Comprehensive Review Report (2004–09)

Appendix D: Canada Small Business Financing Act Background on Cost Recovery

In 1995, the SBL Program was given a cost recovery mandate. The importance of carefully monitoring the financial performance of the loans portfolio and regularly updating the program's cost recovery model was reinforced by the Auditor General in 1997 and 2002.

Methodology

Forecasting program revenues and costs is a complex task. First, sufficient data on loan risk and lender behaviour takes nearly four years to accumulate from the time of a parameter change. This is essential to a forecasting model. Second, the cost recovery model must cover the entire life of all loans made in a given year, which can be as much as ten years. Third, there is a significant lag time between the receipt of revenues and the payment of claims. Finally, lenders are allowed up to three years after default to submit a claim for loss, so the period can be extended to as much as 13 years. As a result, revenues and claims need to be forecast long into the future, making estimates of cost recovery difficult and subject to variance according to economic conditions and other factors. For this reason, Industry Canada updates its forecast and forecasting models on a regular basis to ensure they reflect the most recent experience.

Using a multivariate analysis of the claims received in a given month combined with statistical and econometric-based forecasting models, Industry Canada is able to project future claims²⁴ against the forecast revenues to arrive at the cost recovery forecast for the program.

Findings

Table D-1 below illustrates the current cost recovery forecasts for the first two lending periods of the CSBF Program (1999–2004 and 2004–09). These tables provide a summary of the revenue and expense streams associated with each of the aforementioned annual cohorts.

In aggregate, for the CSBF Program (see Table D-1 below):

• Revenues (registration and administration fees) for the five years of loans during the current review period are expected to reach approximately $281 million.
• Expenses (claims) are expected to be approximately $477 million, for a net cost of $196 million.
• Revenues are expected to offset expenses by 58.9 percent.
• From an overall loans portfolio perspective, the net cost to government is expected to reach 3.9 percent of the total loans made, up from 2.6 percent for loans made during the C1 (1999–2004) period.

Table D-1
Cost Recovery Model Summary: CSBF Program Period C1 (1999–2004) and Period C2 (2004–09)

($ Millions)		Revenues and Expenses				% Cost Recovery1	Net Cost/ Loans (%)
Cohort	Loans	Reg Fees	Admin Fees	Claims	Net Cost
1999–2000	1352.3	26.8	48.5	-118.7	-43.5	63.4	-3.2
2000–01	1159.0	22.9	42.1	-101.0	-35.9	64.4	-3.1
2001–02	899.2	17.8	31.8	-66.1	-16.5	75.0	-1.8
2002–03	951.2	18.8	31.8	-65.5	-14.9	77.3	-1.6
2003–04	999.9	19.8	31.2	-79.1	-28.1	64.5	-2.8
Total (1999–2004)	5361.6	106.1	185.5	-430.5	-138.9	67.7	-2.6
2004–05	1041.3	20.6	39.9	-85.1	-24.6	71.1	-2.4
2005–06	1087.5	21.5	40.5	-101.4	-39.4	61.2	-3.6
2006–07	1024.5	20.2	36.5	-102.1	-45.4	55.6	-4.4
2007–08	987.7	19.5	34.6	-95.7	-41.6	56.5	-4.2
2008–09	918.4	18.1	29.5	-93.2	-45.6	51.1	-5.0
Total (2004–09)	5059.3	99.9	181.0	-477.4	-196.4	58.9	-3.9

Note: Highlighted figures are estimates.
¹ % Cost Recovery: revenues (registration and administration fees) divided by expenses (claims).

Long description for Table D-1
Cost Recovery Model Summary: CSBF Program Period C1 (1999–2004) and Period C2 (2004–09)

Table D-2 provides the same summary of the revenues and expense streams associated with each of the CSBF annual cohorts. This table takes into consideration the three- to five-year lag between when the revenues are received and when the expenses are paid (i.e., presented on a net present value NPV basis).

In aggregate, on an NPV basis:

• Revenues (registration and administration fees) for the five years of CSBF loans are expected to reach approximately $254 million.
• Expenses (claims) are expected to be approximately $404 million for a net cost of $150 million over the term of the loans.
• On a percentage basis, revenues are expected to offset expenses by 62.8 percent.
• From an overall loans portfolio perspective, the net cost to government is expected to be approximately 3 percent of loans made, up from 1.8 percent for loans made during the C1 (1999–2004) period.

Table D-2
Cost Recovery Model Summary: CSBF Program Period C1 (1999–2004) and Period C2 (2004–09) (NPV¹ Basis)

($ Millions)		NPV Revenues and Expenses				% Cost Recovery2	Net Cost/ Loans (%)
Cohort	Loans	Reg Fees	Admin Fees	Claims	Net Cost
1999–2000	1352.3	26.1	42.0	-99.1	-31.0	68.7	-2.3
2000–01	1159.0	22.4	36.6	-84.3	-25.3	70.0	-2.2
2001–02	899.2	17.4	27.7	-55.1	-10.1	81.7	-1.1
2002–03	951.2	18.3	27.7	-54.7	-8.6	84.3	-0.9
2003–04	999.9	19.3	27.2	-66.0	-19.5	70.5	-2.0
Total (1999–2004)	5361.6	103.4	161.3	-359.1	-94.4	73.7	-1.8
2004–05	1041.3	20.1	34.6	-71.2	-16.5	76.9	-1.6
2005–06	1087.5	20.9	35.2	-85.9	-29.7	65.4	-2.7
2006–07	1024.5	19.7	31.7	-86.8	-35.4	59.2	-3.5
2007–08	987.7	19.0	30.0	-81.2	-32.2	60.3	-3.3
2008–09	918.4	16.9	25.4	-78.9	-36.6	53.6	-4.0
Total (2004–09)	5059.3	96.6	157.0	-404.0	-150.4	62.8	-3.0

Note: Highlighted figures are estimates.
¹ Net present value (discount rate = 5%).
² % Cost Recovery: NPV revenues (registration and administration fees) divided by NPV expenses (claims).

Long description for Table D-2
Cost Recovery Model Summary: CSBF Program Period C1 (1999–2004) and Period C2 (2004–09) (NPV Basis)

Conclusion

A comparison of the results for the first two lending periods of the CSBF Program indicates that cost recovery during 2004–09 has declined. Lower levels of cost recovery during this period can be partially attributed to higher levels of incremental lending through the program as well as slightly higher risk lending among a few of the major financial institutions. Industry Canada will continue to update its forecasts and refine its forecasting models on the basis of the latest available data, to ensure appropriate monitoring of this program objective.

---

²⁴ Riding, Allan. Forecasting Expenses Related to SBLA and CSBFA Debt Financing Loans, January 2005.