VersaBank - Q1 2024

Transcript

Operator (participant)

Good morning, ladies and gentlemen. Welcome to VersaBank's first quarter fiscal 2024 financial results conference call. This morning, VersaBank issued a news release reporting its financial results for the first quarter ended January 31st, 2024. That news release, along with the bank's financial statements and MD&A and supplemental financial information, are available on the bank's website in the Investor Relations section, as well as on SEDAR+ and EDGAR. Please note that in addition to the telephone dial-in, VersaBank is webcasting this morning's conference call. The webcast is listen-only. If you're listening on the webcast but wish to ask a question in the Q&A session following Mr. Taylor's presentation, please dial into the conference line, the details of which are included in this morning's news release and on the bank's website. For those participating in today's call by telephone, the accompanying slide presentation is available on the bank's website.

Also, today's call will be archived for replay both by telephone and via the internet, beginning approximately one hour following completion of the call. Details on how to access the replays are available in this morning's news release. I would like to remind our listeners that the statements about future events on this call are forward-looking in nature and are based on certain assumptions and analysis made by VersaBank management. Actual results could differ materially from our expectations due to various material risks and uncertainties associated with VersaBank businesses. Please refer to VersaBank's forward-looking statements advisory in today's presentation. I will now like to turn the call over to David Taylor, President and Chief Executive Officer of VersaBank. Please go ahead, Mr. Taylor.

David Taylor (President and CEO)

Good morning, everyone, and thank you for joining us for today's call. With me for the first time on these calls is our new Chief Financial Officer, John Asma, who was appointed to that role in December. Before I begin, I'd like to remind you that our financial results are reported and will be discussed on this call in our reporting currency of Canadian dollars. For those interested, we provide U.S. dollar translations for most of our financial numbers in our standard investor presentation, which will be updated and available on our website shortly. Now for the highlights. Our first quarter results continue to demonstrate the significant and increasing operating leverage in our highly efficient branchless business-to-business digital banking model. 22% year-over-year growth in total assets generated 35% year-over-year growth in net income, marking another new quarterly record for profitability.

And that, combined with our continued focus on management of our fixed cost, drove both year-over-year and sequential improvement in our efficiency ratio to a new record of 40%, and 24% year-over-year increase in average return on common equity to 13.4%. Notably, Q1 was a solid quarter for our Point-of-Sale Receivable Purchase Program business, which expanded by a healthy 7% sequentially, as the HVAC home improvement sector, which makes up the largest components of our Point-of-Sale portfolio, continues to see robust consumer activity. That contributed to another record high for total assets of CAD 4.3 billion, another meaningful step towards our next milestone of CAD 5 billion, and the continued outsized positive impact of our efficiency, our profitability, and our return on equity.

Taking a closer look at Q1 numbers, even with a continued very healthy year-over-year growth, I will highlight that our Q1 numbers were dampened slightly by a temporary contraction of our non-core real estate lending portfolio compared to the end of Q4. You have heard me say in prior calls that we will always look to be opportunistic with our real estate portfolio, expanding and contracting our portfolio depending on opportunities and risks within the market. You have also heard me say that we would be happy to trade lower net interest margin for return on equity if such opportunities arise. Such a situation recently emerged in the evolving regulatory environment has created an opportunity to transition the focus of our real estate portfolio from higher-yielding, higher-risk-weighted real estate loans to zero-risk-weighted CMHC-insured real estate loans. We are trading net interest margin for return on equity.

This is a great example of our ability of our bank to be flexible and agile to drive additional shareholder value. As we begin this transition in Q1, we saw our real estate portfolio temporarily contract from Q4 as we ran off-hold loans ahead of deploying capital to new zero-risk-weighted loans. We expect that this strategic adjustment will enhance the return on equity and contribute to stronger growth in subsequent quarters throughout the year. With our very low-cost source of funds throughout the Insolvency Professional Deposits, we have a distinct competitive advantage in the CMHC market. The other item I would note is some ongoing softness in our net interest margin. This is a natural outcome of the growth of the point-of-sale portfolio, which has lower margins but higher risk-weighted returns than our real estate portfolio.

So as point-of-sale portfolio grows, we earn less net interest margin, but we make up the profitability on volume. It is also a natural outcome of the growth of our wealth management deposits relative to our lower-cost Insolvency Professional Deposits to fund strong growth in our loan portfolio. The good news, at least for us, at least for Canadians, is that our low-cost Insolvency Professional Deposits, as expected, are expanding as the number of consumer and small business insolvencies continues to increase. And in fact, both the size of these deposits and the number of accounts is now at an all-time high. And this is as we continue to see the significant increase in insolvencies based on recent data, which is a leading indicator for our Insolvency Professional Deposits.

