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Canada Small Business Financing Act: Capital Leasing Pilot Project Summative Review Report
5. Performance Review
Research and consultations were carried out in support of the review of the CLPP pursuant to the results-based management and accountability framework. Small businesses that had CLPP leases were surveyed to determine their awareness of the pilot project, their experience in obtaining financing and any impact financing had on their business. This information was used to determine a level of incrementality for the pilot project as well as to gauge economic impact. Lessor interviews were conducted to examine the experience of leasing companies that had varying levels of participation under the pilot project. The CLPP database of registered leases provided the evaluation with a profile of the user as well as an indication of the cost-recovery situation.
Program Activity
Activity levels under the pilot project have been low, growing moderately in recent years. Fundamental to this low activity was that few lessors chose to participate. Twenty-four lessors were approved to participate, but for most of the term of the pilot project there were only seven active lessors, with three of these extending the bulk of the capital leases.
At the time the pilot project was designed, a profile of potential lessors as pilot project delivery agents was developed.Footnote 6 It was estimated that there were about 660 firms involved in capital leasing in Canada. Of these, 276 were directly involved and 384 operated through a third party (e.g. lease funders and special trusts for the purpose of securitization). Of the leasing companies directly involved in capital leases, 84 percent had been in business for at least five years and 30 percent for 20 years. The majority of leasing companies were located in Ontario (50 percent) and in the West (34 percent), followed by 13 percent in Quebec.
Reasons given by leasing companies for not participating in the pilot project included a lack of awareness of the project, a conception that it did not fit their business model, and a belief that it was too complicated to implement or had overly strict lessor eligibility criteria. Some leasing companies applied to participate but did not meet the criteria under the definition of lessor in the CLPP regulations. Others did not meet the criteria of the Lessor Designation Policy, often because the firm could not provide the five years of audited financial statements required by the policy. One lessor only became active in the pilot project in October 2006.
Industry Canada held consultations in 2003 and 2004 in an effort to design a series of amendments to the Lessor Designation Policy to address concerns regarding access to the pilot project. Discussions with the leasing industry were inconclusive, however, and the policy was not amended.
Leasing companies with experience delivering the CLPP (five companies were interviewed) found that once they had invested the time necessary to train their people, administration of the pilot project was straightforward. They indicated that they are in favour of having capital leasing become a permanent part of the CSBFA as it is useful for higher-risk leasing that is on the margin of their risk profile. Feedback also focused on the need to revisit the Lessor Designation Policy to get more leasing companies on board and increase the reach to small business.
In designing the pilot project, it was assumed that take-up would be slow, as with any new program, and that it would not begin to reach its long-term level until year 3 or year 4 ($2.1 billion or 35 000 leases over the five years). Pilot project take-up was considerably less than expected. As at September 30, 2006, the total number of leases registered was 1104, for an approximate value of $107 million and an average lease value of $97 000. Assuming steady growth for fiscal year 2006–2007, the forecast take-up for the entire period of the pilot project is projected to total $136.1 million (see Table 1).
| Year | Expected Value of Leases Registered ($ millions) | Actual Value of Leases Registered ($ millions) |
|---|---|---|
| 2002–2003 | 180 | 7.8 |
| 2003–2004 | 270 | 14.1 |
| 2004–2005 | 450 | 26.4 |
| 2005–2006 | 600 | 38.0 |
| 2006–2007 (forecast) | 600 | 49.8 |
| Total | 2100 | 136.1 |
Profile of Users
The profile of CLPP users indicates that it is not just young firms seeking small amounts of financing that are in need of assistance in accessing financing. Indeed, research carried out for this review and in general to increase our understanding of small business financing needs suggests that while start-up and young firms are considered a financial risk, firms of any age can find themselves outside the risk profile of their financial service provider.Footnote 7 Small businesses with capital leases registered under the pilot project were more likely to have been operating for more than 3 years (51 percent) and 40 percent had revenues in excess of $500 000 per year. Financing amounts ranged in value, with 40 percent of capital leases for amounts greater than $100 000. This suggests that the original gap identified by the leasing industry either no longer exists or this financing tool addresses needs of firms outside this gap as well as those within the gap.
Other observations:- Lessors participating in the pilot project had a significant regional focus, with registered leases clustered in Quebec, Ontario, Alberta and British Columbia. Minimal activity was registered in other provinces.
- Small businesses that used the pilot project varied in age. As at September 30, 2006, 321 (29 percent) were new businesses, 219 (20 percent) had been operating for one to three years and 564 (51 percent) had been in business for more than three years.
