valuable programs that provide small businesses with support that is not available to the same extent through the banking sector, the chartered banks.

The banks have done a good job of delivering the SBLA program and will continue to do so. From my perspective—and I manage this on behalf of the banks—I don't know that the added competition is really necessary. I don't know that the BDC should be given a product that has been available to lenders other than them. They have enough tools at their disposal now in order to adequately service the small business sector. They have a greater focus on operating credits and things like that.

Mr. Eugène Bellemare: Your answer is no.

Mr. Gareth Powell: Personally, I believe no, but I don't know if that's the opinion of the CBA.

Mr. Alan Young: This is an issue on which we have canvassed our members. We're still gathering those comments, so we don't have an industry-wide position on the question, but it is a question on which we are canvassing people.

Mr. Eugène Bellemare: In other words, you have a concern that they—

Mr. Alan Young: We've been asked to consider whether or not it's a good idea, so we've responded to that request. As an industry association works, if we get a request, we send it out to our members, then gather the feedback and collate it, and then respond.

Mr. Eugène Bellemare: You give me the feeling that the banks wouldn't like the competition, that you're worried about it. You say to your friends, “Let's talk about it. Should the Business Development Bank be included, yes or no, in this program?” If you ask that question, it begs the other question: are you concerned, or are you just wanting to hog everything?

Voices: Oh, oh!

Mr. Robert Heisz: I'm not clear here that the act would restrict that. Would it? I don't think the act restricts that, so the decision would be a decision of the minister.

Mr. Eugène Bellemare: I'll ask him.

The Chair: Thank you.

Mr. Bellemare, are you finished?

Mr. Eugène Bellemare: Yes, Madam.

The Chair: Thank you.

Mr. Jones, did you have any more questions?

Mr. Lastewka, you had another question. Mr. Jones doesn't have one.

Mr. Walt Lastewka: I want to go to your concerns about some of the issues.

The Chair: Mr. Bellemare, I hope you're staying until the end.

Mr. Eugène Bellemare: No, I have another meeting. I'm on three committees. I don't know why everyone wants me to be on their committee.

Mr. Walt Lastewka: Because you're important.

Voices: Oh, oh!

Mr. Walt Lastewka: I've heard your comments on leasehold improvements. Can you make some more comments on the area concerning related borrowers, borrower security, and so forth?

Mr. Robert Heisz: The definitions as you read them in the regulations are in good part extracted from the Income Tax Act. It would be very difficult for a person setting up a small business to figure out whether or not they're in violation of the related borrowers section of the regulations, because it's almost two pages. I would have a hard time figuring out if the applicant were in conflict, because it's brought something from small business to a very complex level that would incorporate all kinds of business situations.

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It doesn't need to be anywhere near that complex. We can make recommendations to the department to clarify what the department is intending to do, but to simplify the definition.

Mr. Walt Lastewka: As you realize, the concern here is from the Auditor General's report and many other members' reports on project-splitting and how to prevent that from happening. You think it can be done in a more simple manner?

Mr. Robert Heisz: Yes, sir, I do.

Mr. Gareth Powell: Bob, can I add something here?

Mr. Robert Heisz: Yes.

Mr. Gareth Powell: This issue was raised under the existing SBLA program about two years ago. The concern—and the Auditor General did correctly pick it up—was that there had been situations in the past, prior to the two-year period I'm talking about, where there was project-splitting. To give you an example, a medical practitioner would set up a management company and get $250,000 in that management company to finance the leaseholds for his practice. Then he'd turn around and, in his personal name—a separate legal entity—he would get another $250,000 for the equipment for his practice.

Two years ago, a rule was put in place through SBLA, which all lenders complied with, that said, if it's the same project, the maximum financing for that project is limited to $250,000. I believe that's what this clause about related borrowers is attempting to do.

The Auditor General did pick up that since the new ruling came in, banks and borrowers were no longer eligible, and there wasn't the incidence of project-splitting and financing that was going on in the past.

So there can be a happy medium here, a compromise. The CBA agrees in principle that we don't want to do multi-SBLA loans or government-guaranteed loans for the same project, but we have to eliminate and streamline the rules that we have the branches follow in order to achieve that goal.

Mr. Walt Lastewka: And your comments on reporting requirements?

Mr. Gareth Powell: The issue here is that we provide, on the loan registration form, a lot of information on every loan that's registered to Industry Canada. We have huge amounts of demographic information on the borrower. We drill down right to what the loan is for and the dollar amount that is being advanced under it. And there's lender information on it as well—which bank underwrote the loan, where they're located, and things like that.

About a year ago, Industry Canada got a whole new computer system. We have seen samples of the reports they're able to generate on the types of loans, where they're registered in Canada, the default rates by borrower type, the classes of assets that are causing problems, and so on. Just yesterday, for example, I phoned SBLA administration and asked where we were in our lending ceiling. This goes back to one of the comments we had earlier about the lending ceiling. Within two hours, I was able to get from them a printout of the claims that had been processed through SBLA administration for the Bank of Nova Scotia for all lending periods, another table for the big six banks, and a third table with that same information rolled up for the total lending under the program.

