You ready?
Yep.
Okay, so it's my pleasure to welcome Andrew Moor, President and CEO of EQB Inc. Andrew is gonna make some prepared remarks with a few slides before he comes into the hot seat, and so go ahead, Andrew.
Great. Thanks, Meny. And really, the purpose of sort of going through a few slides is, you know, our business is changing. We think we're sort of more comparable to the big banks. You know, we've got Meny now covering us, an analyst. Our reporting cycle's now moving on to the same as the bank cycle. So it just felt like for those of you who haven't followed the EQB story, I just- I'm not planning to give you a full investment thesis, but just kind of think about mine, now might be the time to pay attention to us. So just in terms of who we are, you know, we're the- we believe we've got the leading digital bank in EQ Bank. It's something I sort of...
If you haven't, if you don't want to buy the stock, do open a bank account. You can get basically interest on your checking account and free payments. I think it's a good benefit for everybody else. Everybody. We have a strong funding position, you know, whether it's through EQ Bank, through broker deposits. This was something we raised here because a few years ago, people were concerned about our funding posture. We really believe we've diversified that nicely. We lend primarily in Canada's major urban centers, so where we believe with a sort of diversified economy, and I think that's led to a pretty good credit performance, you know, and I'm sure we'll talk about that in more detail with Meny, but feel pretty comfortable with our credit performance. And we've now emerged as Canada's seventh-largest bank.
So, you know, a number of years ago, we were a small trust company, converted that trust company into a bank, and now, I mean, particularly with CWB being bought by National, you know, we emerged kind of as very much the seventh-largest bank in the country, so hopefully you've seen some of our branding. We have been advertising on TV, so Dan and Eugene Levy have been our representatives through the last year and continue to... We continue to use their collateral value. That's actually changed consumer awareness of EQ Bank quite meaningfully, and similarly in Quebec with Diane Lavallée and Laurence Leboeuf, her daughter. We've also building off our franchise quite nicely, and you can see how for a bank that had no brand presence, we're slowly getting there. This is how we create value.
Generally, we've been driving high ROEs, so we generally drive an ROE of 15%-17% a year. We pay a relatively small dividend. Our book value grows at 13%-15% a year, and EPS similarly, because we get the ROE on the reinvested capital. So it's kind of an interesting model that a bank with growth, that, you know, generally the other banks, many of the banks are constrained, don't have that growth opportunity, therefore, pay out a high percentage of their earnings. And with that, you see that we're growing our EPS and book value per share faster than our peers on the S&P and TSX. Naturally, it's kind of a- it's a feature of retaining more equity, and then, as, you know, retaining dividends and therefore and reinvesting at a high return on equity.
Still believe we're undervalued. This is how we think about it. We think banks should trade on these kind of ROE to price to book value correlation. We generate very consistently high ROEs and believe there's still value in the story, and hence why we're here today to try to meet new investors. We have very strong capital ratios, so we're comparing here on a standardized basis. You can see how the 14.7% CET1, Common Equity Tier 1, compares to the large banks that report on the same basis in around sort of 8%-9%. And so this is why we think we could be time for you to look now. You know, we've realigned our fiscal year to align with the other banks.
Analyst coverage has largely transitioned to the major banks, so you can sort of think about us with the people you're talking to every day. Think about big banks. You can get the same kind of view of EQ Bank rather than having to go talk to somebody else. With a market cap now over CAD 3.5 billion, for some of you that are working in larger cap stocks, this may be interesting. Gets you into something you can consider. We have got increased trading volume. We're trying to make the stock more accessible to a broader range of investment houses, and then finally, we believe our share price remains sort of well discounted to what could be a fair value, so presumably we'll provide good returns over the next few years.
So that's the broader pitch, and hopefully we'll chat about it in more detail.
Great. Thanks, Andrew.
Thanks.
