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1 Mortgage Lending Stock Is Upping its Game: Could This Hurt CIBC (TSX:CM) Stock?

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With a market capitalization just under $1 billion, Toronto-based Equitable Group Inc. (TSX:EQB) is a relatively small company in the financial services sector, but has been nipping at the big banks’ toes for some time.

In the last three quarters, Equitable has snagged roughly $3 billion in new mortgages, taking the total mortgages under management to $24 billion. When you are in the business of lending money, it is good when you are lending out more, and this is the case in the last four quarters — a 14% increase from Q1 of 2017.

For comparison, big bank Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM) currently has just over $200 billion in mortgages, according to the most recent quarterly report. That’s almost 10 times more than Equitable, although that hefty amount has not really budged.

Equitable is clearly grabbing more customers, but is this risky business?

The risk in this business is when clients default on mortgage payments. Equitable’s most recent quarterly report shows more than 98% of mortgage receivables were either low risk or standard risk. And this is pretty much on par with other lenders.

The common equity tier 1 ratio is a key risk comparison metric for banks. It’s not worth digging into the weeds on this, except to say that Equitable runs higher risk for this metric than CIBC.

Equitable’s intense exposure to the real estate market is offset by lower operation costs, because it has no branches. Clients do banking entirely online, which is a secular trend. Mortgage payments happen automatically — mortgage top-ups from the convenience of one’s living room! Who really needs a branch, anyway?

Although the quarterly dividend of $0.27 per share is relatively modest, yielding only 1.9% (low for a bank), this has increased by about one dime every two quarters, basically doubling in five years. With a payout ratio of 10%, and the mortgage volumes picking up, it is safe to say the dividend hikes will keep coming. At this rate it will only take approximately two years for the yield to attract attention from income investors.

Equitable may be sounding interesting, but earnings are not likely to move until 2019, at which point the forecasts will increase in double-digit earnings. Earnings aside, I like that the company tends to make its earnings targets.

If income is your investment game, Equitable currently offers preferred shares that pay a 6.3%, but they mature soon.

CIBC is a great starter stock to buy

Being heavily exposed to the whims of the Canadian real estate market is one reason CIBC began diversifying many years ago — an earnest attempt to shed its reputation as being too heavy in the mortgage game.

This was a wise plan to give CIBC shareholders more confidence, as geographical diversification and diversity of business have been solid moves. This is partly why Fool contributor Will Ashworth wrote, “forget what Bay Street says,” and why I recommended CIBC recently.

Take home

Equitable has a low price-to-earnings ratio (P/E) compared to CIBC, even though CIBC is classically viewed as the “cheapest” big bank. When it comes to the financial sector, the P/E is a euphemism for investor confidence and therefore risk. Equitable should not be the first bank stock that you buy, but it does have an upside stemming from the growing revenue stream. Interest rate hikes and a rebounding Canadian real estate market are two driving forces that could make Equitable a market-beating, small-bank play into 2019.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Brad Macintosh owns shares of CANADIAN IMPERIAL BANK OF COMMERCE.

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