So we know the information is available there. They have a great database of information. We're just asking that that information be shared a little more freely and regularly with the lenders.

Mr. Walt Lastewka: It's not about you providing information to them; it's about Industry Canada providing information to you. Is that your concern?

Mr. Gareth Powell: There are two parts to it. I've just explained the first part.

The second issue is that right now, it's proposed in the bill that when we pay our 1.25% annual fee, we provide the borrower name and the loan registration number that is issued back from Industry Canada or SBLA. The problem with that is we can provide reports as long as we capture the information on our systems. We don't currently capture that.

Again, some of the other banks are different in the information they have on their systems, but none of the banks actually record the government-guaranteed registration number on their system. For example, the names, data quality, and issues like that are all a concern. We're not able to comply now with what they've asked for in the bill, because we don't have it. We haven't been capturing it. We only have it in paper form on the files.

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The other issue is that right now we're restricted in terms of year 2000 issues going through the banks. We're trying to get our systems so that they work properly. I can't even get system changes made to streamline lending products, let alone have additional fields made so that I can comply with government reporting.

We're not saying we can't in the long term provide this information. It's just that we can't do it right now, first of all because we don't have it on our systems, and secondly because we have to wait until we get through this year 2000 window before we can have these system enhancements made.

Mr. Walt Lastewka: But this bill comes into effect next year.

Mr. Gareth Powell: Right.

Mr. Walt Lastewka: My understanding from the Y2K program is that you'll be all be finished by this Christmas.

Mr. Gareth Powell: Well, we'd like to think so, but I'm sure the reality will be that we'll be working right though 1999 on testing and things like that, just to make sure things are done.

The Chair: Thank you, Mr. Lastewka.

Mr. Jones, do you have any more questions?

Mr. Bonwick, you had one last question?

Mr. Paul Bonwick: I have a comment and a question.

As for SBLs, not just government-guaranteed SBLs but small business loans in general, I certainly don't view them as the property of any one financial institution or any particular sector of the economy. I see a very significant role for the BDC to play in that as well, and I know that, especially in assisting development in rural Canada, they play a very integral role.

Regarding an allegation, or I guess I should say a statement, made yesterday with respect to potential repeat offenders—those who have not lived up to their SBL commitment—is there a record or notation on the credit rating of a business or a person if they are unable to meet their commitment on a government-backed SBL? I qualify that by asking, if they meet their 15% or 20% guarantee, is there still a blemish or is there still some sort of notation on their record that shows they did go in default of 80% of the funding of a loan?

Mr. Robert Heisz: No, there's not, but borrowers who do default on their SBLA loan generally have defaulted on a lot of other credit. It's unusual to see a default just on an SBLA loan.

There are unscrupulous people, but there are very few of them, on balance.

Mr. Paul Bonwick: I certainly appreciate that, and I think it was suggested yesterday that it is a very small percentage, if there are any repeat offenders in accessing SBLs. But I'm wondering if it would be appropriate to have some sort of mechanism in place so that even though it would be a small percentage, there would be some notation, some mark on the credit rating of a business or a person to identify that they had not fulfilled their commitments under an SBL.

Mr. Robert Heisz: I don't know that it would be right. Legally it would be impossible to do that.

Most people who are unscrupulous are unscrupulous with a lot of people, so there are indications in credit records of fraudulent reporting, which we're able to pick up from the Credit Bureau records. That tells you the person is unscrupulous. Generally, in communities, you also know who's unscrupulous.

So while the odd person will filter through the system, we have to be really careful about the recording of difficulties that an individual has in their financial life flow.

Mr. Paul Bonwick: Just for my notes then, you wouldn't suggest we implement harm to the mass majority just simply to catch a micro-percentage of people who might be abusing it.

Mr. Robert Heisz: Yes, exactly.

Mr. Paul Bonwick: Thank you.

The Chair: Thank you very much, Mr. Bonwick.

I would just like to clarify for the record a couple of things.

First and foremost, I appreciate your proposed amendments and the fact that you've taken the time to outline where you think the concerns are and what the duplication is. As I said earlier, when Mr. Lastewka was speaking, I'm interested in what the department's response will be to replying in 45 days. It's only fair they have equal timeframes here, so if Mr. Lastewka thinks that 21 days' notice is adequate to do an audit, I'm assuming the department can respond within 21 days as well.

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That being said, I like things simple and neat and tidy, and I'm a little bit distressed by what we heard yesterday from the Canadian Restaurant and Foodservices Association. They seemed to be caught off-guard by some of the changes being proposed in the draft regulations. They believe it will possibly exclude a large part of their industry, which is a large part of the financing that did take place under the SBLA.

