VersaBank

Good morning, ladies and gentlemen. Welcome to VersaBank's first quarter fiscal 2023 financial results conference call. This morning, VersaBank issued a news release reporting its financial results for the first quarter ended January 31st, 2023. That news release, along with the bank's financial statements and supplemental financial information, are available on the bank's website in the Investor Relations section, as well as on CDAR 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, so 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 provided 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 the 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 business. Please refer to VersaBank's forward-looking statement advisory in today's presentation. I would now like to turn the call over to Mr. David Taylor, President and Chief Executive Officer of VersaBank. Please go ahead, Mr. Taylor.

Good morning everybody and thank you for joining us for today's call. With me is Sean Clark, our Chief Financial Officer. Before I begin, I'd like to remind you that our financial results are reported and will be discussed on this call and our reporting currency, Canadian dollars. Those interested, we'll provide US translations for most of our financial numbers in our standard investor presentation, which will be updated and available on our website shortly. Now to the results. The first quarter was not only another record quarter for VersaBank, but more importantly, one that was demonstrative of the true efficiency and return on equity generating capability of our branchless business-to-business digital banking model. And once again, this was complemented by the continued profitable contribution of our cybersecurity services business. Our digital banking operations continue to see very strong year-over-year growth in our loan portfolio at 46%. which drove our portfolio to an all-time high of just under $3.25 billion. Growth was again driven primarily by Canadian point of sale loan and lease portfolio, which was up 68% from Q1 last year. The combination of loan growth and stable net interest margin drove record revenue and record interest income. On the cost side, As we anticipated, the transitory costs related to growth investments and our move to NASDAQ that temporarily elevated our non-interest expense and dampened our profitability in 2022 substantially normalized in the first quarter, putting our efficiency ratio back on track towards its full potential. We continue to expect further normalization as our non-interest expense and, importantly, We haven't only barely begun to realize the growth contributions of those investments we made last year. All this drove by far our best quarter ever in terms of net income and EPS. Save for one outside quarter for net income in 2017 due to an accounting recognition when VersaBank amalgamated with PwC Capital. Net income grew 69% year-over-year to $9.4 million, besting our previous record of $6.4 million by a full $3 million. And EPS grew 79% or 15 cents year-over-year to 34 cents. Looking more closely at our performance, as I noted a moment ago, The first quarter financial results were marked once again by our best ever revenue, net interest income and net income and earnings per share. Outside of these record results, there are three metrics that I'd like to highlight. The first is our net interest margin. It's important to note that we have generated loan growth while maintaining our overall net interest margin and without taking on additional risk. This is something relatively unique compared to our peers. The second is our efficiency ratio. Now that we are through the bulk of our transitory costs for our strategic growth initiatives, the true scalability and efficiency of our model is emerging. The third, earnings per share growth, which outpaced net income growth as a result of our active share repurchase program. As we look ahead, in addition to the continued growth we expect in our Canadian loan portfolio, we expect to generate significant long-term growth from our launch of the United States Receivable Purchase Program. This is our high-value ad financing offering for consumers and small business lenders. Based on our proprietary technology that provides them with a regular, reliable, inexpensive funding alternative, to help them succeed in their businesses. As I discussed in our last quarterly call, this acquisition is transformational, the next step in VersaBank's long-term growth strategy that will enable us to bring our track record of innovative digital banking solutions to address unmet needs to one of the world's largest banking markets. We have launched this program on a limited basis in the United States, of the broad national rollout planned upon completion of the acquisition of the Minnesota-based Stearns Bank, Holdingford, a fully operational OCC chartered national U.S. bank. Specifically, this acquisition will enable us to broadly roll out our receivable purchase program to the underserved U.S. market, which has been so successful in Canada, where we call it our point-of-sale financing business. In December, we submitted the requisite filings to the OCC and the reserve, seeking approval of the acquisition. And based on continuing dialogue, we remain optimistic with respect to near-term approval. In terms of an update on timing, which is ultimately the discretion of our regulators on both sides of the border, we anticipate receiving a decision with respect to its approval of the proposed application from the U.S. regulators during the second quarter of the calendar 2023. And if favorable, we will proceed to complete the acquisition as soon as possible subject to Canadian regulatory approval. In the interim, we continue to actively prepare for the significant opportunity to bring our differentiated and attractive financing solutions to U.S. partners. Pumping up U.S. Receivable Purchase Program, or BP, our U.S. portfolio continues to expand with loans now nearly $44 million. As I discussed in our last call, we have limited warning of loans ahead of the fulsome rollout upon completing the U.S. acquisition. And in fact, demand to date has continued to outstrip our self-imposed short-term capacity restrictions. Very comfortable with our progress and with the revised expectations for completion, we have made the decision to ramp up our US RPP loans ahead of closing the acquisition. More on this in a moment. I'd now like to turn the call over to Sean to review our financial results.

