EQGPF - EQB: Small Cap Bank With Multiple Growth Vectors

Summary

• Reverse mortgages continue their strength with EQB gaining market share and accelerating growth in Q4.
• EQB has a growing dividend, reasonable valuation and solid loan growth prospects for 2023.
• The Bank of Canada paused interest rate hikes which should be supportive of credit and mortgage markets.
• EQB's digital banking offering is a long-term play to increase awareness, assets and potential for mortgage originations.

EQB Inc or Equitable Bank (EQGPF) (EQB:CA) is a digital bank, mortgage lender and financial institution in Canada with a ton of upside. This small cap bank is growing assets and revenue at a much faster rate than its peers but trades at a valuation below the major Canadian banks. Reason being is they are seen as being levered to Canada's housing market and due to its small size at 2.5B CAD market cap. Some are worried if that interest rates go higher it could be potentially disastrous for housing, with prices sky high and rates crunching anyone on variable mortgages. However, reverse mortgages are going to explode in popularity in coming years, with 55+ homeowners choosing to stay at their homes by taking their equity at a high interest rate. This should be a large growth driver for EQB, which has a strong start in the reverse mortgage market. They also have digital banking offerings, aiming at those disillusioned by the big 6 Canadian Banks that have 90%+ share of the market. This 'Challenger Bank' mantra they have given themselves is apt with them growing impressively for just 7.3x forward PE. The dividend has grown for 6 straight years and sits at 2% with most earnings retained to fuel growth. Let's delve into the financials - keep in mind all figures here are in Canadian dollars.

Strong Financial metrics

EQB continues its strong growth with 22% revenue growth for the year to $785.4 million. Both personal banking and commercial loan growth were very strong for the year - boding well for 2023. Personal loans were up 43% and commercial were up 44%. This includes a large contribution from the acquisition of smaller Concentra Bank in November . Organic growth was strong as well, however, with 15% organic growth in single family loans. Commercial loans grew organically at a strong 26.5%, far above the 15% guidance the company gave at the start of year. This accelerated growth of revenue combined with earnings growth of 10-15% in 2023 should mean an increase in multiple. Net interest margin grew slightly to 1.87% and impaired loans were just 0.3% of all loan assets. Interest margins should improve over time as asset mix should move more towards conventional loans and reverse mortgage loans.

The company has also increased the dividend to $1.40 annualized giving a solid yield, up 25% over the past year. This puts EQB solidly in the dividend grower bucket having consistently increased the dividend the past 7 years. This is all the while trading at a very reasonable valuation of 7.7x trailing earnings, largely because of the fear of a housing slowdown that could hit earnings hard. A mortgage competitor Home Capital Group was recently sold for 11x earnings, purchased by Smith Financial Corporation . The rub is that Stephen Smith also owns a significant share of EQB at 17%, showing it could be a potential buyout target in the future. Home Capital went for a 63% premium - showing the valuation disconnect EQB has from where it should be trading. The stock had a small pop when it was first announced but the stock isn't given much credit for a very possible future buyout.

Reverse mortgage momentum

Reverse mortgages are growing in popularity quickly because of the large amounts of equity Canadian homeowners have. Many older homeowners would prefer to stay in their paid off homes rather than downsize to a condominium or rental unit. Considering the large number of Canadians in this situation, this solution should continue to grow throughout the 2020s. The table below shows the strong growth in EQB Reverse Mortgages over the past year up to $860m - up 249% y/y. You can see originations were extremely strong in Q4 with growth accelerating and Equitable gaining considerable market share. Marketing and knowledge of Equitable's offering have grown considerably over the past year and bodes well for 2023. While this is still a very small portion of total personal loans, it will drastically grow in importance over the coming years, as EQB leans into this large and growing potential market.

EQ Bank

Equitable's digital banking option EQ Bank is starting to gain a foothold in the retail banking area. Those who are looking for an alternative to the expensive big banks like TD Bank (TD) or Royal Bank (RY) have a new option with a fully digital experience. They just added capability for those in Quebec to join, which is one of the biggest provinces. Equitable also just added a card which should help adoption over time, with benefits like no ATM fees anywhere in Canada plus no foreign exchange fees. These kind of benefits should strongly increase uptake in the coming months, with inflation concerned customers very likely to take advantage of such an intriguing option. Growth of customers was a solid 23% y/y with deposits up 14% to $7.9 Billion. This is a long term growth driver for EQB with ability to sell additional products like mortgages and business lending to these customers down the road. It's also important to improve knowledge of the EQB brand as many Canadians are not aware of them and their extremely competitive offerings in the market. This segment is of strategic importance although it is not a driver of earnings at this time due to its small size.

Technical setup

EQB has had a strong rebound of late, as the market responds bullishly to the slowing rate hikes of the Canadian central bank. The central bank has paused at 4.5% and said they are waiting to see the lag effects of the rate increases before any more movement. While it is possible they hike again, they are wary of the potential risks to the housing market. This is tailwind to EQB as they benefit from the significant prime rate, but a major significant risk is reduced with mortgage originations. The Canadian market continues to outperform the US market with its larger portion of materials, industrials and banks. The lack of technology in the index means a stronger relative market in Canada and should act as a tailwind for 2023. As you can see above EQB went above its 200 moving average, retest it and its 50 day and has continued higher. Resistance will be significant in the high 70s to 80 range where its previous all-time high came at the peak of the market in late 2021. Look for it to go to that area during this year with a strong Canadian market and continued execution on long term plan.

Conclusion - Strong buy

Equitable Bank beat all of its major metrics in 2022, with strong growth in its digital banking unit and reverse mortgages. The growing brand value means more growth in the future with the stock multiple to re-rate higher from just 7x once the market appreciates the growth. The stock is a strong buy for Canadian investors looking for a diversified bank and dividend grower to hold for the long term. It is a great option for younger investors to replace some traditional bank exposure to get additional growth over the coming years. You won't find many stocks with 15% earnings growth, growing dividend trading at just 7 times earnings making this a must own in Canada.

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