VersaBank - Earnings Call - Q1 2025

Transcript

Operator (participant)

Good morning, ladies and gentlemen. Welcome to VersaBank's first-quarter fiscal 2025 financial results conference call. This morning, VersaBank issued a news release reporting its financial results for the first quarter ended January 31, 2025. That news release, along with the bank's financial statements, MD&A, and supplemental financial information, are available on the bank's website in the Investor Relations section, as well as on SEDAR Plus 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 are listening to 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 made 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's businesses. Please refer to VersaBank's forward-looking statement advisory in today's presentation. I would 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 is our Chief Financial Officer, John Asma. Before I begin, I will note that you will see a change in a number of terms we use to describe our business. With the start of a new fiscal year and the context of the evolution of the bank, including the U.S. bank acquisition, we have taken the opportunity to update the manner in which we are describing our asset and deposit classes. The first quarter of fiscal 2025 has been a tremendously busy and eventful one in terms of moving our strategy forward. We signed our first RPP partner in the United States following the U.S. bank acquisition. We completed a very successful CAD 86 million capital raise, including full execution of overall option to support our U.S. RPP opportunity.

We aligned the structure of DRT Cyber to position our digital deposit receipts for renewed opportunity and our cybersecurity service business for planned divestiture. We accomplished all of this as we achieved yet another record for total assets. Let me start with signing of our first U.S. partner post-U.S. bank acquisition. We are thrilled to partner with Watercress Financial, a rapidly growing point-of-sale originator of home improvement loans in the U.S. Watercress has proven track record of originating high-quality consumer loans through its expanding network of contractors nationwide. It's no accident that our first partner finances home improvement sector, as that has been our biggest driver of significant growth in our Canadian business in recent years. Immediately following the agreement, we provided our first tranche of funding, and shortly thereafter our second.

Importantly, the program is functioning just as it should and meeting both our partners and our expectations. We expect our funding with Watercress to steadily expand throughout the year and contribute meaningfully to U.S. growth this year. We are working with multiple other firms in our robust pipeline to add them as our next partners. We are confident that these can be finalized quicker now that we have been through this once. Moreover, with the program now formally functioning in the United States under our U.S. license, we have further evidence of its value for potential new partners. John will run through Q1 numbers in detail in a few minutes, but I want to highlight a few items to provide some perspective on the quarter. One, from a consolidated perspective, the quarter reflects the start-up nature of the U.S. operations.

That is essentially full costs ahead of any generation of revenue and profits from our U.S. RPP. Specifically, we had close to a full cost load, but a de minimis revenue as we signed our first U.S. partner only at the very end of the quarter. Two, our Canadian digital banking operations continue to demonstrate the power of the operating leverage in the business, in particular the power of the Receivable Purchase Program at scale to drive efficiency and return on common equity. I will note here that our Canadian banking operations bear the vast majority of our corporate overhead costs, including our public company costs. As an indicator of its true potential efficiency and return on equity of our U.S. business, it is actually significantly understated. The U.S. business is expected to be even more efficient than the Canadian business at scale.

Three, I noted on our last call that there are a number of favorable trends that we believe will support incremental expansion of our net interest margin in 2025. While NIM on credit assets continues to be dampened by the lag effect of the atypical inverted yield curve that existed throughout fiscal 2024, we began to see small sequential increases in NIM on credit assets in Q1. This was driven to a large extent by the cost of funds catching up to yields as market interest rates decline. Notably, with an outsized proportion of term deposits coming due in the near term, as well as continued expansion of our insolvency trustee deposits, we expect further declines in our cost of funds in the near term. Finally, our EPS for the quarter reflects the significantly higher number of shares outstanding in Q1.

As a result of our December capital raise. In fact, the weighted average shares of Q1 was 12% higher than Q1 last year. This is, of course, ahead of being able to put that capital to work, as we have now started to do. As a reminder, this provided a 30% increase in our capital base, which we deploy at approximately 12 times or more at around 2.5% spread. That is very accretive. I'd now like to turn the call over to John to review our financial results in detail. John?

John Asma (CFO)

Thanks, 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 investor section, as well as on SEDAR and EDGAR. All of the following numbers are reported in CAD as per our financial statements, unless otherwise noted. Starting with the balance sheet, total assets at the end of the first quarter of fiscal 2025 grew 15% year over year and 3% sequentially to a new high of just under CAD 5 billion. Cash and securities were CAD 545 million, or 11% of total assets, up from 6% in Q1 last year and level with Q4 of last year, ahead of expected deployment in Q2. Book value per share increased to a record CAD 16.03. Our CET1 Ratio increased to 14.61%, and our Leverage Ratio was 9.67%, with both remaining above our internal targets.

