EQB Inc. (EQB) Earnings Call Transcript & Summary

Well, I'd like to welcome our next speaker, Andrew Moor, Chief Executive Officer of EQ Bank. Thanks for joining the conference. First time for you and I to chat in this context. I thought, well, we discussed that it would make sense for you to give a little presentation and highlight some of the things you want to highlight about your business, and then we'll jump into Q&A after that.

Yes. Great. Thanks, Gabe. And it is sort of -- hopefully, there are some new faces in the audience -- or I'm seeing new faces in the audience, given Gabe's coverage. Thanks, [ Dechaine ], for covering for many years. We are kind of transitioning to bank analysts, so I thought, just to give you a high-level view of kind of the EQB story for those of you that may be general bank investors, but kind of think about the big 6 as being the universe of investors. So I did kind of want to bring up a few thoughts. So we position ourselves as Canada's challenger bank. We're obviously the largest branchless bank in Canada, over $100 billion of assets under management. And we really have, we believe, kind of Canada's leading digital platform at this point. So EQ Bank is really a marquee deposit gathering platform. And we're -- that's continued to grow. A few years ago, people are concerned about our kind of lack of funding options. We were relying a lot on broker deposits. Today, we have a wide swath of funding opportunities in EQ Bank being a direct-to-consumer range, but we also have covered bonds that we issue in Europe, deposit notes that we access other kinds of securitization ways of accessing liquidity and access, importantly, to the bank and Canada's STLF in the event of a downturn. So we feel that liquidity is always there. We manage it well. In general, our business is about funding the growth of Canada's major cities. So we tend to focus most on Montreal, Toronto, Edmonton, Calgary, Vancouver and feel that lending on real estate in those cities is a great place to be, given kind of the imbalance between population and demand for housing structures effectively. We've become the seventh largest bank in Canada, so it could be a good party conversation, what's Canada's seventh largest bank. Not many of your friends probably know that. Certainly, it was a mystery to my mother until recently. So we are spending more time building our brand. So you'll see here the levies are being used in English-speaking Canada. And theme we're trying to pull apart here is in many categories of life, we've changed providers over the time, right? So we've moved from going to Blockbuster to streaming videos on Netflix. Many of the people that were traditional providers 30 years ago are no longer. In banking, many of us are still banking with the same bank as our parents lead into us into as a teenager. And so we're trying to kind of tease that apart. Why is that. There are other options. And try EQ Bank for the option. And actually, Diane Lavallée and Laurence Leboeuf here in Quebec were actually resonating more strongly in the levies. For those of you who kind of didn't watch Quebec TV in the '90s, Ms. Lavallée seems to be somewhat iconic and attracting a lot of interest. We're actually finding attraction there. So again, this all goes to sort of building our franchise. And this is the way we build value. So we are the slowest -- also one of the lowest dividend paying stocks in Canada from a bank perspective. We pay out about 2% of our capital a year or roughly sort of 10% of earnings, generates a 15% to 17% ROE year in, year out. That means we grow EPS and book value per share at a compound rate of 15% or so. And that leads to this nice little table. I was apologizing to Laurence since I was invited here that you'd think you'd have National Bank represented above us, but either way, to be in the company of JPMorgan and National Bank for the total shareholder return over the last decade is a nice place to be. I think we can maybe chat about why that might be the case, but in any event, this is kind of a good spot to be. And yet, we're still cheap, so this is kind of the classic ROE to price-to-book kind of table. And you can see that we're a couple of standard deviations off of $50 per share, possibly cheap if -- just to get back on to that curve, so you haven't missed anything if you didn't buy the shares 10 years ago and you have, still, opportunity, we believe, to continue to create value. And I think part of the value there, sort of getting into this slide too much, but part of the trick is that we're able to reinvest these retained earnings rather than paying it out as a dividend and able to accrue 15% to 17% on that retained equity, so it creates this growth in earnings that's somewhat unique in the Canadian banking landscape where, yes, these banks produce great ROEs, but effectively, they're distributing most of the most of the ROE generated Canada back out to dividends. We're very well capitalized. I think it's kind of a bit of a logic around kind of Basel III, and Gabe, you're talking about, but you can see here that, roughly speaking, if you just -- if you measure this on an ARB basis, we have about 4.5% -- it's about 4.5% gap between us and the big banks. Roughly speaking, there'd be $900 million excess if you were considering a kind of like-for-like capital risk weighting on if we were an ARB bank, which were not. So I think it's a good time to think about Equitable. We've just changed our year-end, so now we're going to be reporting on the same cycle as the big banks. We've got some big bank analysts kind of covering us. So hopefully, it's giving us a bit more visibility in the market. Many people sort of said, "Well, we can't really invest in you, less than $3 billion in market cap, where you guys are too small." We're now over that $3 billion range. And Chadwick and his team in Investor Relations spend a lot of time trying to kind of make us deal with any objections investors might have to investing in us, so kind of trying to help with liquidity by executing a stock split, for example and just trying to be thoughtful about making sure we're as convenient we can be to be a place for you to invest. So that was hopefully a kind of helpful 5 minute intro, Gabe…

