Did you know that high-growth banks are often extremely cheap compared to growth stocks in the tech sector?
It’s true.
Banks like EQB (TSX:EQB) are growing by leaps and bounds this year. While Canada’s larger banks don’t offer a lot of growth, the smaller ones often do. In this article, I will explore the phenomenon of high-growth banks and how they can add some much-needed alpha to your portfolio.
The curious case of EQB
When it comes to high-growth banks, EQB is one of the best in class. The company is an online-only bank, which means that it doesn’t have the usual branch-related costs that most banks have. In addition, it also has a very sticky deposit base, comprised mainly of Guaranteed Investment Certificates (GICs) that are locked up from a few months to a few years.
Because the overwhelming majority of its deposits are GICs, EQB has a sky-high 339% liquidity coverage ratio, among the highest of Canadian banks. I’m going to be honest with you: I’m a little skeptical that EQB’s liquidity coverage is actually that good. Banks have some leeway in how they calculate this ratio; it all depends on “expected monthly withdrawals.” EQB’s highly liquid assets, as a percentage of total deposits, are not that high. Nevertheless, because deposits are mostly GICs, that does add a measure of stickiness.
EQB is growing rapidly, with its revenue up 39% in the trailing 12-month period. In the trailing five-year period, it has compounded its revenue, earnings, and book value at the following annualized rates:
- Revenue: 22%
- Earnings 16%
- Book value: 17%
These are the kinds of growth rates we usually expect from a pricey tech stock, yet EQB trades at a mere 7.3 times earnings. On the whole, there is a real opportunity here, but EQB’s status as a small bank means that it lacks certain protections its larger peers enjoy. If it gets in trouble, it’s less likely to get a bailout, for example.
Other high-growth banks exist
Although EQB is the poster child for high-growth Canadian banks, there are others. If we stretch the definition of “bank” a little bit, we could count First National Financial (TSX:FN) in the category. First National is a non-bank lender that issues mortgages. Unlike traditional banks, which take deposits in order to finance their loans, FN simply issues bonds to raise money. As a result, it does not face the risk of “bank runs.” All it has to do is issue its bonds to have terms to maturity similar to its own loans.
This model is working well for First National this year. In its most recent quarter, the bank delivered the following:
- $142 billion in mortgages under administration, up 10%
- $8.3 billion in mortgage origination, up 26%
- $563 million in revenue, up 43%
- $86.3 million in net income, up 108%
- $1.38 in earnings per share, up 109%
Overall, it was a very strong showing. And while First National isn’t exactly a bank going by the strictest definition, it is very similar to a bank. Its third-quarter earnings go to show that financials can, in fact, deliver growth.