Total consolidated revenue was CAD 27.8 million compared with CAD 28.9 million last year. The small year-over-year decrease was driven by lower overall net interest margin, as well as lower non-interest income. Consolidated non-interest expense was CAD 15.7 million compared with CAD 12 million in Q1 of last year and CAD 19.4 million for Q4 of last year, which included one-time expenses mostly related to acquisition. The year-over-year increase reflects incremental operating costs associated with VersaBank USA operations and higher operating costs to support current and anticipated increased business activities ahead of any revenue generation. As a reminder, DRT Cyber expenses are included in consolidated net interest expense and totaled CAD 3 million for the quarter, which were elevated, and I will describe in a moment.

Looking at the income statement on a segmented basis, the vast majority of revenue was, of course, driven by our digital banking operations, and within that, our Canadian banking operations, as we did not fund our U.S. partner until the end of the first quarter. Revenue for the Canadian business operations was CAD 23.8 million, up slightly from Q4 of last year. Net income for the Canadian banking operations was CAD 8.8 million, or CAD 0.30 per share. Revenue for U.S. banking operations was CAD 2 million, and income from the U.S. banking operations was CAD 103,000. Within DRT Cyber, the cybersecurity component generated revenue of CAD 2 million, up from CAD 1.9 million in Q1 of last year. Net loss was CAD 757,000, impacted by higher operating expenses related to the onboarding support costs for new cybersecurity offerings. Within DRT Cyber, digital media revenue was CAD 342,000, and net income was CAD 33,000.

Our credit asset portfolio grew to a new record CAD 4.35 billion at the end of Q1, driven once again by our Receivable Purchase Program, which increased 10% year over year and 3% sequentially to CAD 3.4 billion. Our RPP portfolio represents 79% of our total credit asset portfolio at the end of Q1, up slightly from the end of Q4. David previously mentioned changes to the naming of our asset categories. One of those changes was to simplify the commercial real estate portfolio and public sector and other portfolio to the combined multifamily residential loans and other portfolio. Our multifamily residential loans and other portfolio grew 5% year over year to CAD 928 million. We are seeing the ramp-up of our CMHC Insured Loan Program, which drove a 2% sequential increase in multifamily residential loans and other portfolio. We currently have CAD 231 million outstanding at the end of the quarter.

As a reminder, our multifamily loans and other portfolio is primarily business-to-business mortgages and construction loans for residential properties. We have very little exposure to commercial use properties. Turning to the income statement, our digital banking operations, net interest margin on credit assets, that is, excluding cash and securities, was 2.36%. That was 27 basis points, or 10% lower on a year-over-year basis, and 2 basis points, or 1% higher on a sequential basis, primarily due to the lag effect of the atypical inverted yield curve that existed throughout 2024, which dampened the RPP portfolio margins. Net interest margin, including the impact of cash, securities, and other assets, was 2.08%, which was primarily due to higher-than-typical liquidity in the first quarter of fiscal 2025, but still remaining among the highest of the publicly traded Canadian Schedule I banks.

Our provision for credit losses, or PCL, in Q1 increased this quarter to 0.09% on average credit assets, compared to negative 0.01% last year and with a 12-quarter average of 0.02%. The increase this quarter was due to changes in forward-looking information used in our credit risk models. I'd now like to turn the call back to David for some closing remarks. David?

David Taylor (President and CEO)

Thanks, John. 2025 is off to a great start and unfolding on plan. Looking ahead, we expect another year of solid growth in credit assets. We will increasingly benefit from the operating leverage of our business model as those assets scale. We still expect a minimum of low double-digit growth in our Canadian assets, with potential upside from increased consumer spending in the lower interest rate environment. That said, we could see this growth dampened if the recent tariff situation is prolonged and it meaningfully impacts consumer spending in Canada. We expect to begin to see a more meaningful contribution of our growing CMHC insured multifamily residential loan business in our opportunistic real estate portfolio. These zero-risk weighted loans require no capital and generate a very attractive spread.

We are still targeting CAD 1 billion in commitments by the end of fiscal 2025, although the pace of drawdowns on commitments to date has been slower than expected. Each of these will drive greater efficiency, growth in profitability, and higher return on common equity as we continue to capitalize on the operating leverage of our business model. We also expect to see the continuation of several favorable trends that support net interest margin. The yield curve has returned to its normal upward slope. While there is still a lag effect in the very near term, we will see benefit thereafter increasing in 2025. In addition, we should continue to see the benefit of our low-cost insolvency trustee deposit business as bankruptcy activity in Canada continues to increase. In the U.S., we are off and running with our first partner post-U.S. bank acquisition, with the benefit of U.S.

$86 million in capital we raised in December. We have a robust and growing pipeline as our discussions with both potential partners and others in the industry continue to validate that our RPP is both unique and a very attractive solution for companies who finance big-ticket goods and services at the point of sale. We will grow our U.S. RPP business as quickly as our balance sheet capacity permits. I will note here, at this time, we do not expect tariffs to have any negative impact on the ramp-up of our U.S. RPP business. In fact, the uncertainty in the markets could make our RPP solution even more attractive as alternate sources of funding get more expensive.