Of course. Well, my question, and I hear the challenger bank term used a lot from your management team. And I'm just wondering what that means and what it doesn't mean, and more -- maybe more important on what it doesn't mean. So 5 years from now, you're not talking about a bank with 15%, 20% of its earnings coming from wealth management, some capital markets activity. You're still looking at underserved segments of the market, correct?

Yes. I mean, underserved may not be the word I use, but areas where we can be a differentiated and compete, right? Where we can be -- have -- it would be a shame if nobody sort of competes. So for example, we're the largest securitizer of multifamily mortgages in Canada. We've got a great digital platform for deposits. We're 1 of 2 players in reverse mortgages. So it's kind of looking for distinctive niches in the market where we can go in and say something distinctive, add unique value and then kind of succeed as opposed to the ambition we might have if we were a more traditional bank with kind of trying to serve every need of every customer's life cycle. And so that's why you see us talking very positively about things like open banking. We accept that many of our customers will be dealing, not just with us, but with other institutions for other services, but we really want to stand out for the services that we provide. So maybe we've only got half of your financial life, but on the other half, you're going to deal with other specialists that. Doesn't seem necessarily like a bad place to be much as -- let's go back to my analogy. 30 years ago, we used to go into department stores and now we deal with specialists, maybe banking, hopefully, from our perspective, moving more in that direction.

And where are you in the -- like the -- what, EQ or Equitable, back in the day it was and where it is today? And in terms of the trajectory you see for where you ultimately want to be? How far are we into that process?

Yes. I always worry with North America sports analogies, but I think we're kind of in the second or third inning, maybe, of a baseball game. Rugby and football are my, with a ramble, are more my games. But so -- but we're just going to go in. So it took a lot to actually stand up a digital platform. And we made that decision in 2014. We opened our doors in 2016, very much borrowing our best digital bank practices around the world. So the banks looked at are the banks like Monzo, Starling, Nubank in Brazil, DBS in Singapore, to look and see what we can borrow from those markets and adapt to a Canadian environment to provide unique value. And we're getting more and more competent every day. Like, we made some mistakes on the way through. The good news is we've learned from those mistakes. We've embedded them in our systems and processes. So it's hard for others to now catch up with us, frankly, because we're that far.

And in your -- you touched upon a few building block and a financial performance metrics, I guess, if you're paying out 10% of your earnings and then generating 15% ROE. 15%, I think it's earnings per share growth. Could you give a bit more of a sense of the building blocks to get to that 15% ROE where, when we take into consideration what kind of asset growth and revenue growth and expense growth and maybe a bit more emphasis on expense growth. I'm boring that way. I focus on expenses. But being a relatively smaller institution, the investments required in systems, brand awareness, they can be pretty substantial and for a number of years.