We'll get into the questions, and you raised a lot of points that I want to dig deeper into. One obviously the ROE. I mean, one thing that struck me in the Q3 results, 16% basically 16% ROE, despite you know, if I look at it on a sequential basis, flat sequential growth, some margin contraction sequentially, still rising provisions in your equipment finance portfolio. So it seems pretty remarkable to be able to deliver that kind of ROE in an environment that's still not... You know, there are definitely still some challenges there that you're clearly earning through. So the question is, you know, how are you able to do that? And give us a sense in terms of the engine behind this.
Yeah, and I think the margin compression is so more a feature of, frankly, you know, different quarters, different length of number of days in the quarter really drove that. So I'd say margins were flat. Certainly as part of the success we've had as we made a transition to more fee-based income is certainly really helping. So the securitization income, some of the fee-based revenue we're getting from ACM Advisors, which we only bought in the, you know, towards the end of last year, and some other things we bought with Concentra Trust are driving that sort of fee income, which has also been part of a strategic pivot. So I think, you know, it's managing our cost tightly, obviously, and driving good businesses is really what's driving that ROE.
Wanted to talk about capital. It's an advantage of slower growth, I think, if we can call it that. I mean, you're definitely creating a lot of capital, 14.7% CET1 ratios you showed, up 60 basis points quarter over quarter and likely to expand further from here. So that leaves you in a good position. It's a good problem to have a lot of excess capital, and the question is, what do you do with it? What are your capital deployment priorities between, you know, buybacks, dividend increases? M&A-
Right
Obviously, organic growth. So how do you think about sort of ordering those priorities, and how do you think about this?
Yeah, so I mean, there's a lot of different options with capital. I mean, we think we should be operating CET1 in a sort of 13%-14% range. You know, 13.5% sort of being the midpoint of that. So we've definitely got excess capital, excess common equity capital. You've seen that recently we launched an LRCN, so we're trying to have a more sophisticated capital structure, and over time, you'll probably hear us talking more about our total capital ratio than you will about CET1. Historically, we've always wanted... talked a lot about having a very simple capital structure with CET1, able to absorb losses.
In terms of priorities, the first priority, frankly, is to find other investments that we can make that generate our hurdle rates of return, that align with our challenger bank attitude, so things that bring value to Canadian consumers and deliver these returns on equity and kind of we, where we can get our staff and team excited about the value we're bringing to Canada through this kind of challenger bank attitude. So that is the first approach. Much of it is really reinvesting in our business, reinvesting in loan growth, and also finding new services that we can offer, whether it's better services in EQ Bank. We're just going to be launching our small business banking option on September the 11th, I think, this year.
There's the things we're constantly rolling out and having to invest, and wanting to invest in. We've just come off a period where we made a commitment five years ago that we were going to increase our dividend by 20%-25% CAGR over the five-year period. We just kind of job done. In the last quarter, we just achieved that. We're in a process right now of certainly about listening to investors to sort of we'll see what investors think is the right way for us to go. That's gonna help inform our decision. I suspect going forward, we will continue to have an increasing dividend, but still a lower payout ratio than the other banks, 'cause we do believe we've got significant growth opportunities ahead.
While we have a NCIB that we're able to use, we haven't actually used it for our common equity to buy back shares. But I think it's certainly a tool in the toolbox we want to think carefully about when and how we would use that as another way of deploying capital. There's a few alternatives. I would say we're in a bit of a process now as we come through to our year end, and we're sort of thinking about year-end planning for next year. We're actually sort of really open to some conversations. Interestingly, the only comments I've had back from shareholders today is, "Keep your dividend relatively low and do what you're doing," i.e., find high ROE businesses that you can continue to grow and invest in.
Be particularly interested in somebody who has a different view than that, because, you know, the only view I've heard so far is that view, which kind of aligns with where we've been historically, and so it sort of makes sense to us.
When you talk about finding high ROE businesses to invest in, is this sort of an organic strategy or inorganic, both, or how do you think about it?