Finally, we continue to be very encouraged by our favorable stance of the Trump administration on digital assets, which we believe will be very beneficial for our proprietary digital deposit receipts, or DDRs for short. We are now actively pursuing this renewed opportunity. Our DDRs are highly encrypted digital assets based on a one-for-one on actual deposits that combine the safety of a traditional banking with the efficiency, cost savings, security, and flexibility of blockchain technology. This uniquely provides superior security, stability, and regulatory compliance compared to conventional alternatives. Importantly, our DDRs are backed by the bank's very own military-grade cybersecurity technology, which we call VersaVault. We have a tremendous head start having successfully completed the pilot program with our proprietary DDRs providing a secure representation of federally regulated bank deposits on the Algorand, Ethereum, and Stellar blockchains.

Our DDRs have the potential to be an ultra-low-cost source of deposits funding for VersaBank, as well as any bank that uses our technology, while enabling consumers and businesses to confidently engage in the rapidly developing field of digital commerce. To pursue this opportunity, we have transferred the intellectual property and other resources related to DDRs to our wholly owned subsidiary exclusively for DDR assets. The name Digital Meteor is indicative of the potential for DDRs to significantly disrupt the conventional banking deposit framework. With that, I'd like to open up the call for questions. Operator?

Operator (participant)

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. The first question comes from Joe Yanchunis at Raymond James. Please go ahead.

David Taylor (President and CEO)

Go ahead, Joe.

Operator (participant)

Joe, please unmute your line. You are live.

Joe Yanchunis (Senior Equity Research Associate)

I apologize. Good morning. Let me start over. The digital deposit receipts, it sounds like a very exciting opportunity. How should we think about that kind of in the near term? Can you quantify the level of these deposits by year-end that you would consider a success?

David Taylor (President and CEO)

Joe, what we have in mind is piloting the project again in the United States. We completed the pilot project for what we call VCAD, or CADVs, being a digital representation of deposits with our bank in Canada. Now that we have a national bank license in the United States, we plan to do a similar pilot very soon, actually. We're working with the regulators to put that together. Once we've had a successful pilot project, we'll start raising deposits in this fashion, probably towards the middle to the end of the year. I think it's an extremely attractive product.

It's sort of like the modern-day checking account where one of our depositors can pay for some goods or services rather than write an old-fashioned paper check, but transfer a digital deposit receipt that, of course, would be insured in that it's a deposit with a national bank to another person's wallet and thereby transact business, sort of like having a certified check because, obviously, they are drawn on our bank and our bank's deposits attract FDIC insurance. I think towards the end of this year, you'll probably see it rolled out. Right now, the plan is just to start a pilot in the United States.

Joe Yanchunis (Senior Equity Research Associate)

Understood. Certainly look forward to seeing how that matures and grows over time. John, if we could just pivot over to the non-interest expenses, should we think about this being the current run rate kind of moving forward where we're at right now?

David Taylor (President and CEO)

Yeah, I would, maybe even a little bit more. The one thing that impacts our financial statements is the exchange rate in that the expenses we have in the U.S. are a lot more expensive now in terms of CAD. The salaries, of course, the salaries we are paying on the 14 people we assigned to the U.S. bank, in terms of CAD, are a lot more expensive. Yeah, that's what I would do. I'd run at today's rate plus a little more, maybe. That's a good number to estimate.

Joe Yanchunis (Senior Equity Research Associate)

Got it. I appreciate that. Last one from me here. How should we think about this growth in the U.S. RPP volume as we move throughout the year? How quickly do you think you can ramp that up?

David Taylor (President and CEO)

The first account we assigned, Watercress, took a little while to plow through the legal work. Shortly after signing, we did the first draw, about CAD 10 million. We did another draw after that, about CAD 15 million. I think it looks like there is a lot more to come. I would look at it as gathering momentum. The next one is in the hopper, and the legal work should not take anywhere near as long. The original targets I gave for the year were in the order of, I think it was $290 million U.S. I think that is easily attainable just with a few RPP partners, and there is quite a number lined up.

Joe Yanchunis (Senior Equity Research Associate)

All right. I appreciate it. Thank you for taking my questions.

David Taylor (President and CEO)

Thank you, Joe.

Operator (participant)

Thank you. The next question comes from Tim Switzer at KPW. Please go ahead.

Tim Switzer (VP of Equity Research)

Hey, good morning. Thank you for taking my questions. I have a follow-up on kind of the trajectory of the U.S. point-of-sale business and the origination there. Can you provide an update on how the conversations with some of your newer partners are going and what it's going to take for them to want to launch quicker and start originating loans as soon as possible?