Accordingly, according to Statistics Canada, insolvencies in Canada in January were up 34% from the prior year and up 14% from December. We have seen that reflected in our insolvency deposit accounts, which are opened by trustees ahead of being filled with actual deposits, which were up 18% year-over-year and 6% sequentially. This will go some way towards supporting stronger net interest margins going forward. As our Canadian point-of-sale receivable purchase program business continues to see steady growth, we are increasingly encouraged by the very positive feedback we continue to receive from potential U.S. partners for this unique and attractive solution. In fact, we just returned from the annual KBW FinTech conference in New York City last week, where we once again had the opportunity to introduce ourselves to a number of potential partners.

Our meetings continue to confirm that there is a massive unmet need for our solution, and potential partners are eager for us to enter the U.S. market. With respect to the approval process for our proposed acquisition of U.S.-based Stearns Bank Holdingford, the process does continue to move forward. We continue to have productive engagement with the U.S. regulators, and we remain optimistic as we have been at any time throughout this entire process about the prospects for a favorable outcome. With three weeks left in the calendar quarter, while we still think it's possible that we could receive a decision before March 31st, we have adjusted our expectations to the second calendar quarter of this year. We continue to do everything we can to advance the process as quickly as possible but respect the need for regulators to be thorough.

And we continue to appreciate the patience of our shareholders. I'd now like to turn the call over to John to review the financial results in detail. John?

John Asma (CFO)

Thank you, David. Before I begin, I will remind you that our financial statements and MD&A for the first quarter are available on our website under the investors section, as well as on SEDAR+ and EDGAR. As David mentioned, all of the following numbers are reported in Canadian dollars as per our financial statements, unless noted otherwise. Now turning to the balance sheet. Starting with the balance sheet, total assets at the end of the first quarter of fiscal 2024 grew 22% year-over-year and 3% sequentially to a new high of CAD 4.3 billion. Cash and securities were CAD 260 million, or 6% of total assets, down slightly from 7% from both Q1 last year and Q4 of last year. Book value per common share increased to a new high of 4.0, or CAD 14.46.

Our CET1 ratio increased to 11.39%, and our leverage ratio was 8.44%, both well above our internal targets. Turning to the income statement. Total consolidated revenue increased 11% year-over-year but decreased 1% sequentially to CAD 28.9 million. The year-over-year increase was driven primarily by higher net interest income as our digital banking loan portfolio continues to grow, while the sequential decrease was mainly due to the impact of lower gross profits from Digital Boundary Group attributable to seasonally lower service engagements in the current quarter. Consolidated non-interest expense was CAD 12 million, down from CAD 12.3 million for Q1 of last year and CAD 12.4 million for Q1 of last year or sorry, Q4 of last year. I'm sorry. As management continues to focus on managing the fixed expenses line across the business.

Consolidated net income for Q1 increased 35% year-over-year to a record CAD 12.7 million and was up 2% from Q4 of 2023. As David mentioned, notwithstanding the healthy growth, Q1 profitability was slightly dampened by the temporary impact of the transition of real estate loans to higher return opportunities. Consolidated earnings per share increased 41% year-over-year and 2% sequentially to CAD 0.48, also a record, with year-over-year increase benefiting from a lower number of shares outstanding due to the buyback program we had in place during fiscal 2023. The loan portfolio grew just shy of CAD 4 billion at the end of Q1, driven once again by our point-of-sale receivable purchase program, which increased 28% year-over-year and 7% sequentially to CAD 3.1 billion.

Our point-of-sale portfolio represents 78% of our total loan portfolio at the end of Q1, up slightly from the end of fiscal 2023. Our commercial real estate portfolio expanded 9% year-over-year but was down 7% sequentially to CAD 831 million at the end of Q1, with the sequential decline due to the recalibration of our real estate portfolio. As a reminder, our real estate portfolio is primarily mortgages and construction loans for residential properties. We have very little exposure to commercial use properties. Turning to the income statement for digital banking operations. Net interest margin on loans, that is excluding cash and securities, was 2.63%. That was 40 basis points or 13% lower on a year-over-year basis and six basis points or 2% sequentially.

Net interest margin overall, including the impact of cash and securities and other assets, decreased 35 basis points year-over-year, or 12%, and decreased six basis points or 2% sequentially to 2.48%. As David discussed, Q1 net interest margin was lower primarily due to the strong growth of the POS financing portfolio, which is comprised of lower-risk-weighted, lower-yielding but higher return on common equity assets than commercial real estate, as well as the transitory impact of the transition of the real estate loans to the higher return opportunities. With respect to cost of funds, cost of funds for Q1 was 3.99%, up 104 basis points year-over-year and up 13 basis points sequentially. Cost of funds again was somewhat elevated in Q1 due to the elevated rates for term deposits.