Well, I think our superpower is actually setting up things organically. So when you think about what we actually grew, I mean, frankly, we've grown our single-family business almost from scratch. We did grow it from scratch and really grew it since the global financial crisis. Things like getting into multifamily insured mortgages through the Canada Mortgage Bonds, a big driver of growth, was something that set up entirely organically, as was reverse mortgages and lending to other lenders. All of these have been great businesses. But on the other hand, you know, we did buy Concentra Bank a couple of years ago, and that would, you know, added to our growth, added to scale, added some capabilities and servicing the credit union system.
And more recently, we're very pleased with the investment in ACM, which is an alternative asset manager with about CAD 5 billion of mortgages that it manages on behalf of pension plans and institutions. And so buying more capability through M&A is also an interesting option for us. We believe we've actually developed the skills to buy businesses and integrate them and oversee them. Both of those things are available. We certainly spent a lot of time thinking about how could we build businesses from scratch. You know, I love the idea of building businesses. There's no goodwill associated with buying a business. You know the risks you're taking as you enter them, and I think that's actually a capability that we already have in spades.
So in terms of that, build versus buy, I mean, your preference is to build, but if you don't have the capabilities in-house, you
I think that's right. And so just, you know, your point on things like things we probably most focused on would be a wealth offering. You know, we're the largest bank in the country. You could argue ACM is a wealth offering, but I think certainly we have 450,000 customers in our digital platform that we know from customer research they are open to a wealth offering from us. So would there be something we can do in wealth? I think that that's a really interesting opportunity. Payments as well is an area that we, you know, are involved with.
We have payments infrastructure that we provide to others, but there may well be other wealth, other payments businesses that we could add to supplement to our capabilities, and that would probably be a buy rather than a build.
In terms of this idea of building new businesses, you know, I thought maybe we'd get a little bit of a flavor in terms of how you go about deciding to launch new products. I mean, one product in particular that I'm thinking about is just, you know, your small business offering, and so maybe just focusing on that to get a flavor of how you think about this in terms of, you know, why that offering, why now?
Yeah, absolutely. That's a great, good question. So we're very informed by what we see in banks around the world and trying to bring the best ideas we see from around the world into Canada. So, you know, we look at DBS in Singapore and Nubank in Brazil. I spent a fair bit of time in London thinking about what's Starling and Monzo and other digital banks there doing. I think generally, we've taken the view that small businesses are poorly served by large banks, and it's probably natural. It's... These are hard businesses to serve. There have been a number of digital players, certainly in Europe, that have stood up and really kind of created breakthroughs for small business.
It seems to us, and then we obviously bring the research back to Canada, think about it, and talk to a lot of Canadian small businesses, figure out where we think the offering might fit for us. We believe the same opportunity also arises in Canada. We already have a digital platform for individuals. Many of our customers already have small businesses alongside their personal accounts. The view is that if we offer them a single pane of glass where they can see the cash sitting inside their small business as well as in their personal account, that that provides value to them, and then the ability to move money easily between both of those accounts.
Since really it's a 100% shareholder that owns a 100% of the business and really thinks of the money in the small business as being their personal money. And so we've seen that Starling actually came from almost zero, well, zero... no presence in the small business market in the U.K. to over 10% today. And we believe that, you know, we can bring similar innovation into the Canadian market and capture a good share there. And obviously, there's lots of deposits sitting inside small businesses. Much of the cash is often deferred for tax reasons, and so we think that there's a lot of reasons that we can gather deposits from the small business community.
I just wanted to get you to talk a little bit about the Laneway House Mortgage, just again, to get a sense of how you think about product innovation and servicing your clients.
Yeah, I would see that one as more an extension of what we're already doing. I mean, we put a press release out about it, 'cause we're trying to make sure that mortgage brokers know that we have this product. I don't think this is gonna be something that, you know, three or four years from now, many are saying, "Well done, EQ Bank.
