Starting a few weeks ago, Equitable Bank made headlines in the Canadian PF-o-sphere, offering 3% interest in a high yield savings account. Most five-year GICs only pay a fraction of that, so it’s of little surprise your favorite PF blogger was more excited than an ADHD kid before mom finally shuts him up with Ritalin.
EQ Bank also very clearly paid for exposure on some of the leading blogs. I’m not opposed to this, because hey, I’ll sell out for about 40¢. It’s just for some reason they didn’t bother with this blog. I have no idea why either.
BOOB. FART. PENIS.
No idea either…
Anyhoo, I noticed something about the EQ Bank reviews out there. Nobody looked at it from EQ’s perspective. When presented with a question about EQ’s motivation for the new ultra-high rate, they all gave us a regurgitation of the same canned answer — that EQ is trying to attract clients so that’s why the rate is so high.
On the surface, that makes sense. Attracting deposit capital is a very viable thing for a mortgage lender to do. But at the same time, it’s a hell of a lot more work than just depending on the institutional market. Each year the company has to print up thousands of different forms for its thousands of different high interest account holders for them to claim the $44.93 in interest earned over the last year.
Look at it this way. If EQ needs $50 million in funding, it can either find five different investors to take $10 million in bonds or try to attract 5,000 investors to each put up $10,000. Which would you rather do?
So there’s likely a different reason why EQ is offering such an attractive interest rate. And I think I know why.
The real reason
For the record, even though this is right under a heading titled “the real reason”, I don’t really know if this is the real reason. I’m 99% sure I’m right, but I don’t know enough about the inner workings of Equitable Bank to be certain. There. Don’t sue me.
You might think Equitable Bank is a typical bank. You’d be wrong. Here’s what they do, according to Google Finance:
“The Company’s business lines include single family lending services, which include mortgages for owner-occupied and investment properties; commercial lending services, which include mortgages for commercial property; securitization financing include insured mortgages on multi-unit and prime single family residential properties funded through securitization programs, and deposit services include safe and secure savings products.”
Uh, Nelson? English please.
In layman’s terms, Equitable Bank is a subprime mortgage lender. They specialize in the kind of clients that banks usually reject.
Here’s Equitable’s stock chart in the last year. I’ve included the TSX as a comparable.
As you can see it hasn’t been great, especially after hitting highs back in May. It’s handily underperformed the TSX since then, although the difference isn’t much if you go back a year.
I’ve spent a lot of time talking about the Canadian housing bubble on this blog. One thing that happened with the U.S. housing bubble is when the whole thing started to collapse, the funding sources for the subprime mortgage companies were the first to dry up.
There are plenty of differences between the U.S. subprime market and the Canadian one, of course. Our borrowers are, as a whole, better than the ones in the U.S., especially at the end of their bubble. We verified income and things like that (although, admittedly, we could improve on that stuff), and our borrowers tend to have better credit scores than the subprime part of the U.S. market did.
But there’s a huge danger in comparing ourselves to our southern neighbors. If you’re less obese than this week’s My 600lb Life honoree, it doesn’t mean you’re healthy. Comparing our subprime market to the one in the United States is silly.
I think y’all can get the point I’m coming to. EQ Bank isn’t doing this because it wants retail deposits. It’s doing this because institutions are scared silly of the whole Canadian subprime mortgage market, and it needs money from somewhere. It could be as innocent as they can see the potential risks and are trying to diversify. Or they could be having real problems attracting institutional capital.
Either way, it’s a little bit concerning.
The bigger picture
“Always invert.” – Charlie Munger
Warren Buffett gets all the credit, even though his right-hand man Charlie Munger might be every bit as smart.
One of Munger’s biggest keys to investing is to always invert. This means that if you identify something that looks like a good deal, look at it from other angles. Or, as Greg from Control Your Cash has put it time and time again, always look at a transaction from the other person’s perspective.
You might call it being cynical. You might call it being a downer. But the ability to think non-linearly is the biggest thing that separates the rich from the rest of us. They’re able to see the stuff that we don’t until it kicks us in the crotch.
It takes years to become at least somewhat competent at the skill. You have to be willing to question everything, to ask why when everyone else accepts an answer at face value. It’s exhausting. It’s not going to make you any friends, especially when you take a giant coiler on whatever the masses are excited about this week.
Getting back to Equitable, I’m not suggesting for a minute it’s about to go to zero or anything that dire. I’m the first to admit I don’t know enough about what they have behind the scenes to make that call. And the bank is insured with CDIC, so the first $100,000 is guaranteed. I’m not saying you (or anyone else) should take your money out or anything like that, because I still think it’s safe.
But the fact is Equitable is a levered financial company. It depends on a constant influx of cash to keep on going. When a company takes in money and immediately lends it back out again at a higher interest rate, it needs access to capital to survive. It’s the very thing almost every bank is built on.
When that capital dries up, growth is impossible. But that’s not the worst part. Any bank constantly needs to renew debt to keep going. When the market gets really spooked and no institutional investor will supply a bank with capital, what happens? It’s simple. Without the ability to refinance the debt, the whole thing collapses.
The ultimate point is this. If Canada’s housing market really falls off a cliff, the market will shun Equitable, Home Capital, and all of their peers worse than me at a hot cheerleader conference (I’d shun the cheerleaders. I’m married now). The stock price collapses and guys like me start publicly pondering whether the company is still a going concern.
Now imagine you had your emergency fund in that bank. Sure, it’s CDIC insured, but I can’t believe anyone would be feeling good if such a situation played out.
In finance especially, there’s no such thing as a free lunch. There’s a reason why this product exists, and it’s not to pad your pockets. Looking at every financial decision you have from this perspective will ultimately make you much more aware of what’s really going on. Switch the rose colored glasses in favor of something a little more… brown.