EQB Inc. (EQB) Earnings Call Transcript & Summary

Our next session, and I'm very happy to have with us Andrew Moor, President and CEO of EQB. This is EQB's first time at our conference. Really happy to have you join us today, Andrew.

Well, thanks, Geoff, and thanks for having me.

Maybe as a start, as is given it's the first time at the conference, I know you've got a few kind of opening remarks that you wanted to run through before we get into the fireside chat. So I'll hand it over to you.

Great. Thanks, Geoff. Given as Geoff mentioned, this is the first time we've appeared at this conference. Hopefully, it's a chance to meet some new people. I thought it might be useful to kind of come up with a new few slides. So I'll tell you the top of the house story rather than getting to some of the detail with it that Geoff and I will talk about as those of you more familiar with the story. Thank you very much for being here for the last session of the afternoon. I recognize we're not the main draw, but really pleased that you're taking some time with us. So we position ourselves as kind of a challenger bank. I think it's a distinctive position in the marketplace. We are now the seventh largest bank in Canada, and people tend to think about the banking industry being occupied by 6 guys. We are the seventh. And I think we've got a [indiscernible] position. I'd like to kind of try and jog up into the kind of thinking about where we might fit in your investment portfolios. So in terms of how we differentiate our position, first of all, EQ Bank is -- we believe, the leading digital bank in Canada today. You'll see a lot of noise from us for any of you watching football on the weekend, you'll see us with new advertising platform in the marketplace with starting [indiscernible] down levy to try and really elevate our brand and try to get a consensus consciousness around the value that we're offering in the EQBank platform, really grow very fast. We've launched this business in 2016. Today, we have 400,000 customers, and many hundreds of customers are joining every day, and we expect as we build our brand in the marketplace, that will continue. We have a really strong funding position. Not only do we have EQBank, providing deposits we've got the broadest reach on brokered deposits, access to covered bonds in Europe, deposit notes a really strong position. Most of our lending is in major urban centers and really most of it relates to things that people -- places that people live. So while half of our business is described as commercial and half personal and the commercial side is mostly funding apartment buildings, condominium construction and things that really are useful to solving the kind of major structural issues that we seem to be facing core today, which is we don't have enough places for the people, people to live that a number of deals want deliver in the country. And with the acquisition of Concentra that got concluded in November 2022, we're now the seventh largest bank in the country, and the acquisition has gone very well for us. Here is our value creation methodology. We generate about a 15% to 17% return on equity. We pay out about 10% of that or 1% of our capital as dividends every year. Dividends growing at about 20%, 25% a year, but still not a high yield compared to the other banks. That leads to book value growth per share growth of 14% to 16% and EPS growth of 14% to 16% as well. This is a plan we put out many years ago as kind of what we're trying to achieve, and this is what's led to the superior returns you can see on the next slide. So if in fact, you take all of the banks listing on TSX and the S&P 500, look at the total shareholder return over the last decade at this point with the top of the stack in that regard. And you'll see that while we produced a 15% CAGR on total shareholder return, that really lines up very well. This is not because of multiple expansion. This is because the book value per share has actually grown by 14.9% CAGR over that period. EPS lagging that a little bit that could be a little bit volatile depending on earnings in any one kind of period. But I think the book value per share tells the story that over that period, the earnings have been strong enough so that retained earnings as growing the book value. It's great to see so just beating out JPMorgan and there's some other kind of lustrous names in the U.S. market, and I think we can all agree, have had a pretty good decade as well. When you think about Canada, again, obviously, given those same banks are included on the list, you see again that we're top of the stack here. And I think it's interesting to think about the top 2 banks being National Bank of Canada ourselves, having those total best returns over the decade. And it certainly gets you thinking why that might be the case. And I think one of the reasons why that might be the case is, both of these banks are more focused on investing in the Canadian market where good returns are available. There's a rational structure to the industry, and we continue to be focused on Canada or it's a place to invest and build our business. Having said that, you might have seen these returns and say, well, it's all over I missed it if you did indeed miss it. But I'm not committee story at all. In fact, when you look at this kind of conventional way of value in banks in terms of kind of regressing ROE to price to book, you can see the value to date could be $136 is a fair value, where trade just shy of $90 as we speak. So I think there's going to be opportunity on the upside even to kind of correct that close that gap. And then, of course, hopefully, we can compound the returns of 15% as we have over the last decade in the years ahead as well. I think one of the interesting stories, one of the differentiators between us and the other 8 banks you've heard from today is the amount of earnings that we're retaining. When you think about retained earnings, really, it's an opportunity to invest in the bank at book value in a sense because in fact, that payment got paid out as a dividend, you'd have to pay the premium available in the market if you just wanted to reinvest back in the bank. And so I think that's a bit of a secret sauce to kind of why we've been able to generate these higher returns is that ability to keep compounding the capital within the bank returning on the balance sheet and finding ways to deploy it, but continue to drive this 15% to 17% ROE story. So why might be the time to look is the first time we've been invited to the Royal Bank Conference to come and speak to you. So it obviously shows we've passed a barrier that maybe could set off a new series of shareholder growth. But we also just relying our fiscal year to the Canadian public traded bank. So we had a 10 months here last year that concluded at the end of October. Geoff has been a very strong analyst with us for many, many years, and we really value his insight. Many of the other banks to have the same history and we're largely getting the bank analysts to track this now with the market capitalization now comfortably over $3 billion to some extent, it moves us into the other investable opportunities with other portfolio managers. So hopefully some of you want may not have considered this before, but now that we're past that $3 billion on a threshold, perhaps there's an opportunity to think about. We are trying to generate more liquidity in the stock, one of the NOCs in the past has been -- there isn't enough liquidity to allow me to buy stock. So we have been trying to do some deliberate things to increase trading volume and liquidity. One of them was stocked a couple of years ago. Anything else if you have any other ideas about how we might be helpful in that regard. That would also be good. But clearly, actually, that insight cable, the stocks that came from Royal Bank actually talking to traders and understand dynamics of you actually do get more volume when you speak -- and as I say, we believe the share price remains well discounted versus the peer group. And so there is opportunity still to have a better around there. So that's kind of my comments, Geoff, maybe we can move to my [indiscernible].

