EQB Inc. Analysis

New to VIC, EQB Inc (TSX: EQB) is a financial services company and digital bank servicing nearly 700,000 customers as of October 31, 2024, with $127bn of assets under management and administration, $47bn of on balance sheet loans, and $67bn of total loans under management (includes derecognized loans from securitization). EQB is Canada’s 7th largest bank, and is a high quality bank: It boasts a 10-year average PCL of 4bps, well below the Big 6/Domestically Systematically Important Banks (DSIB) average of 30bps. It also targets, and historically has achieved, leading ROEs (target at 15-17% adjusted), and has seen significantly faster growth than peers (10-year EPS CAGR 12% vs DSIB average of 6.5%). Lastly, it is very well capitalized, with a leading CET1 ratio of 14.3%.Is Apple a good investment?Apple Cost of EquityApple Cost of DebtHow to Invest in OpenAIHow to Invest in SpaceXHistorical TSR performance has been strong, indicating that the market acknowledges the above points: 10-year total return of 286% vs S&amp;P/TSX Total Capped Financials Index at 166%. However, we believe that even under conservative growth assumptions, EQB remains ~40% undervalued, and is an attractive long term compounder. Our arguments touch primarily on the following points:Recent credit quality headwinds will prove temporary, and aggregate portfolio quality remains very robustDespite higher concentration relative to peers, EQB’s end-markets are attractive in the long-term and strong loan growth is sustainableRegulatory change awaiting OSFI approval for EQB to move from Standardized to Advanced Internal Rating-Based (AIRB) modelling will substantially increase CET1 ratios, further increasing excess capital available for distribution/deployment Business Overview:Plenty of banks (and digital banks with similar lower efficiency ratio benefits) have already been written about on VIC, so we will focus here instead on what makes EQB different:Mainly, EQB is concentrated. Whereas peers see diversification across several dimensions, including revenue source, funding, and loan portfolio, EQB tends to be concentrated across all of these areas. We will go deeper into why we believe this isn’t necessarily an issue from a long-term perspective given the end markets EQB is exposed to, but for now, the quick facts are:Revenue mix: EQB has only recently started pushing into expanding into non-interest revenue sources, acquiring Concentra Bank in 2022, which through its subsidiary Concentra Trust allows EQB to offer fiduciary/trustee services. EQB then acquired 75% of ACM Advisors Ltd. (ACM) in 2023, which provides wealth management services. While exposure to fee-based revenue is guided to continue to see strong growth with ACM performing above expectations, EQB’s non-interest revenue as a % of total revenue is only 16.3% as of FY2024, vs DSIB peers at ~50% average. Fees and other income is currently only 6.5%.Funding profile: Term deposits make up 80% of EQB’s funding sources, while demand deposits make up the remainder. Within term deposits, brokered term deposits comprise ~60% of deposit balance, while EQB’s digital bank subsidiary EQ Bank comprises ~20%. Within demand deposits, EQ Bank comprises ~65%. While higher exposure to term and brokered deposits raises funding costs, EQB maintains this funding profile to meet its core strategy of closer maturity matching to reduce interest rate and liquidity risk. This results in a one-year equity duration, and stable NIMs amidst changing interest rates. It is noteworthy that EQB has been moving away from higher-cost brokered deposits to lower cost deposits sourced from EQ Bank. In 2019, 93% of deposits were brokered vs 51% now, and just 4% were from EQ Bank vs 27% now. Economic Value of Shareholder’s Equity (EVE) sensitivity to a 100bps increase in interest rates is just -1.1%, and NI increases by just $333k. We see this as a benefit given current uncertainties surrounding Canadian macroeconomic conditions.Loan portfolio: Before touching shortly on why we believe EQB’s lending end markets are attractive in the long-term, we first note here that EQB is nonetheless highly concentrated in its lending strategy. EQB is primarily focused on residential lending: 62% of loans are residential (single-family) mortgages, 32% are commercial loans, and just 6% are personal loans (excluding single-family mortgages). To be clear, this rough categorization is imperfect and understates housing-related exposure—Commercial loans here include loans for residential construction, and personal loans excluding single-family mortgages include reverse mortgages. Compared to DSIB peers, exposure to residential mortgages is ~40%. EQB’s loan portfolio is broken into Personal and Commercial, with Personal loans including insured and uninsured single-family mortgages, decumulation loans (includes reverse mortgages), and consumer lending. Commercial lending include commercial loans (includes construction loans), equipment financing, and insured multi-unit mortgages (of which ~75% are securitized and derecognized subsequently).Nancy Pelosi Stock PortfolioNancy Pelosi Stock TradesNancy Pelosi Insider TradingIs Apple undervalued?Is Apple a buy? Point 1: Recent credit quality headwinds will prove temporary, and aggregate portfolio quality remains very robustHistorically, EQB has maintained an extremely high quality loan portfolio. 10 year average PCL ratio (provisions/average loans) has been 0.06%, while DSIBs have had PCL ratios of ~0.30% over the same period. EQB also significantly outperforms on this metric in times of stress: Peak PCL ratios during the GFC was 0.13% vs 0.90% vs DSIBs, and 0.15% vs 0.78% during COVID. Actual losses in terms of net charge offs have been similarly restrained at 0.04% of average loans over the past 10 years.<br>