For sure. I mean, so first of all, ROE is kind of the number I was looking to. So things like expenses are part of building that broader story. Think about NIM, think about expenses, think about the capital being absorbed in every activity. We do have some benefits that more traditional banks don't have. There's no COBOL in the room. We're operating largely on cloud. I think 87% of the bank is now cloud enabled, so the kind of cost of transferring servers and so on and maintaining all the infrastructures is behind us, really. Still, there's always technical debt growing, but we try to be pretty rigorous around managing that. So we feel like we're pretty well set to continue that story. And when you think about the portfolio of businesses we've now built, we've got quite a range from reverse mortgages we lend to other lenders, sort of smaller mortgage investment corps and others. We have a big commercial lending operation, which is really the traditional heart of the business. We think we've got a lot of levers. So some things may be a bit soft for a while, but probably the demographics of a growing society are going to be something that's going to be with us. I'm talking for the next 20 or 30 years, so that feels like a pretty good kind of growth business. Mortgage business generally is going to fluctuate a little bit with the activity in the real estate market. But again, this imbalance between supply and demand of a very open economy open to immigration and that creates a lot of activity in real estate for sure.

Sticking to that topic, I had a speaker up here earlier, Scotiabank, and he was saying how it's starting -- their mortgage book could have been deliberately downsized and now they're maybe seeing the growth come back sooner than expected. What are you seeing as far as the stabilization and potential acceleration of the mortgage business this year?

Yes, I mean, spring is coming. I mean, spring is coming...

Upon us.

Literally and figuratively in terms of the mortgage market. We are seeing sort of slightly elevated transaction volumes, so I still say that we're really waiting. I think the market -- I mean, the house buying market is really waiting to see the Bank of Canada start to drop rates and that we'll see more liquidity return. But clearly, we're getting to a point now there's sort of pent-up demand. You've got homebuyers thinking, should I buy now before the house prices start to run on me because interest rates have dropped or should I wait until interest rates are clearly dropping. So I think that's kind of the dynamic we're into. So I'm reasonably optimistic that as we work through the next couple of months, we're going to see more transactions coming through, but it's still somewhat muted. Let's not forget that we're coming off a year, last year, 2023 was the lowest year for housing market transactions in Toronto in 23 years. So, I mean that's a spectacular number given how much bigger the city is today. So clearly, any kind of relief on the mortgage rates is going to trigger some activity.

So the last quarter, one of the big takeaways, I guess, is that the impaired loans in the commercial book were up and that was flagged, I guess, and you identify that as this particular industry like trucking and -- but you also said that post quarter, the impaired balances have been declining because of resolutions. Is that still -- like, we're almost a month since then. Is that still the message?

So to be super clear here, so we have a relatively modest sized leasing business in the overall portfolio called Bennington Financial. Within that, there's a $200 million portfolio of long-haul trucking leases that were originated in 2022. It's sort of showing elevated credit losses. We expect that to continue for the next couple of quarters. I guess this way we were lending in the kind of height of COVID when demand for transportation services were very high, and it's turned out to be much more volatile in that industry. On the commercial business, generally, lending against department buildings primarily, we've seen some of our borrowers get stressed by interest rates going up, effectively a mismatch between fixed rental income and interest, variable rate interest, borrowings. I am pretty confident that by the end of this quarter, the level of impaireds and that book will be down a little bit, modestly quarter-over-quarter. And we really seem to be on a good track for many of the other loans to get resolved. We've got one fairly large loan in there, for example. We've got a bid to buy the building from us. Frankly, it's not going to actually happen until next quarter, but I'm very confident it will get resolved. So it still shows up as an impaired from an accounting perspective. On the single-family side, we're definitely seeing some people are struggling to pay their mortgages. These are relatively low loan-to-values. We don't expect losses, but it does take time for those situations to get resolved. The house needs to get sold. The mortgage needs to get repaid. And people need to move in different kinds of accommodation, and single-family housing, just the prices are holding up well. Loan-to-values are in kind of 60s to sort of 70%-type ranges, so not expecting much in the way of any kind of losses in that.

So just on the commercial side, flat to down? Or...