Perfect. Andrew. Maybe I'll start off similar to Darko with his previous fireside chat start on interest rates. It seems like in Q4, calendar Q4 last year, interest rate expectations in terms of size and then how quickly things might move seems to have changed during the quarter. I wanted to better understand from your standpoint, what your latest rate expectations are for 2024. And if we actually see things move a little bit more aggressively here, how that's going to impact the business in terms of NIM yields, NII, loan growth, those sorts of things.

We don't think we're smarter than the market to figure out how interest rates are going, frankly. The market is telling us is 100 basis points of back account is going to be decreasing rates by 100 basis points this year, probably starting in April. So that's our best guess. And that's the way we would try to run the business based on those market proxies. I think there's a number of things there that are helpful. So we run a 1-year duration of equity. We always keep our equity, the equity position to manage interest rate risk in the banking book at 1 year. That implies that as rates have dropped 100 basis points as they have broadly along the curve over the last few months, last couple of months, we picked up about $30 million of future NIM. So that's the good news. I also generally find that spreads on mortgages and lending products tend to increase as rates are dropping, just general find that the kind of competitive environment is not to race to cut rates. On the other hand, we'll see a little bit of a drag on the NIM from a reduced deposit beta in our EQ Bank platform. We saw some gains last year as we only increased the savings rate to EQ Bank by 1.25% as the bank went through a much more aggressive tightening cycle. So we'll be giving up a little bit there. So it's a bit of gives and takes. Broadly speaking, we expect the NIM, the margins to be broadly similar over the next couple of years and not terribly sensitive to the pace at which the bank changes rates.

I wanted to go over next into -- on mortgage renewals. One of the, I think, kind of interesting disclosures that you made in the Q4 results was that 80% of your uninsured residential mortgage borrowers had the mortgage either originated or renewed in the current higher interest rate environment or mortgage rate environment and are not expected to have a material increase on the payment at renewal. And given your residential mortgage rate book largely geared towards that Alt-A Type R, which typically take a 1-year, maybe 2-year type term. How do you kind of define what high -- like how should we think about what exactly is higher rate when you define that when computing that 80% figure? And how do you define not expecting to have a "material increase".

Yes, the way we got to that number was, I think, all the mortgages are renewed or were priced after the bank can already moved 300 basis points. So not the last 100, but those that would have seen the kind of the bulk of the shock. So really the ones that either renewed or were originated after the spring of 2022. So I think a pretty good proxy for those have probably already seen the bulk of the mortgage shock. And I think the encouraging thing, frankly, is the big picture is, as you're hearing, I think, over lunch. And so there's the most people are still managing their mortgages pretty successfully even on these higher shocks. And we're pretty confident that we're not going to see material losses in the single-family mortgage book.

And why is that? What has been really driving the ability so far the people that have had renewed why they have been able to still service the mortgage payment. Is it coming up with cash somewhere else to adjust the [indiscernible] ? Is it they've got income somewhere else to be able to cope with the higher mortgage payment?

