DBRS Morningstar Confirms Ratings of Equitable Group Inc. at BBB (low) and Equitable Bank at BBB, Trends Changed to Negative

DBRS Limited (DBRS Morningstar) confirmed Equitable Bank’s (the Bank) long-term ratings, including its Long-Term Issuer Rating, at BBB and confirmed the Bank’s Subordinated Debt rating at BBB (low). DBRS Morningstar also confirmed the long-term ratings of the Bank’s parent, Equitable Group Inc. (the Group; together with the Bank, Equitable or the Company), at BBB (low). Additionally, DBRS Morningstar changed the trends on all ratings to Negative from Positive. The Bank’s Intrinsic Assessment (IA) is BBB while its Support Assessment is SA1. The Group’s Support Assessment is SA3, and its Long-Term Issuer Rating is positioned one notch below the Bank’s IA.

KEY RATING CONSIDERATIONS
The revision of the trend to Negative reflects the anticipated adverse impact on Equitable from ongoing uncertainty regarding future economic conditions as a result of the Coronavirus Disease (COVID-19) pandemic. Business closures to halt the spread of the coronavirus continue across Canada and are having a major impact on employment, particularly for smaller firms and entrepreneurs, many of whom represent Alternative-A (Alt-A) borrowers. DBRS Morningstar is concerned that these interruptions will have a significant impact on Equitable’s Alt-A residential mortgage portfolio especially as there is no indication as to how long these measures will remain in place. Furthermore, the Negative trend also considers Equitable’s commercial lending portfolio, which is also likely to experience stress as economic activity is reduced and construction projects are disrupted.

RATING DRIVERS
Given the Negative trend, a ratings upgrade is unlikely at this time. DBRS Morningstar could change the trend back to Stable if the impact of the current economic environment on Equitable’s earnings and credit quality metrics is manageable.

Conversely, material losses in the loan portfolio resulting from a prolonged adverse coronavirus-related impact or significant pressures on funding and liquidity would result in a ratings downgrade.

RATING RATIONALE
Equitable is Canada’s largest Alt-A mortgage provider for borrowers who for the most part are either self-employed, new immigrants, or are recovering from bruised credit. Residential Alt-A mortgages formed around 43% of the Company’s $26.6 billion loan portfolio as of December 31, 2019. The current economic crisis is having a disproportionate negative impact on small businesses and those who are self-employed. As a result, DBRS Morningstar notes that Equitable might receive proportionally higher applications for loan deferrals than larger banks as the economic climate is specifically affecting the Company’s customer base. Furthermore, a particular nuance of Alt-A mortgages is their short renewal terms which average 18 months to 24 months. This implies that Equitable will see a larger proportion of its borrowers seeking mortgage renewals in any year versus the larger banks. With jobs being lost and income reduced from the pandemic, this increases credit risk as already stressed borrowers may face difficulties renewing their mortgages with Equitable or finding alternative lenders to transfer their mortgage to. In addition, the restrictions currently in place around real estate transactions due to the coronavirus distancing measures will pose challenges for Equitable in cases where it needs to efficiently foreclose on a property, therefore potentially driving up impaired loans on the Company’s balance sheet and leading to an increase in write-offs.

Meanwhile, Equitable’s commercial loans of $8.3 billion represented 31% of the on-balance sheet portfolio in 2019. Although 46% of these loans are insured, the uninsured loans include a construction portfolio of $1.1 billion. DBRS Morningstar is concerned that a high proportion of these loans could be halted or face challenges, thus increasing impairments in the commercial portfolio as well. Furthermore, through an acquisition in 2019, Equitable now has a portfolio of approximately $0.5 billion in non-prime equipment leases which, in DBRS Morningstar’s opinion, could also experience stress, particularly if they cater to the industries most affected by the crisis, such as restaurants.

DBRS Morningstar views Equitable’s funding and liquidity positions as currently stable, especially given the Bank’s access to some of the Canadian federal government’s liquidity programs; however, tightening market conditions are widening spreads, making access to wholesale and brokers deposits more expensive. Therefore, despite the Company’s cost containment and efficient operations, a prolonged economic deterioration will likely depress revenue and profitability. Furthermore, although capitalization levels are solid with the a Common Equity Tier 1 ratio of 13.6% as of Q4 2019, pressures on profitability and a potential increase in credit losses could affect the Bank’s capital.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

The Grid Summary Grades for Equitable are as follows: Franchise Strength – Good; Earnings Power – Good/Moderate; Risk Profile – Good/Moderate; Funding and Liquidity – Good/Moderate; and Capitalization – Good/Moderate.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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