Yes. On the commercial real estate side, flat to down and then in trucking, continue to show some losses. And then single-family real estate, probably going to take couple more quarters before it restarts to move in any meaningful direction.

And the important distinction there is that I knew you've been clear about that as well, the commercial side is where you'll have losses. But on the single family, the impairments could go up, but you're underwriting that with no expectation of loss.

Right. And even on the commercial real estate, frankly, the losses are very modest. But there's 1 or 2 construction projects ran to a bit of cost overruns, combined with high interest rates, not completely on time, modest losses against the capital we've got out. Just as we're coming -- just to be clear, we're always first lien, so it puts us in a pretty good spot to kind of drive the process. Often, we've got second mortgages behind to a kind of institutional quality who help support that loan, so we feel pretty comfortable we can work our way through the situation.

And we've talked about the growth outlook, the credit aspect of the single-family mortgage. I don't know if you have any early impressions on the stories kind of coming out, not directly from us, but in the media as far as the loan-to-income ratios. At our lunch discussion, it sounds like they'll be tailoring the rules in such a way that if you have a certain business model that might naturally gravitate towards higher LTI mortgages, there'll be leniency, I suppose?

Well, that's what I heard from Peter. And I mean, I think what he was talking about was quite consistent with our understanding. What they don't want to happen is if interest rates go sort of back close to 0 again to stimulate the economy and a second -- another downturn, that we don't get too much leverage building in the system, so that's the purpose of this. As he said, it's not likely to be a binding constraint anytime soon. It's kind of a bit of a circuit breaker against the general stress test approach, frankly.

So as far as rate cuts, if and when they do happen, let's talk about what would you like to see this year? Forget the projection, but what would you like to see in terms of the amount of rate cuts, just to stimulate demand? And then, other side of that coin is you might have higher loan growth, but then the spreads might tighten a little bit. Correct me if I'm wrong there, but let's talk about that.

I think spreads don't really change, frankly. We're competing against other people with a similar kind of cost structure to us, so we're all generally looking for the kind of similar types of return. Home Capital being one of our bigger competitors. Now they're no longer a public company, but owned by one individual who's looking for probably similar types of returns and against a similar cost structure, so I don't think any of that changes NIM. Frankly, what I'd like to see is a bank of Canada having success, slowing inflation and being able to reduce interest rates. I mean, it's good to have confidence in the economy, to have inflation under control. And what the path is there, I think there is a bit of natural caution that if we move too fast on interest rates, that the housing market might take off too fast and then stimulate inflation again, which then puts us into a cycle of having to tighten. I think what I'd like to see is kind of -- it feels to me, like, we could stop moving already, frankly, in terms of moving rates down slowly without too much danger, clearly. Kind of core inflation seems to be under control, but that's for monetary policy economists to think about. But certainly, you'd like to see it kind of make sure that the CPI stays under control for longer term.

And what's the biggest challenge now from the demand side? Or is it demand or sellers just waiting for a better market and that's -- or is it both?

Yes. I mean, I think buyers are waiting for lower interest rates. They -- I think they've lost -- I think there was -- 6 months ago, they were thinking that the prices would drop in the face of higher interest rates. They should wait. My impression is that, at the margin, most people now think that prices are probably likely to go up from here, whether they'll go up faster or slower, it's kind of -- I mean, it's the sort of general context. And so there's a bit of a standoff right now. People think of the house is worth something, and they're not going to be prepared to drop the price. But we're really tight on inventory. We don't have that houses for sale, frankly. So people need to feel that if they bring the house to the market, they're going to be able to meet their price expectations. And so you need to see more activity in the market to make that happen.

Okay. And then one topic that comes up a lot with -- well, the big 6 and then Canadian Western Bank from time to time is AIRB risk-weighted asset models. I'm wondering what the situation -- is it equitable? Is there any appetite to convert? I don't think so, but I just want to hear what you have to say about it.