Mortgage market is really complicated. So anybody that's sort of have been studying mortgage markets for 35 years, still learning something every year. But -- so it's all of the above, I assume. But clearly, employment is really important. So employment is really important in mortgage delinquency. So mortgage -- so employment situation in Canada and North America generates still pretty strong. The ability of people to work extra shifts take gig work and so on. It seems to be the big driver. But I think also many of the people that we lend to have probably got more complex family situations. We got maybe the kids that can ship in a bit parents that can ship in a bit from savings. And I think all of that is leading to a pretty good conclusion.

And did you -- it doesn't sound like you've had much, but how -- if you were to quantify it, of those people that were renewing did wind up having some sort of difficulty being able to service the. higher payments? And how did you kind of treat those situations?

We certainly listen through stories, and that's a regulatory expectation, but it's also the way we want to treat our customers. And so if there is a some kind of remedy, maybe extending the amortization a little bit so that the payment can be slightly reduced and people can make it with the income they're able to make with certainly listing of those stories. What I would say is the number of loan modifications on that basis are really small kind of less than 10 type of thing out of a book of 30,000 mortgages. So it's there where are listening -- we always have, but it's not a big feature of what's really going on.

And looking ahead to 2024. I'm not going to hold you to it, but what does your crystal ball tell you about how the Canadian real estate market and mortgage market is going to fare.

Certainly, the way we built our budgets and the kind of messaging to our investors is that we expect the second half of the year to be stronger than the first half. You presumably triggered by [indiscernible] starting to move rates down, but also in terms of people giving -- getting confidence in the rate market is not going to be something that's going to move against them, but I think that has been a bit of fear. We've got a lot of pent-up demand. I think Ron [indiscernible] was putting some notes, some comments at lunchtime trying us have the slowest real estate market in 23 years and something. So housing markets do need to move. There are real life events, another child arrives another betrays needed. People who are in the get married, they want to set up a household together. There are real things that pressure people to being active in the housing market. So I think the combination of that pent-up and a bit of confidence by where interest rates are going, will actually trigger more activity and that's obviously good for us gives us more opportunity to lend. And so we're looking forward to the second half of the year with some optimism. I think I mall concerned actually already been sort of talking about principally coming down this year and people starting to jump the gun a bit on that, right? I'd like to -- I hope that the market isn't -- doesn't get so far so quickly that feels like a bigger risk than things being a bit too slow.

I want to switch over now just talking about on the expense side here. And I promise you, there is a question of all this. I want to try to put everything into context here. So I mean, historically, EQB's efficiency ratio has been lower than the Canadian banks in large part because you don't have a branch network. Your efficiency ratio typically has been around 40-ish percent. We saw post the Concentra acquisition because they had a higher efficiency ratio kind of moved into that roughly 44-ish kind of percent. But there's been other things too, right? There's been the increased spending on brand awareness and it's also increased spending related to kind of growth of the business and what kind of the branding is a more sophisticated bank. You're continuing to expand the EQ Bank product offering and also other investments you'll need to support your scale. Just wanted to understand here is, how should we be kind of thinking about expense growth or the efficiency ratio over the next couple of years? And what are really the key factors that are going to drive OpEx growth going forward?

Yes. So we're always thinking about ROE as you probably kind of gather from my opening comments and some ways efficiency ratio is one of the signposts lead you to ROE. You need you measure efficiency ratio to get to drive those -- so as you pointed out, our efficiency ratio appears to have gone backwards a little bit. It's a little bit higher than it has been historically. We have got more fee-based revenue coming in. And generally, fee-based revenue has a higher efficiency ratio. It's i.e., less efficient. If it doesn't absorb capital and presume they can't demand the pricing that would going to have really low efficiency ratio. So some of the kind of service businesses that we're delivering now through the Concentra acquisition and so on, are inherently capital-light and therefore, that's sufficient. So we've indicated in the market, I think that we're going to be slightly higher than the 44% last year and around the numbers, still driving the bottom line ROEs that we're looking for. But things like investing in our brand are really important to the long-term value for shareholders. So we've just starting some TV advertising started yesterday with down in Eugene levy from Schitt's Creek, starring and them trying to create this tension around why we should think about EQ Bank has offered. We've got a fantastic platform. We need to push the people a little bit to actually try and create that tension. So that's a worthwhile investment in my view, and it does push up the operating expense shopping efficiency ratio, a snick. And also, as we get bigger, we're aware, you see other banks getting damaged by potential issues with compliance and risk and so on. As we become a larger, more sophisticated bank, we don't want to be doing that at the extent of creating risk just by not having the right people in place to understand what our obligations are under the regulatory framework and regulatory regime, which is demand and getting more complex as we go. The good news in all of that, frankly, is the barriers to entry in this industry are becoming in surmountable. So if we think about sort of Warren Buffet type valuation, there's a deeper moat around banks than wherever has been, and I don't see that coming down any time soon.