They told us that implicit in the former SBLA guidelines for two lenders was the recognition that the program could be used for leasehold improvements and existing leasehold improvements. Do you have any idea what percentage of your loans are to restaurants that would be excluded or have difficulties because of the draft regulations?

Mr. Robert Heisz: I think in lending to the restaurant and food industry, our numbers were about 13% of the loans that were granted.

More important—and it's not just in the restaurant and food industry—lending to purchase an existing building, to finance the existing leaseholds, is very difficult. Few sources of financing are available for this, because the assets attached to that property really have value as long as the business operates. All the fixtures in the restaurant have real value as long as it operates as a restaurant.

The advantage that this program has given the lenders is it has allowed them to give value to those assets and to take them as security. Even though you cannot realize on them per se, they have value as long as the business continues.

So unless you start out at the beginning of your loan saying, “I think this loan is going bad, and I'm going to try to figure out how to get my money back”—which is not the object of the exercise; you try to make sure the business has a chance of succeeding—there is no way of saying those assets are going to have any residual value at the end.

We feel the regulations are much too restrictive and will exclude many kinds of situations—not just restaurants, but many situations a day. I see a lot of these loans go through every month, and a whole variety of businesses would be affected by this restriction.

Mr. Alan Young: The most recent SBLA annual report identified that 17.7% of all SBLA lending financed small businesses in the accommodation, food, and beverages services sector, and a further 13.6% went to the retail trade industries. Those were the two largest sectors covered under the act.

The Chair: The other issue raised by the CRFA yesterday was the buy-back agreement for franchisers. They have claimed that it's unprecedented, and I never saw it when I was practising law, so I'm just wondering if you can tell me if you have this in other types of lending practices or if you've ever seen anything like it.

Mr. Robert Heisz: We very seldom see this in any of the lending practices.

What's more important is that this would restrict the start-up business from purchasing a franchise, because they wouldn't have adequate cash to put in to purchase the leaseholds. They're not going to have the chance to go into these businesses. It just won't be there. Those regulations are too restrictive.

We think we can design regulations that will adequately protect us against a loss ratio that is considered to be too high in financing this business, and we've made recommendations on changes in portfolio management. However, you can't move yourself out of this type of business, because it would disqualify too many of the applicants who rely on this program, who are just starting out in business.

The Chair: Have you seen evidence to suggest that the loss ratio for this type of lending is high?

Mr. Gareth Powell: Anecdotally, Industry Canada and SBLA administration have basically taken the position that whenever a claim comes through where some or all of the funds were used in leasehold improvements, they realize there's going to be no recovery.

Because of that, they had put different rules in place in the guidelines, where the banks had the option of still financing the leasehold improvements but could take other assets of the business' collateral. That was a good compromise, because it allowed us to continue to finance leasehold improvements but shore up that loan request by taking other assets of the business that we would have some realization on, where we wouldn't on the leasehold improvements.

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So they've realized that, as Bob Heisz was saying, while it's a very real need of small business to be able to obtain financing for leasehold improvements, when it comes to a claim and a windup situation, you're not going to get anything out of it.

There's a way we can still continue to finance the leasehold improvements but perhaps put in place different parameters when we're financing that type of the asset, which will allow us to get some sort of recovery.

The Chair: My last question is, were you as surprised as the CRFA claims to be by the draft regulations in these provisions?

Mr. Robert Heisz: Very much so. It's contrary to the fundamentals of the act.

The Chair: I know that in one of the several books provided at the time that the new legislation was tabled, called Access to Financing for Small Business: Meeting the Changing Needs, section 15 does talk about how Industry Canada is recommending that the program no longer finance acquisition of existing leasehold improvements. I haven't really had it spelled out any other way than by having the researchers go through, from yesterday to today, and look for something.

CRFA was surprised. You're telling me you were just as surprised. I appreciate that.

I want to thank you very much for your presentation today and for your participation in the consultation process and in our hearings. We do appreciate it. It's been a very interesting discussion.

For committee members, I want to let you know you received several documents today, which you have in front of you.

Months ago I made a commitment, as chair, to all parties involved that we would have full hearings, adequate time, and proper information. On October 7 we asked for one of the documents to be translated—because as all federal departments know, we're not allowed to distribute documents that are not in both official languages—and it's taken 21 days to receive it. It is the Eadie study that talks about success stories, which we only received today and which you now have in front of you.

As well, the Canadian Restaurant and Foodservices Association, the CRFA, has told us, and we've heard as well from the banks that will administer these loans, that they're surprised by some of the draft regulations and don't believe the proper place for policy changes is in the regulations.

Therefore I have decided that tomorrow we'll proceed with having the department before us to answer any questions you may have, to review and discuss several things we've heard, and to present their side of the story. If they have any evidence they'd like to share with us as to why they're proposing some of these things, we'd be happy to receive it.

I will postpone clause-by-clause until the beginning of next week to give everyone adequate time to review all the materials they've heard, but we will proceed with the meeting tomorrow with the department.

The meeting is adjourned.