Yes, we've been working on it for a few years. And as I mentioned, if we would -- being treated under AIRB, roughly speaking, we'd have sort of $900 million of excess equity on the balance sheet, which is roughly $23 a share, so it's a big number, but it's not really for that reason that we'd do it. I think it would allow us to compete across a broader range of asset classes using standardizers as a bit of a blunt instrument where any commercial mortgage, for example, is risk weighted at 100%. If we put cash into one of the D-SIBs, that's risk weighted at 20%. So in fact, if we have cash sitting on D-SIBs' balance sheet, it's actually risk weighted, higher than they would risk-weight a residential mortgage in many cases. So it's sort of a somewhat strange kind of approach. So we would like to become a more sophisticated bank and level the playing field with the D-SIBs, and we're doing a lot of work in those areas. In the meantime, as we build those models, it's giving us a much more sophisticated risk management approach as it's not sort of thrown away or under-invested money in the meantime. But we're still talking a few years away before we'll actually be able to make that transition. So that's kind of how that's booking.

But theoretically, the conversion would be -- I don't know, easy -- is ever applicable as a term in the situation, but 80% of your loan book is somewhat homogeneous. So that should help, no?

Yes, absolutely. I mean, the big one is sort of $20 billion worth of single-family mortgages, for example. And you're kind of correct, a good chunk of the -- 40% of the assets on balance sheet, for example, cash, that's easy to deal with provincial bonds. I mean, we [ should have ] analysts. So yes, it's an easier problem than it would be for a large commercial lending assets, different kinds of asset classes theoretically.

As far as the capital management strategy goes, you're running comfortably -- with a very comfortable capital position. And if I look at it on the AIRB basis, even better, not that we really should, but theoretically, it makes sense. Buybacks are not -- like, they wouldn't rank highly in your priorities?

Not highly, but I do think that it's -- if we can't grow the assets to meet at this 15% aspiration, and if the stock was trading a bit as cheap, we'd take this [ as Buffet ] for you on stock buybacks. We only buy back stock when it's fundamentally cheap. It could be a way of deploying capital that would benefit our shareholders, and I think that would be the lens we're looking at it through. But our broader capital value creation model is to grow at the sort of 15%-ish kind of cadence and redeploy the capital back in the business.

Okay. We've got a couple of minutes left, and I'd like to wrap up on your financial targets for the year. So the low end of your guidance range for this year is $11.75. And I know you've pushed back probably on -- if I just multiply Q1 by 4, we're a fair bit shy of that. So how do we get from the Q1 pace to a higher pace to hit the low end of that guidance range?

It's a good question. Of course, the bank that's growing at 15%, you generally expect every quarter is going to be progressively -- progressive kind of slope anyway, so that deals with some of it. We also look at some of the kind of idiosyncratic things around, say, our securitization revenues that we know we've gathered an inventory of loans to be securitized. That helps. That will help in this quarter compared to last quarter, for example. And also last quarter, as we spoke about, we had some credit -- elevated credit losses associated with the trucking business and so on that might still be there next quarter, but probably not to the same degree. So when we add all that up together, we did reinforce our targets for the year. So the financial team has been through that, looking at all kind of variables. And we always thought, frankly, so we're running some advertising at the first part of this year that we talked about. So that, again, our costs could be a little bit better in the second half of the year. So we always thought it was going to be a story of a better second half than the first half even coming into the year, and I think that story is going to play out.

So seasonality of expenses were higher in Q1. That'll taper off and your guidance on loan losses is for similar Q1, Q2, and then lower losses in the second half and book growth, presumably. So you're back on track that way, and you're comfortable with that guidance still?

I mean, the future is always got to be -- it seems like a reasonable thing. I was -- obviously, all these risks to any forecast, but we'd look at these things prudently. And generally, we try to surprise -- the Street slightly to the upside with a bit of margin in there. But so we're feeling -- we wouldn't be saying these things if we hadn't been through it carefully and thought about.

Okay. Well, that's a wrap. I can -- is anybody in the audience wanting to ask a question before we call it. No.

Well, thank you.

Andrew, thank you.