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financial services

Shares of Equitable Group Inc. have performed much better than the market over the past year, but this Toronto-based mortgage lender may still not be getting the respect it deserves.

It serves markets that are largely neglected by the Big Five banks: new immigrants, small business owners and customers who are establishing credit for the first time.

Since the end of 2007, Equitable has grown both its earnings and its book value per share at a 13 per cent annual rate. Yet its stock is cheap in comparison to the broad market, trading at less than seven times its projected earnings for the year ahead.

And there's a potential catalyst on the horizon: This past week, it received approval to form a Schedule 1 bank effective July 1.

Equitable, which had previously operated as a trust company, expects its new bank status will allow it to capitalize on consumers' perception that a bank lender offers greater safety; bank status should also allow it to raise capital by issuing equity and by expanding its lending to businesses.

After the bank announcement, investors were so impressed that the stock jumped by 3 per cent when most Canadian financial stocks were down on the day.

Since opening its doors in 1970, the company has been one of several quasi-banks that operate solely as niche mortgage originators for both residential and commercial real estate in Canada. The company's competitive advantage is its streamlined business model.

Unlike the big banks, which must maintain expensive bricks-and-mortar branches, Equitable raises funds from deposit brokers and lends money through mortgage brokers – a relatively no-fuss system that puts most of the considerable costs for customer service on someone else's shoulders.

The company's strategy is not going to change when it becomes a bank, as it doesn't plan to open up costly retail branches.

Also in contrast to the big banks, Equitable goes to considerable lengths to maintain friendly contacts with mortgage brokers through sponsoring educational workshops and professional accreditation programs. It's small and nimble enough to respond quickly to customer requests, especially in areas, like the immigrant community and the business for self areas, that the big banks tend to shun.

To be sure, there are risks in this model. The biggest is the possibility that Canada's housing market could take a tumble and default rates could soar.

But the company is managing that risk. It insists that any unsecured mortgage loan it makes be for no more than 70 per cent of the value of a property. It avoids single industry communities, where the closing of a factory could devastate homeowners' bottom lines. It recently tightened its lending criteria in higher risk markets like the Toronto and Vancouver condo markets.

For now, there is little evidence of stress. At the end of the first quarter, Equitable's common equity Tier 1 ratio, a core measure of financial strength, was 12.2 per cent, well above the minimum industry benchmark of 7 per cent.

The company's net impaired loans plus loans in arrears represent 0.42 per cent of total mortgages outstanding as of the end of the first quarter. This is only marginally higher than the equivalent problem-loan rates at the big banks, which range from 0.35 to 0.39 per cent.

In addition, the company is growing quickly, with total mortgages climbing from $5.9-billion in 2008 to $11.6-billion as of the end of the first quarter.

All of that adds up to an attractive proposition for investors who are willing to bet that Canada's housing market will continue to generate a healthy demand for loans in the years ahead.