Going forward, we expect to increasingly benefit from the continued expansion of our Insolvency Professional Deposits as insolvency activity in Canada continues to steadily increase. Our provisions for credit losses, or PCL, in Q1 remained negligible at negative 0.01% on average loans compared to 0.05% last year and with a 12-quarter average of 0%. I'll now briefly turn to DRTC. On a standalone basis, Digital Boundary Group Q1 revenue increased 24% year-over-year to CAD 2.9 million, and gross profits increased 31% to CAD 2.1 million, both due to higher service engagements. DBG also remained profitable within DRTC. Total DRTC revenue, including that from services provided to digital banking operations, increased 36% year-over-year and was down 32% sequentially to CAD 2.5 million.

DRTC's net income of CAD 435,000 was an improvement over the net loss of CAD 516,000 a year ago but down from a net income of CAD 1.2 million in Q4 of last year. I'd now like to turn the call back to David for some closing remarks. David?

David Taylor (President and CEO)

Thanks, John. Building on 2023, which was by far our best year in the history of the bank, fiscal 2024 is off to a very solid start. The year is unfolding slightly ahead of expectations for our Point-of-Sale Receivable Purchase Program, providing continued confidence in our ability to surpass our next total asset milestone of CAD 5 billion during 2024 fiscal year, and the efficiency and return on equity that naturally fall out of that as we hold increases in our fixed costs to more or less in line with inflation. Notably, we should achieve this CAD 5 billion milestone before any potential contribution from the broad launch of the RPP in U.S. Should we receive favorable regulatory approval for our proposed U.S. acquisition.

While we do continue to see some signs of potential slowdown in the broader economy due to the current interest rate environment, we are seeing resiliency in the sectors in which we participate, hence our confidence in our growth outlook for this year. Q1 positions VersaBank for another year of healthy growth and profitability. As I mentioned earlier, we expect to recapture the dampening profitability in Q1 throughout the year as we capitalize on the zero-risk-weighted CMHC-insured mortgage opportunity. Again, we may trade some net interest margin for return on equity. The more successful we are with the zero-risk-weighted CMHC loan program, the more we still continue to have, by far, the highest net interest margin amongst Canadian banks. Unlike our peers, we give nothing back for loan losses.

And as noted earlier, we expect some favorable impact on cost of funds as the increased insolvency activity should drive continued expansion of this low-cost deposit source. Provisions for credit losses should, of course, remain low, with the start of the year tending to a negative provision as a result of our highly risk-mitigated lending practices, in particular the holdback model for the Point-of-Sale Receivable Purchase Program on loans and leases. Finally, we are seeing solid momentum in our cybersecurity services subsidiary, which we expect to continue throughout the year. This remains a tremendous opportunity in a rapidly growing market, and we expect continued growth and success going forward. With that, I'd like to open up the call to questions. Operator?

Operator (participant)

Thank you, ladies and gentlemen. Should you have a question, please press the star followed by the one on your touchstone phone. If you'd like to withdraw your question, please press the star followed by the two. If you're using a speakerphone, please leave the handset before pressing any keys. One moment, please, for your first question. Your first question comes from David Feaster from Raymond James. Please go ahead.

David Feaster (Managing Director of Equity Research)

Hey. Good morning, everybody.

David Taylor (President and CEO)

Good morning, David.

David Feaster (Managing Director of Equity Research)

I just wanted to start out maybe, you know, with all the moves that you guys have done. You talk about kind of, you know, shifting towards lower risk, lower yielding but lower risk, less capital-intensive, lending. You've done a great job driving operating leverage and taking expenses out, just kind of given the scalability of, of the platform. I'm just curious, how do you think about the profitability profile as we look forward, you know, in the next year or two? Where, where do you think profitability kind of shakes out?

David Taylor (President and CEO)

Well, it's probably grow at the pace that you've been seeing in the last year and this quarter improve somewhat. The ROE will increase, fairly dramatically. We're shooting for about 16.5% once we get to the CAD 5 billion milestone. And that's because these CMHC mortgages absorb no capital, and they're easily matched against the insolvency portfolio. The insolvency portfolio is priced at approximately prime minus two. And these CMHC construction mortgages average around prime minus, say, 25 basis points. So, it nets the bank 175 basis points, with a perfect match. And that's sort of free, from a return on equity point of view.

