Equitable is relentlessly focused on providing better and more efficient services than the largest Canadian banks. Its asset base has doubled over the past five years and continues to grow quickly.
The bank's all-digital approach, non-existent physical footprint, low-cost operating structure, disciplined risk management, and partnerships with key fintech companies and brokers allow Equitable to expand its reach, manage capital well, and reinvest in its business. The result is a consumer-centric business with superior returns for shareholders.
Equitable has tons of room to grow. Aside from the strong core Canadian housing market and secular demographic trends supporting growth in it, Equitable's efforts in building open banking and modernized payments networks should propel it as a leader in the fintech and banking industries.
Management at Equitable has the shareholders' interests in mind in everything they do. Shareholder capital return and long-term thinking in terms of reinvestment or acquisitions to uphold or expand return on equity ("ROE") bode well for the bank's share price going forward.
Key Company Metrics
A set of metrics we constantly keep updated to monitor the investment thesis.
Canada’s All-Digital Bank
Equitable is the most efficient Schedule I bank in Canada, operating entirely as a digital model with no physical retail footprint. EQ Bank is Canada’s first all-digital bank with aspirations to lead the imminent mobile-first future that awaits us. Equitable was also the first Canadian bank to migrate its core banking operations onto the cloud.
The bank derives major advantages from being an all-digital bank. For one, it can target underserved Canadians that are not within the footprint of other major Canadian banks. Secondly, Equitable has a lean, all-digital operating model that is much more efficient than other Schedule I banks. Equitable's efficiency ratio (i.e., non-interest expenses divided by revenue) has been consistently below the peer average.
With this, Equitable can establish itself in niche markets and regions in Canada, as well as reinvest its savings from its branchless model right back into where it matters most for clients and shareholders - the business.
Disciplined Risk Management
Operating primarily as a non-prime lender, Equitable faces risks that other major Canadian banks may not. Its client base, in the aggregate, will be of lower credit quality than the others. To combat these risks, Equitable employs a disciplined risk management model that allows it to rival the risk profile of the Big 5.
Equitable protects itself by following a few stringent practices:
Lending only to liquid urban and suburban markets
Avoiding direct lending to oil and gas companies
Diversifying commercial lending across industries and geographies
Focusing on commercial asset classes that are recession-resilient, like multi-unit residential and mixed-use properties
Limiting uninsured lending exposure in Alberta
Requiring cash deposits on higher-risk leases
Equitable also has a high-quality portfolio of assets despite the amount of non-prime loans. The average credit score of a non-prime single-family residential borrower was 702 in 2020, up from 691 in 2019. On the small business side, this credit score was 741.
The bank insures many of its loans to further prevent downside. 100% of the loan portfolio is secured by some sort of asset (i.e., the real estate itself in the case of a mortgage, a vehicle for leases, etc.) and 56% of loans are insured against credit losses with the Government of Canada being the ultimate backstop. Based on the bank's stress test, it determined its expected credit losses in the worst, yet realistic, economic scenario, would be around $110 million, a relatively small fraction of Equitable's total assets.
The effects of these practices are profound, and the numbers are clear - Equitable's credit losses to total loans are the lowest among all Schedule I banks.
As a 100% online business, Equitable knows it may be challenged with existing and prospective client outreach. It needs help to reach clients and build awareness - to do this, it has built a foundation of a few key partnerships with technology, fintech, and financial services companies.
These companies work with Equitable to maintain and build on a great online banking interface with functionality that rivals other major banks. For example, TransferWise enables EQ Bank to send international money transfers at a fraction of the cost of a Big 5 bank wire transfer.
Additionally, Equitable partners with brokers and agents to provide deposit services, originate loans, and continually expand its product offerings. This is facilitated through EQ Bank's partnership with nesto to launch the Mortgage Marketplace in May 2021. The Mortgage Marketplace offers customers a network of over 2,000 mortgage products from various brokers and lenders.
Even though Equitable risks losing a prospective customer to a competing bank in the Mortgage Marketplace, it increases the number of eyes on Equitable's mortgage products. The bank is confident that its ultra-low mortgage rates will drive mortgage volumes higher, and cross-selling opportunities will be robust. If the customer is lost, Equitable still makes some money on the referral to a competing bank.
By expanding their channels and service distribution network, Equitable makes it more likely that a client will end up banking with Equitable. The more customers it can reach to provide the exceptional service that other Schedule I banks cannot, the faster it can grow and reinvest in newer and improved financial products and services.
Two major areas of growth opportunities for Equitable include Open Banking and Payment Modernization. While the Open Banking concept adds tremendous value to Canadian bank clients, the latter is a clearer money-making opportunity for Equitable. Equitable is preparing for these opportunities by seeking to introduce an EQ Bank payment card in late 2022. Not only will this payment card be a convenient substitute for, say, a big bank's debit card and chequing account, the payments card would also help Equitable aid in the modernization of the Canadian payments landscape. On top of this, Equitable will also earn generate interchange fee revenue every time the card is used by a customer in-store or online to purchase things. Among other things, Equitable is engaging in other product launches, geographic expansions, and efficiency initiatives throughout 2022 and 2023.
On February 7, 2022, Equitable announced an agreement to acquire Concentra Bank - Canada's 13th largest Schedule I Bank - for ~$470 million, or about 1.08x Concentra's book value. Concentra Bank is the largest provider of wholesale banking and trust solutions in its respective operating markets. Concentra also has wide reach, having partnered with over 200 Canadian credit unions and the 5 million members served by those credit unions. Concentra operates in some markets that Equitable currently does not operate in. Adding Concentra means Equitable adds consumer loan interest, Trust and estate services, and credit union counselling services to its portfolio.
Although Equitable's asset mix is diversifying at a steady pace, its portfolio is still heavily loaded with residential real estate exposure. Therefore, the most significant macro trend that could make or break Equitable is the health of Canada's housing market and the lending that comes with it. The government aims to introduce 432,000, 447,000, and 451,000 permanent residents into Canada in 2022, 2023, and 2024, respectively. In contrast, Canada accepted about 300,000 immigrants per year from 2015 until the COVID-19 pandemic began.
Equitable's capital allocation priorities are clear and simple. Health of the business and prudent debt management come first, as they should. Equitable looks to increase dividends at high rates to entice shareholders to stick around and act as business owners. Management's guidance for dividends increases currently stands at a high 20 - 25% increase per year over the next few years. In February 2022, announced a 51% dividend hike, making up for the blocked dividend raise in 2021 due to OFSI regulations. If there is still cash left over, acquisitions and share repurchases are on the table.
Housing Market Gearing
Most of Equitable's assets are tied to the housing market in some capacity. Additionally, many of its loans are made to non-prime clients who may be at higher risk of failing to make payments during financial hardship. This exposes Equitable to significant downside in market downturns or economic recessions, especially if they are not accommodated by federal income support or other fiscal and monetary stimulus efforts.
Equitable, as a Schedule I bank, faces substantial regulatory oversight that could prevent it from conducting business in a manner consistent with its growth strategy. Rising house prices in Canada are also attracting lots of political attention. Depending on the federal party in power at any given point in time, there are many ways – some more significant than others – that could cool the housing market and hurt Equitable's core business.
Equitable is reliant on many key partners to conduct its core business and offer compelling new products at attractive rates. The breakdown of any of these relationships could potentially destroy its client base as Equitable would likely be left with no viable internal alternatives under its current suite of products.