One reminder before I start. My Canadian bank earnings overview will be sent out on Tuesday, September 2nd, due to the long weekend!
This email is outside of my routine weekly newsletter issues, just because I know Equitable Bank is a popular stock here at Stocktrades Premium.
The company has been featured here since late 2018, as we highlighted it almost immediately after launching the platform to our first-ever members.
I would like to preface this email by saying that there is still a reasonable chance the company can turn things around and get operations in order.
However, some issues have surfaced over the last year or so that have ultimately changed my thesis for this company, including a change in management due to the unfortunate circumstance of CEO Andrew Moor’s passing.
My stance has not changed solely because of the company’s results. It is also due to my desire to reduce my overall exposure to Canadian Banks. This is nothing abnormal for me if you’ve been a member for a while here. I like to keep my banking exposure to anywhere from 5-7%, and because of the considerable success of Royal and National over the last year, my exposure has increased to nearly 8%.
Outside of that, let’s get into why I’m removing Equitable Bank from the Bull List and why I have decided to move on after holding this one for a long time.
Reasonings for my sale and the company’s removal
Earnings quality has deteriorated for the better part of 18 months now, and credit risk is proving more volatile than that of its peers.
If we look to other alternative lenders in Canada, such as Goeasy, for example, they are not facing this type of situation, which leads me to believe that Equitable Bank is not strategically executing.
If you have ever read my main risk points in my Equitable Bank report, you will notice that practically every one of them is coming to fruition at this point. Not to a scale that would significantly impact the stock price, but it is kind of a slow bleed that is causing the company to underperform its banking peers substantially.
Here are some main highlights from my report:
“Credit risk is arguably the most considerable risk, which takes the form of provision for credit (or loan) losses. As a smaller bank, its loan book is not as diversified as the larger institutions, making it more susceptible to risks in a particular area of the economy.”
“Equitable Bank is positioned to benefit from a thriving economy, with growth opportunities tied to favorable economic conditions. However, if Canada were to experience an economic downturn, the bank’s reliance on mortgages could expose it to certain challenges. Secondly, the housing market would likely slow in a recession, thus Equitable’s growth.”
“it is important to understand that Equitable Bank is a deposit-heavy bank. This means they are relying heavily on new customers via deposit methods like GICs, savings accounts, etc. Equitable will be exposed to the ebbs and flows of interest rates, which will impact the profitability and attractiveness of its products.”
“It needs to continually adapt and offer the best suite of products possible to continue the trajectory of its client growth.”
Confirmation that virtually all of these risks for underperformance are coming to fruition
On the reliance on mortgages issue:
Equitable’s gross impaired loans climbed 5% quarter over quarter to $815 million, driven mainly by single-family uninsured mortgages in Toronto suburbs.
On the deposit heavy issue:
Net interest margin fell 25 basis points to 1.95%. While management stated that they will reach their full-year target of above 2%, the margin composition is no longer as attractive as it once was.
Deposit growth at EQ Bank is strong, and customer counts continue to increase, but they have slowed from previous numbers. I believe one of the main reasons is the types of accounts it offers, like high-interest savings accounts, simply do not yield all that much anymore, and consumers are not as interested in opening them.
At one point, Equitable Bank had a 33% compound annual growth rate on its customer base. Currently, it has slowed dramatically to 20%~. Still strong customer growth, no question. But with the products they offer, they need more to move the needle.
On the credit risk issue:
EQB has a heavier concentration in Ontario than some peers and targets niche borrower groups. For example, 70% of its customers are self-employed or new Canadians.
They acknowledged that high unemployment and housing weakness in GTA suburbs are pressuring their loan book more than the big banks’ more diversified portfolios.
However, this is what really piqued my interest, and not in a good way.
EQB’s coverage ratio on Stage 3 residential mortgages is only 4%, compared to ~22% at a big bank like CIBC. The company argues this reflects its loan-by-loan approach and confidence in recoverability, pointing to an average LTV of 64% and average credit score of 711 on uninsured mortgages.
Still, the much lower reserve ratio leaves Equitable heavily exposed if things get worse.
Basically, when a mortgage goes bad (Stage 3), the bank must determine how much money it is likely to lose on that loan. To account for those future losses, the bank sets aside reserves.
At CIBC, for every $100 of bad mortgages, they’re setting aside about $22 just in case they don’t get all their money back. At Equitable, they’re only putting aside $4 for every $100 of bad mortgages.
This is a strategy that could pay off, but one that could also be detrimental.
On the product development side:
Don’t take this the wrong way, I do not believe that Wealthsimple is taking clients from Equitable. There is plenty of room for more than one player in this space, as the need for digital banking in Canada extends to tens of millions of people.
However, I believe that Wealthsimple is developing a better suite of products, and Equitable will need to adapt, or they won’t gain as much market share.
Wealthsimple is a one-stop financial app—you can save, spend, trade, invest, file your taxes, and manage crypto all under one platform. EQ Bank mainly covers efficient, low-fee banking and GICs, but doesn’t offer investing or tax tools. I think it will need to get into these areas eventually in order to become more convenient for Canadians.
Overall, I believe Equitable is still a solid bank and a great Canadian stock, but my thesis is broken, and as a result, I am selling
While Equitable remains well-capitalized and has a history of strong execution, the combination of margin compression, rising credit risk in key residential areas, and an uncertain transition under new leadership means my investment thesis has changed.
My original thesis relied on sustained above-average ROE, outsized customer acquisitions, and stable credit quality. With all three now under pressure, I no longer see the same margin of safety or upside potential as the major institutions. For that reason, the majors will be the ones I hold in my portfolio.
On a final note, this is why developing an investment thesis before you make any investment is absolutely critical.
Yours might still be intact. You might still like the company, and that is perfectly fine. My decision to sell does not mean you have to sell, because you may have different reasons for owning.
As always, feel free to drop any questions you’d like into the Q&A.