Thanks, David. Before I begin, just a quick reminder that our full financial statements and MD&A for the first quarter are available on our website under the Investor section, as well as on CDAR and EDGAR. And, as David mentioned, all of the following numbers are reported in Canadian dollars as per our financial statements, unless otherwise noted. Starting with our balance sheet, Total assets at the end of the first quarter of fiscal 2023 were just over 3.5 billion, up 46% from 2.4 billion at the end of Q1 last year, and up 8% from 3.3 billion at the end of fiscal 2022. Cash and securities at the end of Q1 were 251 million, or 7% of total assets, compared with 155 million, or 6% of total assets at the end of Q1 last year, and 230 million, or 7% of total assets at the end of fiscal 2022. Our total loan portfolio at the end of the first quarter expanded to another record balance of $3.24 billion, an increase of 46% year over year and 8% sequentially. I'll break this out into its component parts in a moment. Book value per share increased 8% year-over-year and 3% sequentially to another record at $12.77. These increases were both a function of higher retained earnings resulting from net income growth, partially offset by dividends paid, and also benefited from the lower number of outstanding shares as a result of our active share buyback program. Our CET1 ratio was 11.2%, down from 14.8% at the end of Q1 last year, and down from 12% at the end of fiscal 2022 where our leverage ratio at the end of Q1 of this year was 9.21%, down from 12.7% at the same point last year, and 9.8% at the end of fiscal 2022. Both of our CET1 and leverage ratios remain well above our internal targets. Turning to our income statement. Total consolidated revenue increased 42% year-over-year and 7% sequentially to a record $25.9 million, with the increase driven primarily by higher net interest income derived from our digital banking operations resulting from the strong growth in our loan portfolio that I mentioned earlier and the maintenance of our net interest margin. Consolidated net income for Q1 increased 69% year-over-year and 46% sequentially to a new record of $9.4 million, excluding Q1 2017, which is attributable primarily to a one-time recognition of deferred income tax assets pursuant to the amalgamation of VersaBank with PwC Capital, as David mentioned earlier. In addition to the growth in net interest income, as expected, non-interest expense substantially reduced year-over-year and sequentially as the transitory costs related to our strategic investments in several strategic growth initiatives including the U.S. bank acquisition and the launch of the Receivable Purchase Program in the U.S., rolled off. Consolidated earnings per share increased 79% year-over-year and 48% sequentially to $0.34, with the increase benefiting from strong earnings and a lower number of outstanding shares due to our active share repurchase program. During the first quarter, we repurchased and canceled just over 822,000 shares, bringing the total number of shares purchased under the NCIB as of the end of Q1 to just over 1 million. Primary driver of growth in our loan portfolio was once again our point-of-sale financing business, which increased 68% year-over-year and surpassing the $2.4 billion mark. This growth continued to be driven mainly by strong demand for home, home improvement, HVAC, and auto receivable financing. As we noted on our last call, although we expect very healthy growth from our point-of-sale business in 2023, we won't see the same outsized growth as last year. Q1 of this year saw sequential growth in the point-of-sale portfolio of 9%, relative to Q4 of last year, and we believe sequentially quarterly growth in the same range throughout the remainder of the year is achievable as consumer spending in the sectors on which we focus remains active. Our point-of-sale portfolio represents 75% of our total loan portfolio as of the end of Q1, which was unchanged from the end of fiscal 2022. Our commercial real estate portfolio has expanded 5% year-over-year and 6% sequentially to $807 million at the end of Q1. As discussed in our last several quarterly calls, we have taken a more cautionary stance with respect to our commercial lending portfolios due to the expected volatility in valuations within this asset class in a rising interest rate environment, as well as concerns related to higher construction costs resulting from supply chain disruptions and a very tight labour market. That said, we are seeing healthy demand for our construction and term financing products in the form of very high quality deal flow. We expect this to continue throughout 2023. We remain very comfortable with the risk profile of our commercial real estate portfolios based on our criteria of working only with well-established, well-capitalized development partners to demonstrate excellent track records and, of course, restricting transaction to modest loan-to-value ratios. Turning to the income statement for our digital banking operations, net interest margin on loans, that is, excluding cash, securities, and other assets, decreased 20 basis points or 6% year-over-year, but was unchanged sequentially at 3.03%. The year-over-year decrease was due mainly to a shift in the bank's funding mix combined with rising interest rates