You know, look at the fantastic business we've built in Laneway Housing." But I do think that it is another product that we can go to the mortgage broker channel and say, "Here's a lender that really is looking after the mortgage brokers, providing them a full product suite, so that they can be more competitive in the market." And just by way of background, we deal in the single-family mortgage business, in people's residences, we deal exclusively through mortgage brokers. And those mortgage brokers have gone from having about a 10%-12% market share back in 2000, to having close to 50% market share today. So we've been riding the success of the mortgage broker channel, which has been professionalizing dramatically over that period.
The more that we can be relevant to them, and if a niche product like a laneway house, a more relevant product like a Reverse Mortgage, can help them kind of have more customer relationships, be more relevant to their customers in many different needs, then we win in the broker channel, and we believe strongly in the broker channel.
I want to talk about loan growth and... Well, maybe a more fundamental question in terms of. I get this question in terms of: Should we be focused on loan growth, which, as I mentioned, you know, sequentially was flat in Q3, or is Loans Under Management a better lens to judge Equitable?
I think certainly thinking about Loans Under Management tells you something about the breadth we're having in the market. Now, we are seeing good growth in Loans Under Management, principally because one of the areas of focus since the monetary tightening kicked in has been insured multifamily mortgages that we're securitizing through the Canada Mortgage Bonds, and so we are seeing good growth in Loans Under Management, even while the on-balance sheet assets are showing a more muted growth, and frankly, I'm actually positively surprised by how the business has responded in the wake of, you know, most unprecedented monetary tightening, certainly stuff that we haven't typically observed in our careers.
So, you know, there's still activity in the housing market for sure, and then presumably, as it's very clear, that the inflationary sort of pressures have been beaten and the Bank of Canada starts to ease here, we're going to see more pent-up demand coming into the housing market and showing up as transactions, which sets us up for a more positive year next year, and then the year after.
In terms of the timing of that transfer mechanism between rate cuts and when you expect to see activity, how do you think about that?
I think you're probably as well as better equipped than I am to figure that out, 'cause I think it's... There's no analytical answer to that, right? At some point, the mindset changes where people say: The housing market's getting more active, and if I don't buy a house now, maybe the house price runs ahead of interest rates coming down. Quite when that happens, you know, I don't think it's going to happen next week, but I would have thought by March or April next year, we'll be into a more typical spring market for Canadian housing, where rates will be an acceptable level and people will be thinking more constructively about purchasing a home.
And there's got to be all kinds of pent-up demand, people that have had children that would like an extra bedroom but haven't chosen to move and disturb a low-rate mortgage today, or maybe are thinking that the house they want to buy is going to come down in value. There's a lot of people that have been sitting on the sidelines for a couple of years here now, frankly. So when activity does start to move, then I think we could be surprised on the positive side by how things move upwards. You know, I don't think our business success is predicated on that, but I'd have a fairly constructive view on how that moves going forward.
Sort of the key risk to that outlook, would it be the unemployment rate, or would you have-
Certainly, that's always the risk of defaulting mortgages and housing activities is really about unemployment. So if we see, but we're talking about, you know, dramatic increases in unemployment from where we are today. While we've seen unemployment increasing a little bit, frankly, we needed to see that, otherwise inflation couldn't come down. You know, if you're concerned about scenarios where we've got sort of 12% unemployment, then you've got different stories to tell. But I don't think anybody would suggest we're going to go anywhere like that. Probably will see rising unemployment over the next little while. You know, frankly, in many industries, a shortage of labor for a number of years here now, that starts to get fulfilled as a slackening of the labor market. I don't see us suddenly going to these, you know, very dramatic unemployment levels.
In terms of the, you know, the strength that you're seeing on the multifamily side, you know, we're hearing the government scale back immigration targets, and that conversation is moving in the opposite direction of where it has for a long time. Do you see any risks to the multifamily story, or is that pretty well on a pretty good growth trajectory in your view?
