The Ottawa Citizen
May 9, 2000
While the EDC maintain its standard banking procedure not to disclose details of loans, a former bank regulator is calling for an independant review of the agency’s practises. (Excerpt)
The federal Export Development Corporation, which backstops $40 billion in loans, guarantees and insurance coverage on Canadian export ventures, says a mere $21 million in loan writeoffs over the past decade proves that its accounts are managed to commercial bank standards.
And because EDC says it must adhere to the same standards as a commercial bank, it maintains that it cannot disclose details of its individual transactions.
But a former chief regulator of Canada chartered banks says the EDC accounts don’t match commercial bank standards in key areas, and Finance Minister Paul Martin should order an independent examination of its lending practices.
Michael Mackenzie, who was the director of the Office of the Superintendent of Financial Institutions (OSFI) from 1987 to 1994, says the EDC: has a highly leveraged ratio of total credit risk ($40.1 billion in loans, guarantees and insurance coverage) to equity capital ($1.8 billion); has 10.4 billion of its $18.6 billion in outstanding loans ranked below investment grade, speculative or impaired; does not declare all loans “impaired” after interest payments are 90-days overdue; restores sovereign loans – those made to foreign nations and their agencies – with overdue interest and principal to “performing” status without obligating the debtor to first repay all delinquent interest and principal.
“They make riskier loans than banks do”, Mr. Mackenzie said after the EDC’s most recent annual reports. “The ratio of bad debts to total loans is way higher than the banks.”
Despite this, he said, the EDC has no independent, objective means to gauge the true risk to taxpayers, in whose name the EDC has borrowed $16 billion. The EDC capital base of $1.8 billion includes $980 million supplied by taxpayers, and accumulated net earnings of 815$ million.
Since 1992, the EDC has received a further $86o million from taxpayers to cover EDC loans to developing nations later forgiven by the federal government.
“They’re not getting an oversight on their credit and market risk management”, said Mr. Mackenzie, now a lecturer with York University’s Schulich School of Business, and a consultant to the World Bank.
“The main benefit of OFSI scrutiny would be an objective, comparable review of their credit risk magement and foreign exchange business, against all the other standards. OSFI would go in and look at their credit risk management practices and procedures, compared to the best standards of the CIBC or Scotia or TD or international banks.”
Mr. Mackenzie said Finance Minister Paul Martin could ask OSFI to go into the EDC books to evaluate their risk management controls.
If they say they are a commercial bank, then apply commercial bank standards to the EDC. I think that would be a good idea. The downside could be that these people would not be allowed to make the kind of loans they’ve made.”
An OSFI audit of the EDC book could be accomplished quickly, Mr. Mackenzie said.
“It wouldn’t take an awful lot of time. I think an experienced bank examiner and his staff could find out all he needs to know in three or four weeks.”
The EDC counters that it uses commercial bank accounting standards on its commercial loans, but treats its array of sovereign loans in the same way as other export credit agencies of OECD nations.
“It’s important to differenciate between a sovereign loan and a commercial loan. You can’t apply commercial loan practices to sovereign debts”, said Peter Allen, the EDC chief financial officer.
Because you’ve got the good faith of another country to repay its obligations, which is the highest quality of debt you will get in the world. Ultimately it will get repaid; it just may take some time during re-scheduling.”
Senior EDC officials say sovereign loans that become delinquent are automatically rescheduled if the debtor nation is among those whose debts are subject to rescheduling through international agreement. They are classified as “impaired” if the rescheduling payments are not honoured.
In 1999, the EDC had $720 million in re-sheduled loans, and $1.3 billion in impaired loans. The EDC defineses im- paired loans as those which have failed to meet contractual obligations.
Mr. Allen stresses that the EDC does not count the interest owed on sover- eign loans as income until those loans are re-classified as performing. This can occur when the country begins making regular payments on its debt, or the EDC converts the amotmt owing to equity or a larger, re-scheduled loan.
