Morningstar DBRS Confirms Equitable Bank at BBB (high) and EQB Inc. at BBB; Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the credit ratings on Equitable Bank (Equitable or the Bank), including the Bank's Long-Term Issuer Rating at BBB (high). Morningstar DBRS also confirmed the credit ratings on Equitable's holding company, EQB Inc. (EQB or the Group), including its Long-Term Issuer Rating at BBB. The trends on all credit ratings are Stable. The Bank's Intrinsic Assessment (IA) of BBB (high) and Support Assessment (SA) of SA1 remain unchanged. The Group's SA remains at SA3 with its Long-Term Issuer Rating positioned one notch below the Bank's IA.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends reflect Equitable's increased scale and growing franchise as the seventh-largest Schedule I bank in Canada by assets. The Bank has $123 billion in assets under management and administration and is one of the largest mortgage providers in the self-employed and new immigrants space in Canada. Although credit quality has deteriorated in recent periods, Equitable maintains sound credit fundamentals and the Bank generates consistent profitability, producing top-tier return on equity and efficiency metrics. The Bank maintains solid capitalization and adequate liquidity levels. Further, while brokered deposits remain Equitable's primary source of funding, the Bank continues to grow its consumer deposits while expanding its wholesale funding channels.

Although the acquisitions of Concentra Bank (Concentra) and ACM Advisors Ltd. (ACM) provide some revenue diversification, the high proportion of net interest income (NII) remains a credit ratings constraint. Additionally, Morningstar DBRS remains concerned about high Canadian household debt levels and the still uncertain macroeconomic environment, which is resulting in higher-for-longer interest rates that continue to materially increase debt servicing costs. Morningstar DBRS considers the Bank to be more susceptible than its large bank peers to significant adverse changes in the Canadian real estate market, particularly with respect to its uninsured residential mortgage portfolio. Nonetheless, Equitable's mortgage lending exposure is manageable given its history of low impairments and charge-offs.

CREDIT RATING DRIVERS
Continued progress in diversifying funding sources, particularly through stable direct-to-consumer channels, and revenue, through higher noninterest income, while maintaining sound asset quality would result in a credit ratings upgrade.

Conversely, significant and/or sustained losses in the loan portfolio, disproportionate growth in commercial originations that weaken the risk profile, or substantive funding pressures would result in a credit ratings downgrade.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Good/Moderate
Equitable is a fully digital bank, providing customers with an alternative to the large banks, particularly through EQ Bank. Equitable's uninsured residential mortgage portfolio has a primary focus on borrowers that are self-employed or new immigrants. The Bank also has a notable prime insured mortgage portfolio, along with a growing wealth decumulation business, particularly reverse mortgages, and momentum in its insured multi-unit commercial lending portfolio. The Group has increased its scale and reach and product offerings through acquisitions, such as Concentra and ACM. Additionally, EQ Bank's launch into Québec and Equitable's new bank accounts, namely its Notice Deposit Account and small business account, should strengthen customer relationships and have a positive impact on customer acquisition.

Earnings Combined Building Block (BB) Assessment: Good/Moderate
Equitable generates consistent profitability. The Concentra acquisition provides revenue diversification, doubling the Bank's adjusted noninterest revenue to $92 million in the first half of 2024 (H1 2024); however, NII still represented the majority of adjusted revenue at 85% in H1 2024 (versus 91% for the six-month period ended March 31, 2023) and is a credit ratings constraint. Adjusted H1 2024 net income as reported by Equitable increased 13% year over year (YOY) to $219.4 million, as higher revenue was only partly offset by higher noninterest expenses and increased provisions for credit losses (PCL). Adjusted H1 2024 NII as reported increased 15% YOY to $523.3 million on contributions from Concentra, asset growth across the Bank's conventional loan portfolios, and higher net interest margin (NIM), which expanded 15 basis points (bps) YOY to 2.06% in H1 2024, as reported by the Bank. The NIM benefitted from higher prepayment income in uninsured residential mortgages, margin improvement in the single-family residential portfolio, and improving cost of funds. Equitable's H1 2024 adjusted return on equity of 15.7% and an efficiency ratio of 45% remain at or near the top of the peer range.

Risk Combined Building Block (BB) Assessment: Good
Morningstar DBRS considers Equitable's risk profile to be sound, with its loan book nearly 100% secured by assets and 54% insured. At Q2 2024, personal lending comprises approximately 50% of loans under management (LUM). Commercial banking lending (nearly 50% of LUM), including equipment leasing, is diversified with shopping centres and hotels representing a manageable 3.0% and 0.1% of commercial loans (1.0% and 0.03% of total loans), respectively. Similarly, approximately 1% of the Bank's LUM are offices with an average loan-to-value ratio of 67%, and total construction loans represent 5.8% of LUM. Credit metrics have been deteriorating, driven by the commercial banking segment, with Q2 2024 reported net impaired loans as a percentage of total loans at 92 bps and PCL at 19 bps.

Funding and Liquidity Combined Building Block (BB) Assessment: Moderate
Equitable continues to gain increased benefits from its funding diversification strategy, although it still relies on brokered deposits. EQ Bank and credit union deposits acquired through the Concentra acquisition represented about one-third of on balance sheet funding in Q2 2024 (compared with 16% in Q4 2018) and have somewhat reduced the Bank's reliance on brokered deposits, which decreased to 51% as of Q2 2024 from well over 70% in F2019. The Bank has also further diversified its funding base by building out its covered bond program (its lowest cost and most stable source of wholesale funding), with covered bonds outstanding up 43% quarter over quarter and up 94% compared with March 31, 2023. At Q2 2024, Equitable held adequate levels of liquidity, with $4.6 billion in liquid assets (8.4% of total assets and approximately 75% of demand deposits).

Capitalization Combined Building Block (BB) Assessment: Good
Equitable is well capitalized with a CET1 ratio of 14.1% at Q2 2024, providing a sound cushion to withstand adverse scenarios. The Bank is able to grow CET1 through stable internal capital generation combined with a relatively low dividend payout in the 10% range. Equitable remains committed to maintaining a CET1 target ratio of 13%+ for 2024.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/436459.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 4, 2024), https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030, in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

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 dbrs.morningstar.com.

The credit ratings were initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

These are solicited credit ratings.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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