Certainly, it seems to be on a pretty good growth trajectory, and frankly you know, we've got behind, right? We've got to catch up here to build enough housing units for the number of people that have come into the country and, you know, want to form households here in Canada. People living in substandard housing, and we need. We've got a lot of building that needs to be done before we'd ever be talking about the problems the other way, and I think what will be interesting is, over a sort of five or 10-year period, what is the national sort of consensus on immigration? You know, have we changed this fundamentally? I don't really believe we have. I mean, fundamentally, Canada is a country that's open to immigration.
It's just, I think, over the last two or three years, possibly we let it get a bit out of control, and that's caused a bit of a pushback. But I would have thought over the longer time period, we're still going to be a country where we've got, you know, above normal population growth for the G7 as we continue to welcome people from around the world, into what's, you know, one of the world's sort of good democracies, for sure.
I want to talk about credit. Obviously a big focus for investors. Your gross impaired loan ratio continuing to climb higher, 118 basis points in the most recent quarter. Now, fundamentally, what's been driving that? How would you kind of unpack that? And why shouldn't that be concerning for investors? You know, when investors see that kind of-
Right
... growth in that gross impaired loan ratio, their natural inclination is to get nervous, but why should that not be the case?
Certainly the biggest increase this current quarter, which probably really came from two commercial loans. These can be lumpy, and they, we're very comfortable they're fully reserved. Losses are going to be minimal to none. So that gets me comfortable on the commercial side. On the single-family side, you know, we're really not seeing any losses. So, yes, we're seeing GILs increase, but not expecting any losses. I think, you know, losses so far are less than one basis point on that portfolio. So it feels pretty good. And certainly, one of the points of conversation in the last, you know, quarterly call last week was really about losses in our leasing portfolio, and, you know, that's really been the story for a couple of quarters now.
We still think we might have some things to work through here, but we're getting kind of feel more and more on top of it as time passes.
You know, we've talked about it on the calls, but can you give us a little bit more color in terms of, you know, what's going on in that equipment finance portfolio and on the transportation side in particular?
Yeah, so I mean, the total equipment financing is about CAD 1.2 billion. Sort of under half a billion is long-haul transportation. And that industry, in particular, has had really taken it on the chin as sort of moved into a post-COVID era, where the demand, you know, suddenly dropped quite dramatically, and we've seen surprising, you know, propensity to default there. That is really the one area of our business where we expect credit losses. You know, in the real estate financing businesses, obviously, we can get credit losses, but we're not really pricing for credit losses.
We do price for a 1.5%-2% annual loss rate in our equipment financing business, and we're seeing loss rates higher than that, and it's really all stemming from this long-haul equipment business that we primarily from our 2022 cohorts, where there was such demand that people were borrowing from us to buy trucks, and as demand came out of the market, just unfortunately lost the routes, and that's been problematic for us.
And so, you know, sticking with that portfolio. If you could just highlight sort of the outlook there in terms of how you expect that portfolio to perform over the next few quarters?
Yeah, so I mean, we are seeing encouraging signs, so fewer NSFs and so on going through, but it's still a stressed environment. We are seeing good second-hand equipment values too from a recovery perspective, so we, you know, not seeing higher losses when we do go to default than we expected, but I still think, you know, the jury is out a little bit for another couple of years here.
And in terms of, you know, when you look at this experience, as you highlight, pretty unusual experience.
Yeah
... for EQB, what lessons do you draw from that? Does anything sort of stand out to you?
I mean, certainly, it highlights something we already know, that when we make acquisitions and we move into less familiar businesses, there's risks that we didn't otherwise understand, and you know, I think that that's certainly one of the learnings that we actually knew that already, but it certainly came home in spades, and so I think you know, we really really understand the other businesses we're in, and we need to kind of think through how we would approach acquisitions where we're taking credit exposure going forward.
