Investors are all too aware of the problems being faced by Canada’s largest non-bank lender Home Capital Group Inc. (TSX:HCG). The fears triggered by a massive run on its deposits have spread to other non-bank lenders, which are also feeling the pressure.
Alternative mortgage lender Equitable Group Inc. (TSX:EQB) has experienced what it describes a modest run on its deposits, but to reassure investors that it has sufficient liquidity, it has secured a $2 billion credit facility. Along with recent events at Home Capital combined with ongoing fears that Canada’s housing bubble is on the cusp of bursting, this has triggered considerable concern that Equitable Group could be the next to fall.
Now what?
The key worry is that depositors who are fearful that the issues being experienced by Home Capital are systemic and widespread across the subprime lending industry will escalate the pace of deposit withdrawals from Equitable Group. This has caused its stock to plummet in recent days; it’s down by a massive 34% over the last month.
Nonetheless, the situation at Equitable Group appears far more stable.
This is because, while deposits have plunged sharply, total withdrawals only represent roughly 2.5% of its deposit base. The non-bank lender has not experienced any of the issues currently affecting Home Capital, most notably the mortgage fraud scandal that broke in 2014.
Furthermore, it is not facing the same degree of regulatory scrutiny as Home Capital, nor a class-action lawsuit relating to disclosure failures.
Equitable Group has also moved quickly to reassure investors that it has sufficient liquidity by obtaining $2 billion secured funding from a syndicate that includes all six of Canada’s largest banks. Given that Canada’s six largest banks have demonstrated an unwillingness to engage in risk behaviour in recent years, it is difficult to see them backstopping a non-bank lender that is on the brink of failure.
More importantly, that loan has been made on far more favourable terms than the facility secured by Home Capital. Equitable Group is paying a 1.25% interest rate on any drawn balance, a 0.75% commitment fee, and a 0.5% standby charge. This is compared to the usurious 22.5% that Home Capital stated it was paying on the first draw-down from the facility made last week.
At those rates, Equitable Group is likely to be capable of originating profitable mortgages. It is difficult to see Equitable group finding itself in the same situation as Home Capital.
Not only is the run on Equitable Group’s deposits far more modest, but the stench of mortgage fraud is not hanging over its loan book, and it has a high-quality portfolio, as evidenced by an impressively low net impaired mortgage ratio of 0.21%. This is, in fact, lower than the Big Six banks and attests its underwriting standards.
It should also not be forgotten that in its recently reported results, it had $537 million of cash on hand, giving it yet another lever with which to manage its operations and any ensuing liquidity issues.
So what?
While Equitable Group’s stock has been hit hard, there are signs that it is not facing the calamitous issues that have infected Home Capital’s operations. For risk-tolerant investors seeking a contrarian play on the extremely negative sentiment surrounding subprime mortgage lenders in Canada, Equitable Group offers an attractive opportunity.