David Feaster (Managing Director of Equity Research)

That's helpful. Maybe just touching on the point of sale growth, you know, growth accelerated this quarter. Curious if we could talk maybe a bit about some of the drivers behind that. You know, how much is demand from existing partners, you know, adding new partners, additional growth in the U.S., and just kind of any color on the health of the consumer in Canada and kind of how you think about the breakdown between Canadian growth and U.S. growth, even exclusive of Stearns'?

David Taylor (President and CEO)

Well, that was primarily from existing partners in Canada. The biggest driver was the HVAC home improvement area, which tends to be super prime or prime Canadians looking to replace inefficient furnaces and such with the new energy-efficient furnaces and more insulation. So it's, I think it's about 70-odd% of our portfolio now flows from that area. And that's what's sort of dampened the impact of sort of a recessionary time or higher interest rates. Folks are still quite rightly believing that they should it makes economic sense to replace an old furnace. So that's helped. Now this is normally a down quarter for us on point of sale. And that, you know, in Canada, you know, there's a little less activity when it's winter than there is in the spring and summer and fall.

So this bodes well with a 7% sequential growth quarter-over-quarter. And we, you know, we're not into the springtime, warmer climes that tend to bring people out to use car lots and new car lots and all the things you buy in the summertime. So it bodes well. But that's strictly the Canadian market. We haven't done much in the U.S. market. We're just sort of waiting patiently for our U.S. banking license so that we can expand that market.

David Feaster (Managing Director of Equity Research)

Okay. And then just wanted to get an update on DRT Cyber. It sounds like, you know, revenues are seasonally slower as expected, less a little less intercompany work. But curious how the pipeline is. How's demand trending and just any new products or, or, you know, additions or, or just kind of expansion of that business that you're working on?

David Taylor (President and CEO)

In the cybersecurity business, it is growing 20%-30%. And, you know, with the rate we're at now, it probably end up in U.S. dollars around $10 million revenue this year. It's getting pretty close to that in the seasonally down quarter. We always work on improving our product offering in the cybersecurity area. But there are some products that we have in DRT Cyber such as the VersaVault that we talked about a few years ago. I think we're the first in the world to create a digital vault that's ideally suited for storing cryptocurrency keys and such, like Bitcoin keys. And that is empty. The vault is empty in that we see that as being an incompatible business with our banking operations.

But that vault is, you know, if it was to be used by somebody else perhaps, it would be ideal for this resurging interest in Bitcoin. That's what it was designed for, to facilitate the storage of those what are getting to be very high value digital assets.

David Feaster (Managing Director of Equity Research)

That's great. Thank y'all.

David Taylor (President and CEO)

Sounds good, David. Thank you. I'm in Florida, by the way. I'm in your neck of the woods.

Operator (participant)

Ladies and gentlemen, as a reminder, should you have a question, please press the star followed by the one. Your next question comes from Mike Rizvanovic from KBW. Please go ahead.

Mike Rizvanovic (Equity Research Analyst)

Hey. Good morning. Just wanted to start with some.

David Taylor (President and CEO)

Good morning, Mike.

Mike Rizvanovic (Equity Research Analyst)

Good morning, David. Quick question on the POS in Canada and thanks for the color. I think you've given us a pretty good sense of demand and how trends are moving, directionally. But just in terms of your partnerships, do you have capacity to add anything that would be meaningful? I'm just thinking through perhaps a potential slowdown with your existing partner base. Can you supplement that with some sort of growth that comes from additional partners? Or have you sort of run the gamut on that and you're saturated in the Canadian market?

David Taylor (President and CEO)

No. We think there's some ideal partners that should be dealing with us that aren't yet. So I'd like them to sort of try it and see if they like it. And as has been in the past with the others, they probably will like it and start utilizing us. But there's still some partners left in Canada for us to deal with. In the States, there's a huge number sort of lined up at the door. The KBW conference that you guys sponsored, and thank you for the invitation in New York City. We must have met at least a dozen ideally suited partners that some are actually very familiar with our operations in Canada and are keenly interested. So in Canada, we still got some room to grow with partnerships. And in the United States, we have a tremendous opportunity.

Mike Rizvanovic (Equity Research Analyst)

Okay. But is it fair to say that you're not really seeing anything in the near term in the pipeline in Canada? You're sort of running with the existing partner base?

David Taylor (President and CEO)

That's true. We are working on some new partnerships that actually are in the States, because they're so sort of keen that, despite us not yet having the U.S. license, we're sort of cobbling together a Canadian solution for them, even despite them operating in the States.