Sometimes, that can take decades. “We are not taking writeoffs over it”, said Mr. Allen. “We ultimately collect it all. But we don’t bookkeep it as income until we receive it because the re- scheduling process can cause it to take sometime.
“The test is: do we conform to generally accepted accounting principles (GAAP)? We consistently do.
Adds Eric Siegel, an EDC vice-presi- dent: ” The EDC is mandated to operate in a commercially self-sustaining fashion, is independently authenticated by an (auditor-general) opinion on an an- nual basis, subject to an extensive re- view every five years, and obligated to operate under GAAP, using commer-. cial disciplines. That’s the assurance the EDC is not recklessly committing the government’s funds.”
Asked if the EDC would welcome an annual review of its accounts by the Regulator of Canada’s banks, Mr. Allen responded: “I don’t know that I could answer that question. I would have to research all the implications of it… Suf- f’ice it to say that we monitor very closely the direction OSFI is taking.”
EDC’s books am examined annually by the federal auditor general, who has concluded that its accounting methods fail within generally accepted accounting practices.
Following his 1999 audit, the auditor general concluded that the transactions he reviewed “have, in all significant re- spects, been in accordance with the (federal) Financial Administration Act and regulations, the Export Develop- ment Act and regulations, and the by- laws of the Corporation and its wholly- owned subsidiary.”
Mr. Mackenzie’s view of the EDC op- erations is shared by Michel Boucher, a professor at the Ecole Nationale Administration Publique in Quebec City. He said the EDC earns a very low re- turn on the s4o billion it risks in loans, guarantees and insurance policies, while offloading the risk onto taxpay- ers. (The EDC earned a 6.6-percent return on equity in 1999, compared to eight per cent in 1998.)
“You have to compare them with a bank, or a specialized financial institu- tion related to those kinds of risks on in- ternational trade. It is not a healthy institution,” said Mr. Boucher.
Someone else pays for nonchalant behaviour. Canadian firms and import- ing firms know that the EDC will pay for their risky situation if an “act of god” or unexpected circumstances come in play.
They do not mind and they do not care because a third party, the EDC and Canadian taxpayers, will bear the bur- den. As the EDC pours in more money, few of them will show restraint. It means that more and more loans will never be repaid because the level of risks is not really assessed.
The EDC counters that it carefully gauges the risk involved on all its loans and insurance policies, has only written off 21$ million in defaulted loans during the past decade and has shown an operating profit for more than a decade.
“As long as the EDC is solvent, Canadian taxpayers are not at risk”, said Mr. Allen. “We do not carry the kind of leverage that a commercial bank does.”
Mr. Mackenzie discounted the EDC’s contention that it operates as a com- mercial bank and cannot disclose basic details about outstanding loans like its U.S. counterpart, the U.S. Export-Im- port Bank (Eximbank).
“First of all, it has access to Her Majesty’s credit card. Second, it doesn’t pay any income tax. Those two things should bring obligations commensurate with the American (disclosure) practice .
The Eximbank Web site posts the dollar value of approved loans, borrowing country or state agency, the product being produced, the U.S. companies benefiting from the export loans, and the place of manufacture.
Citing a list of outstanding loans in the EDC 1999 annual report, Mr. Mackenzie noted that $6.3 billion (including one sovereign loan for $709 million) falls under the designation: “other”. That’s an awfully big figure to call ‘other’. The commercial banks give more information about where their loans are: Somebody owes (the EDC) $709 million. You would think they’d list that – let us know what country is. I’d like to see more. How much is owed by Russia, or Ukraine, or Kazakhstan, or African countries?
“I’m a great respecter of banker’s confidentiality about their customers”, said Mr. Mackenzie. But the Americans have set a (disclosure) standard that’s good.”
Mr. Siegel retorts that EDC is subject to commercial confidentiality agree- ments. “The applicant for financing, the borrower, says: “Without my approval you cannot disclose this information”. So it’s not the EDC using a different practice. You wouldn’t get it from a bank, either. The banks don’t disclose who their borrowers are. They don’t print that in their annual report or the terms and conditions of their loans. That is information that is considered to be commercially confidential”.