DBRS Morningstar Changes Trends on Equitable Bank and Equitable Group Inc. to Positive from Stable, Confirms Ratings Following Concentra Bank Acquisition Announcement

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

KEY RATING CONSIDERATIONS
The trend changes to Positive from Stable reflect the Bank’s solid and growing franchise as Canada’s largest mortgage lender in the Alt-A market niche. Equitable has also successfully launched new lending products that complement its mortgage offerings in addition to expanding into adjacent verticals through acquisition. Furthermore, the Group continues to attract direct deposits through its digital bank, EQ Bank, while enhancing its wholesale funding channels. While the ratings reflect Equitable’s good asset quality and history of low impairments and charge-offs, the ratings also consider government support measures that have largely mitigated the negative impacts of the Coronavirus Disease (COVID-19) pandemic. Despite remaining uncertainties related to the pandemic, high household debt levels, and housing market imbalances, economic performance has rebounded and the labour market has approached full capacity.

Additionally, the Bank’s announced acquisition of Concentra Bank (Concentra; rated A (low) Under Review with Negative Implications by DBRS Morningstar) should enhance its franchise, gaining access to the credit union ecosystem and increasing the Bank’s asset base by about 31% on closing, to position it as the seventh-largest publicly traded Schedule I bank by assets. Furthermore, the acquisition includes Concentra Trust, the seventh-largest trust company in Canada with $31.8 billion in assets under administration, which would enhance revenue diversity. The acquisition is expected to be immediately accretive to earnings per share. The Bank will also gain access to new and lower cost funding from credit unions across Canada, along with commercial deposits, and its CET1 ratio is expected to remain at or above 13%. In DBRS Morningstar’s view, the combination does not add incrementally to credit risk, with residential mortgages comprising 80% of acquired loans (52% prime and conventional mortgages and 28% Alt-A).

The Bank’s IA is positioned one notch below the Intrinsic Assessment Range (IAR) because of the heightened integration and operational risks associated with the significant announced acquisition of Concentra.

RATING DRIVERS
Continued execution on diversifying funding sources while maintaining sound credit fundamentals would lead to a ratings upgrade.

Conversely, the Bank’s ratings would be downgraded if there were material operational issues with the acquisition integration. Additionally, significant losses in the loan portfolio as a result of unforeseen weakness in underwriting and/or risk management, disproportionate growth in commercial originations that weaken the Bank’s risk profile, or substantive funding pressure caused by deposit outflows would also result in a ratings downgrade.

RATING RATIONALE
The Bank announced the acquisition of Concentra for approximately $470 million. The transaction is expected to close in the second half of 2022, subject to customary closing conditions and required regulatory approvals. The Bank is acquiring Credit Union Central of Saskatchewan’s (SaskCentral) 84% stake in Concentra and expects to acquire the remaining 16% minority interest shortly after the acquisition closes as it has entered into support agreements with the majority of Concentra’s remaining minority shareholders. The acquisition adds approximately $11.3 billion in total assets, $6.3 billion in deposits (including $3.1 billion in attractively priced credit union deposits and $0.7 billion in commercial deposits), and expands the Bank’s reach with more than 200 credit union relationships with more than five million members across Canada. Overall, DBRS Morningstar views the announced acquisition as bolstering the franchise strength of the Bank through better scale, improved revenue diversity, and enhanced presence in underserved markets through the credit unions.

The Bank has identified annual synergies of more than $30 million, representing approximately 42% of Concentra’s cost base, and expects to incur integration costs of approximately $45 million to $50 million over a period of time. DBRS Morningstar’s view is that cost savings are likely to come from staffing, technology, professional and advisory fees, and other operating expenses. Revenue synergies have not been included, although there is additional upside as the Bank plans to grow its services to credit unions by establishing an advisory board focused on collaboration and the expansion of mutually beneficial solutions products and services.

Despite the uncertainties in the current operating environment, both banks have been performing well in recent periods. Additionally, both banks have shown strong asset quality through previous economic cycles. On a pro forma basis, the combination modestly reduces the Bank’s exposure to commercial loans from 17.5% to 15%, while residential mortgages remain at approximately 77% of loans. Although stable, the residential mortgage mix shifts 5% from single family Alt-A (45%) to single family prime and conventional (32%). Overall, DBRS Morningstar views Concentra’s loan portfolio as complimentary to the Bank’s historical loan portfolio while having a slightly more favourable mix.

The Bank is expected to maintain its strong capital position post acquisition, with the transaction being financed by a combination of equity (i.e.; $200 million bought deal subscription receipts offering, concurrent with acquisition announcement) and debt (i.e.; $270 million senior debt facility at the Group level). In the event of volatile equity markets, the senior debt facility can be upsized to fully finance the transaction.

The Group reported strong Q4 2021 net income of $80.1 million, a 10.5% increase quarter over quarter, driven by solid revenue growth partially offset by a lower release of provision for credit losses (PCL). For F2021, the Group reported record earnings of $292.5 million, an increase of 30.7% from the prior year, driven by PCL reversals and strong growth in net interest income. Operating expenses were up year over year as the Group continues to invest in talent and technology, resulting in an efficiency ratio of 40.5%, within the target range of 39% to 41%. In addition, Equitable announced a 51% increase to its quarterly dividend over the declared dividend in February 2021 following the Office of the Superintendent of Financial Institutions’ lifting of restrictions on capital distributions.

Franchise Combined Building Block (BB) Assessment: G/M

Earnings Combined Building Block (BB) Assessment: G/M

Risk Combined Building Block (BB) Assessment: S/G

Funding and Liquidity Combined Building Block (BB) Assessment: G/M

Capitalization Combined Building Block (BB) Assessment: S/G

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/392040.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organizations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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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