Mike Rizvanovic (Equity Research Analyst)

Okay. That's helpful. And then just one quick one on Stearns's and the timing of the close. And I, I fully understand why there has been, such a long delay just given what, what happened last year with the U.S. regional banking sector. And I'm just wondering, you sound confident on the closing and, and, and, you know, I appreciate the, the conservative viewpoint on saying that it probably lands in the second calendar quarter. But is there any risk at all that this does not get approved in your view? I'm not sure if you could even, you know, make that commitment on, on, on that commentary. But is, is there any potential roadblock that could derail the acquisition altogether?

David Taylor (President and CEO)

Well, I'd never, never say never. I, I think there's a tiny risk that it that it wouldn't close. But, you know, being a sort of a quantitative guy, go 9.9% chance it would close. I don't know of any impediments to the close. I, I think the product we're offering to the United States is unique and will have a huge benefit for the U.S. economy. The point of sale companies that we're talking to, you know, provide a good portion of point of sale financing in the States. And what we're providing them with is an economical alternative source of funds. They already have sources of funds, of course. But ours is kind of a new mousetrap.

It's efficient to probably have less equity and less liquidity in that we can buy loans and leases on almost a real-time basis. So it's a very attractive product. And I think the U.S. regulators realize that we're bringing something to their economy that they'll be very helpful. And you know, in the final analysis, it means more economical pricing for small businesses and consumers as our funds flow through the model.

Mike Rizvanovic (Equity Research Analyst)

I appreciate that. I'll take that 99.9% to, to reflect a very confident view, at this stage. Thank you. Thank you, David.

David Taylor (President and CEO)

Yeah. That, that's, you know, like I say, in the banking world, you don't ever want to say 100%.

Mike Rizvanovic (Equity Research Analyst)

Right.

David Taylor (President and CEO)

It's, I would say it's pretty close to that. I can't think of any reason why the U.S. regulators wouldn't want us to present this product to their consumers and small businesses. You know, it's worked well in Canada for the last 12 years. And, I think it worked just as well, maybe even a little bit better given the size of the market and the solution that we're providing has been refined over the last few years.

Mike Rizvanovic (Equity Research Analyst)

Yeah. Thank you. Thank you, David. I really appreciate the color.

David Taylor (President and CEO)

No problem, Mike. Good. Hey, Mike, you're up in Toronto, right? Don't feel bad, but I had to come down here to Florida to catch up on a few things. That being said, Shawn.

Mike Rizvanovic (Equity Research Analyst)

You always have to check that out, don't you?

Operator (participant)

Ladies and gentlemen, as a reminder, should you have a question, please press the star followed by the one. Your next question comes from Stephen Ranzini from University Bank. Please go ahead.

Stephen Ranzini (President and CEO)

Hi, David. Congratulations to you and your team on another great quarter. I was just curious, if you could provide some color around the status of getting approval for buying back more shares.

David Taylor (President and CEO)

Well, Steve, it's not on the list of our things to do right now. We put that program on pause in that, as our share price is tending to go over book value, the great opportunity we had in the past, that three-quarters of book, isn't there anymore. It's quite likely, I think, you know, given I'm a little bit prejudiced on this. I think this stock price should continue upward, to well over, well over book value. Secondly, we're sort of in a static scenario, while our application is in to finish the purchase of Stearns Bank Holdingford and, you know, not looking to introduce another variable into our capital.

Stephen Ranzini (President and CEO)

All right. Thanks so much, David. And, keep up the great work.

David Taylor (President and CEO)

Well, thank you, Steve. Yeah. As hopefully, it's warming up in Michigan.

Stephen Ranzini (President and CEO)

Well, it was 75 the other day. It was like summer in the middle of the winter.

David Taylor (President and CEO)

Wow. Bring on that global warming.

Stephen Ranzini (President and CEO)

Very, very unusual weather.

David Taylor (President and CEO)

Yes. Yes.

Stephen Ranzini (President and CEO)

We'll, we'll take it.

David Taylor (President and CEO)

Well, it's both.

Stephen Ranzini (President and CEO)

Every day in Michigan that it doesn't snow is a good day.

David Taylor (President and CEO)

Indeed. Well, good talking to you, Steve.

Stephen Ranzini (President and CEO)

Thank you.

Operator (participant)

There are no further questions at this time. I will turn the call back over to David for closing remarks.

David Taylor (President and CEO)

Well, thank you again for everybody for signing in to join us for this call. I look forward to speaking to you at the time of our second quarter results.

Operator (participant)

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining, and you may now disconnect your lines. Thank you.