- Small businesses that accessed financing through the pilot project were mainly from sectors that require a significant amount of equipment, including transportation and warehousing, construction, manufacturing, agriculture, retail trade, and food and beverage services.
Performance Objectives
Performance of the pilot project is measured primarily by its ability to satisfy two key objectives set out for the CSBFA:
- Cost recovery — the pilot project will be independently cost recoverable (i.e. separate from the core CSBFA loans program), where user fees will cover projected claims payments over the life of the capital leases made during the five years of the pilot project; and
- Incrementality — capital leases made under the pilot project would not have been made or would have been made under less favourable terms for small and medium-sized enterprises (SMEs).
Cost RecoveryFootnote 8
When the pilot project was first designed, some assumptions were made regarding activities. Based on 40 years of experience with equipment loans under the CSBFA and its predecessors, combined with research and consultation, projected revenues were estimated at $122 million and claims costs were estimated at $116 million. In calculating projected revenues from fees and the cost of claims, the following key assumptions were made: total capital leasing activity of $2.1 million, default rate of 12 percent and realization rate of 15 percent.
The pilot project has collected fee revenues of $3.5 million and paid 24 claims totalling $820 000 (as at September 30, 2006), for net revenues of $2.6 million. Current cost recovery forecasts suggest leasing over the life of the pilot project could translate into net revenues of $0.84 million and a claims loss rate of 4.1 percentFootnote 9 (on a net present value (NPV) basis). This represents the most likely cost-recovery scenario but, given the time lag between receipt of revenues and receipt of claims, there is currently insufficient information to determine if the pilot project will meet the objective of cost recovery.Footnote 10
In alternative scenarios with claims loss rates as low as 3 percent or as high as 7 percent, the cost-recovery analysis produced estimates (NPV) that vary from net revenues of $2.59 million to net losses of $2.52 million, on an estimated $138.7 million in leases.
Incrementality
Research indicates that both lessors who have extended capital leases under the pilot project and small businesses that received them believe that the financing was incremental.
Results of a survey of 150 users of the pilot projectFootnote 11 (out of 1104 registered leases) indicate that for 49 percent of the users the CLPP lease was the only option available. This could be viewed as full financial incrementality, i.e., the firms would not have had any financing options without the CLPP (this is consistent with how incrementality is viewed under the CSBF Program loans program). In addition, for 21 percent of users other sources of financing were available, but this either did not cover the full amount needed or would have been available under less favourable terms (partial financial incrementality). Thus, 70 percent of financing under the pilot project was fully or partially financially incremental.
More than one third (37 percent) of 150 surveyed lessees believe that if they had not obtained the CLPP lease their business would have been prevented from setting up or expanding. This could be viewed as full incrementality in terms of economic impact. For 28 percent, not obtaining the lease would have meant a delay in the set-up or expansion of their business, while 13 percent said they would have proceeded on a smaller scale. For these two groups combined (41 percent), this could be viewed as partial incrementality. Thus, 78 percent of financing under the pilot project was fully or partially incremental in terms of economic impact.
The surveyed users also stated that access to financing under the pilot project had strong, positive economic benefits, enabling businesses to remain solvent, increase production, expand geographic reach, reduce costs and hire more employees. One quarter of the surveyed users felt that their company would have ceased to operate had they not obtained the capital lease at that time.
Footnotes
- 6 back to footnote reference 6 This was based on a study commissioned by Industry Canada: Compas, Inc. Building and Verification of Capital Leasing Company Database. April 2001.
- 7 back to footnote reference 7 At the time the pilot project was being designed, the leasing industry and small businesses indicated that about 25 percent of all applications for leases were rejected and that these rejections were, in large part, related to firms with less than two years of experience and those seeking leases of less than $100 000.
- 8 back to footnote reference 8 Cost recovery does not include Industry Canada's operating costs (approximately $11 000 in salary costs in each of fiscal years 2003–2004 and 2004–2005) associated with administering the pilot project.
- 9 back to footnote reference 9 Claims loss rate is defined as the value of claims as a percentage of overall lending.
- 10 back to footnote reference 10 There is considerable variation in claims paid (e.g. no claims were paid in fiscal years 2002–2003 or 2003–2004), which may contribute to underestimation or overestimation of expenses and the 1.25 percent administration fee revenues, thereby affecting the cost-recovery forecasting model. Assumptions were also made regarding capital lease registrations for the latter half of fiscal year 2006–2007.
- 11 back to footnote reference 11 Phoenix Strategic Perspectives Inc. Canada Small Business Financing Program: Capital Leasing Pilot Project Evaluation Survey. August 2006.
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