Equitable Group adds RBC to syndicate of Canada’s other big banks backing its $2 billion emergency credit line

The Equitable Group offers mortgage financing that in many respects is similar to that offered by Home Capital. Borrowers who cannot get financing at Canada’s major banks will turn to Equitable. In order to ensure the availability of financing to the Equitable Group, it has arranged for an emergency credit line as discussed in the article noted above. DBRS, the Canadian bond rating agency, has commented on the financing: DBRS Comments on Equitable Group Inc.’s Q1 2017 Results; New Liquidity Facility Provides Support for the Ratings.

Details on the equitable Group financing

The DBRS review only provides a few details on the financing. But there are a couple aspects of the financing which I believe raise some questions:

To combat contagion risk, Equitable took action to shore up its liquidity profile by obtaining a letter of commitment for a two-year, $2.0 billion secured backstop funding facility from a syndicate of the six large Canadian banks. The terms include a 0.75% commitment fee, a 0.50% standby charge on any unused portion of the facility and an interest rate on the drawn portion of the facility equal to the syndicate’s cost of funds plus 1.25%. The effective interest rate is approximately 60 basis points over Equitable’s existing Guaranteed Investment Certificate (GIC) funding costs, which the Group can absorb at its current rate of earnings. The facility is secured against mortgages originated by Equitable.

The funding facility has a term of two years. The Equitable Group has, therefore, the risk that it might not be able to rollover any of the drawn facility on the maturity date (refinancing risk). In addition, it would seem that the mortgages originated by Equitable are, to a considerable extent, for terms in excess of two years. It’s hard to understand how, if the facility is drawn on, it will be able to use it to fund mortgages with a term to maturity in excess of two years. These questions remain unanswered in the DBRS review. You would have thought that these two points would have been subjects for discussion.

In addition, it’s noted that the facility is secured. I wonder how much of the portfolio has been pledged as security. Remember that the GICs normally issued by Equitable are unsecured, so the assets of the institution are no longer available to satisfy the unsecured creditors (now those assets are encumbered, namely, the banks will liquidate assets in the event of a dissolution and be paid out before anyone else gets paid out). Nice position to be in, but that’s normally the way the banks play the game. In the end, the GIC holders would look to the Canada Deposit Insurance Corporation of Canada to be paid out if it gets to that.

Further thoughts

As we have seen with Home Capital, when these things unwind, they unwind quickly. It would seem to me that the arrangements made to support Equitable may not be enough if things unwind quickly. Only time will tell. I wouldn’t rely too heavily on what the rating agencies say. They have a poor track record, in my opinion, when it comes to these situations.