And then in terms of how this impacts how you think about business mix overall, I mean, your portfolio is very heavily weighted towards real estate secured lending. I think sometimes when I speak to investors, there's a pushback that view that maybe you should diversify away from that. You know, in these kind of credit experiences, maybe the message is the opposite, that actually more resilience is better. So how do you view that from a business mix perspective?
Yeah, I do think, you know, we're committed to broadening our business over time. And while most of our assets are backed by, you know, real estate, we also have loans backed by, say, cash surrender values on life insurance policies, other kinds of assets. So there are other things that we want to go into. But I would say generally, we view ourselves as an asset-based lender, as a bank, so generally, we're looking to have some kind of hard asset or you know, contract behind whatever we're lending against. I think we're unlikely to move into more unsecured lending, but generally speaking, you know, we would like to broaden the asset categories for sure.
Maybe just to round out the discussion in terms of, you know, why the increased impairments are not translating into losses? I mean, I think maybe it's a little bit self-explanatory, but just in terms of, you know, fleshing that out in terms of, you know, what's underpinning that performance there?
Yeah, I mean, really, it's because we're already lending at a relatively lower loan-to-value, so you can have a commercial mortgage that's gone into default, the cash flow isn't necessary enough to support, service the loan, but nonetheless, the building is worth more than the underlying mortgage. So the mortgage, the building gets sold, and we get our money back. And the nice thing in commercial real estate, you know, is even though it's a larger number than we've ever seen before, we can be pretty comfortable in the underlying collateral values and the, you know, what the recovery is gonna be available. So you can get super comfortable with the Stage 3 provisions that we're putting up and on that basis.
Wanted to talk about non-interest revenue. It hit a record in Q3. As a share of total revenue, 17%, it's above your 15% target. So I guess the fundamental question is: What's driving this, and how sustainable is it? And could it go much higher in the near term? Is there that power there?
I mean, it's certainly been a strategic direction that we've been taking to try and, in addition to kind of lending returns and NII, to move to more, fee-based revenue, and we're seeing it across a number of parts of our business. So ACM, that we referred to, is an alternative asset manager, managing about CAD 5 billion of commercial mortgages that provides fee income to us. So far, very happy with that acquisition. When we bought Concentra Bank, we're providing a bunch of services to the credit unions. These are quite wide-ranging, actually, sort of helping people with an RESP, but, but also things like we provide asset-liability matching services, so advisory services to about 30 credit unions.
Then, you know, one of the bigger drivers in this quarter of that fee-based revenue is related to multifamily mortgages, where we're originating multifamily mortgages and securitizing them into various Canada Mortgage Bond programs, so it's across a kind of a wider range of activities, but we certainly see opportunity to continue to drive that.
The sustainability of this quarter, how would you characterize it?
Yeah, absolutely sustainable and growable from here.
I want to ask about ACM. You've referenced it a few times. You acquired it last December. Can you remind us why you decided to acquire it, and how it fits in with the bigger strategy that you're set for the company?
Yeah. So these, these are assets that are adjacent to what we do. Many of the same customers of ACM would also be customers of ours, so we might be lending to a client on a construction loan, for example, where a cash flowing loan from the same client sits within the same ACM port, within an ACM portfolio. ACM, the funding comes from pension plans, institutional investors that want exposure to commercial mortgages. So, for us, it's part of that diversifying into fee-based revenue, while at the same time, working into something that's very familiar to us, many common customers, opportunities to cooperate where potentially there's a mortgage that we can. Or we've got a customer that ACM may not know, where we can provide a referral.
Clearly, they need to be operating in a way that's, well, they've got prudential responsibility to their own client base. There's many things we can do to cooperate and help each other through the piece.
Andrew, I think we're running out of time here, so I appreciate the time that you gave us, and always looking forward to speaking to you.
Thank you, Meny. Thank you.
Thanks a lot.