David Taylor (President and CEO)

It's sort of a matter of doing the paperwork to we have what we call a master purchase and sale agreement, and it's a fairly hefty document. Our partners and their lawyers have to become familiar with it and interact with us. That's sort of what we experienced in Canada, too. It's a unique new program, and it takes a little while to understand how it all operates. It's just simply do the paperwork. Everybody seems keen and excited. In fact, we've talked to some partners who have huge potential. Some of them dealt with us in the past in Canada. They're familiar with the bank. They're familiar with the personnel, actually. It'll just do like it did in Canada. It'll just start gathering momentum and get a little bit of help. The alternative financing is securitizations.

I guess, unfortunately, due to market conditions, securitizations are getting a little more expensive. There is sort of a flight to quality again, which plays into our hand. Of course, it is not so good for the stock market and investors.

Tim Switzer (VP of Equity Research)

Thank you. As you begin to ramp up the originations in the U.S. business, how should we think about the capacity of the balance sheet, which I think is pretty large now following the capital raise, versus the loans that you want to put in the syndication? What does that mean for the related fee income?

David Taylor (President and CEO)

As we start to approach our budgeted figure, we'll be sharing the loans through the syndication model with other community banks and maybe some investment firms. We're well underway with that with the program. The software is developed. The software works, and it's easily able to look after it. We've been working with some large investment banking firms to package the participation into a security that hopefully has a decent bond rating. I'm looking for about a double-A concerning our bank is single-A unsecured, which gives a favorable risk weighting on a participant's balance sheet, about 20% versus a 75-100. That'll make the product even more attractive. With respect to management fees, we've been targeting around 1%. It remains to be seen. We haven't concluded a transaction yet.

The more attractive the product is, i.e., bond rating and risk weighted at a very low level, the better fees we'll be able to earn, obviously. The market conditions, too. When the market's frothy, rates are narrow, and we have to sharpen our pencils. When the rates, as it seems to be happening now, increase the plate to quality versus higher risk debt, then we do better.

Tim Switzer (VP of Equity Research)

Okay. Great. Thank you so much.

Operator (participant)

Thank you. The next question comes from Andrew Scutt at ROTH Capital Partners. Please go ahead.

Andrew Scutt (Equity Research Associate)

Hey, good morning, guys. Thank you for taking my questions. First one for me here, can you just kind of parse out a little bit more of the detail of the impact of the flattening of the yield curve? You kind of talked about the roll-off of some of the deposits on the book right now and just kind of what you see in the 2025 trajectory.

David Taylor (President and CEO)

Yeah. Thanks, Andrew. Yes. Last year around this time, we were warning about our deposit rates, that would be Canadian deposit rates, increasing on a margin over the same-term Government Canada bond. They got to sort of historical highs, 80-90 basis points over the same-term Government Canada bond. Those GICs in Canada, they call them GICs or CDs, are going through the system now. They're maturing. The unusually high margin we were paying over the risk-free rate is diminishing in 2025. That gives us quite a tailwind on margins. Historically, we run around a 3% margin. You've started to see it inching up a little bit, but we've only had the beginning of the maturities of those higher-priced GICs go through.

The other thing that's helpful for us, but not so helpful for the rest of Canada, is that there's been a huge increase in bankruptcies, about 26% year over year. It might even be a lot higher in the next few months. While that doesn't bode well for the Canadian economy, dampens consumer enthusiasm to buy things and such, it certainly provides us with a lot more economically priced deposits. All in all, keeping those things in mind, our margins should widen back up to where they used to be running around three.

Andrew Scutt (Equity Research Associate)

Great. Thanks for the caller there. Second one for me, a little bit of housekeeping. You guys took a bit of a provision in the quarter. I believe it was due to an accounting change. Can you just provide some details there?

David Taylor (President and CEO)

Yeah. We have our provisions based on, as all the other banks do, on forward-looking models. It is a provision for expected losses or possible losses. It is driven by a lot of factors. We are in a little more unstable credit environment on both sides of the border. Our models are producing higher provisions than they have historically. Mind you, they are still only tiny basis points, one or two basis points, versus the industry is around 30-40 basis points. That is what happens when you have disruptions in the credit markets that the models we use and all the other banks use start kicking up increased provisions for losses. No, they are not losses, but they are provisions for losses.

Andrew Scutt (Equity Research Associate)

Great. Thanks for the time this morning, and thanks for taking my questions.

David Taylor (President and CEO)

Oh, thank you. Look forward to seeing you soon, Andrew, in California. I'll be seeing you in California, right?

Operator (participant)

Thank you. We have no further questions. I'll turn the call back over to Mr. Taylor for closing comments.

David Taylor (President and CEO)

I would like to thank everybody for joining us today, and I look forward to speaking to you at the end of our second quarter. Thank you very much. Have a good day.

Operator (participant)

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.