over the respective periods, offset partially by generally higher yields earned on our lending portfolio. The interest margin overall, which includes the impact of cash, securities, and other assets, increased six basis points, or 2%, year-over-year, and two basis points, or slightly less than 1%, sequentially to 2.83%. This is attributable to higher yields earned on lending and Treasury assets, offset partially by higher cost of funds. Non-interest expenses for Q1 were $12.3 million compared with $10.6 million for the same period of 2022, however down meaningfully from the elevated levels of $13.8 million for Q4 2022. The year-over-year increase is due mainly to higher salary and benefits costs, resulting from an increase in staffing levels to support expanded revenue-generating business activity across the entire bank, higher costs related to employee retention in a very tight labour market, and higher costs related to investments in the bank's business development initiatives, offset partially by lower insurance premiums attributed to VersaBank's listing on the NASDAQ in September 2021, as well as lower capital tax expense. The sequential decrease is due to the expected significant reduction in transitory costs related to strategic growth investments and our listing on NASDAQ that David and I have both mentioned earlier, as well as lower capital tax expense. Cost of funds for Q1 was 2.95%, up 166 basis points year-over-year and up 50 basis points sequentially, with both increases due mainly to the larger proportion of wealth management deposits relative to our lower cost insolvency professional deposits versus the comparative periods, as well as the general increase in market interest rates. The increase in our cost of funds remains significantly less than the Bank of Canada's increase in the benchmark rate of 425 basis points to the beginning of fiscal 2021. Insolvency professional deposits once again contracted slightly in Q1 on both a year-over-year and sequential basis due to the historically low bankruptcy activity Canada has experienced, primarily as a result of government support for both individuals and small businesses extended during the pandemic. Wealth management, or what we refer to as personal deposits, expanded 87% year-over-year and 14% sequentially. Dave will talk a little bit more about our expectations around funding mix in just a moment. Our provision for credit losses, or PCLs, in Q1 once again evidenced the prudent risk mitigation strategies inherent in our lending models and outstanding credit quality of our loan portfolio, especially evident given the broader expansion in PCL ratios that our peers are reporting. Provision for credit losses for Q1 was $385,000 compared with a provision for credit losses of $2,000 in Q1 of last year and a provision for credit losses of $205,000 for the fourth quarter of 2022. Sequential and year-over-year changes were a function primarily of changes in the forward-looking information used by the bank and its credit risk models, as well as higher lending asset balances. PCLs as a percentage of average loans for Q4 was 5 basis points, and our average for the past 12 quarters was 0. Our PCL ratio continues to remain one of the lowest in the Canadian banking industry. Turning now to DRTC, I would like to remind you that DBG's gross profit amounts are included in DRTC's consolidated revenue, which in turn is reflected in non-interest income and VersaBank's consolidated statements of income and comprehensive income. DBG's revenue for Q1 decreased 3% year-over-year and 19% sequentially at $2.3 million as a function of lower service work volume in the current quarter. Historically, Q1 is softer for DBG, attributable to the impact of the slower holiday period, which typically results in lower revenue-generating activity. Gross profit, however, increased 70% year-over-year and decreased 6% sequentially to $1.6 million, with a year-over-year increase driven primarily by higher pricing on engagements and improved operational efficiency. DBG remained profitable on a standalone basis this quarter. DRTC consolidated revenue for the quarter, that is, including revenue generated through the provision of various technology support and consultation services provided to VersaBank's digital banking operations, increased 3% sequentially, 29% year-over-year to $1.8 million. DRTC recorded a net loss of just over a half a million dollars compared to net income of $150,000 in Q1 last year and net loss of just under half a million in Q4 of last year. The year-over-year trend was a function primarily of higher non-interest expenses attributed to higher salary and benefits expense due to higher staffing levels to support expanded business activity and higher costs associated with employer retention amidst the current challenging labor market. I'd now like to turn the call back to David for some closing remarks. David?

Well, thanks, Sean. As many of you know, I'm an avid pilot, and we aviators have a term that describes the absolute best conditions for flying, that being cab-okay, which means ceiling and visibility okay. As I look out to the foreseeable future for VersaBank, we have cab-okay. As a side note, I'm sitting here at London Airport looking out my window, and today it is indeed cab-okay. Our comps for Canadian digital banking operations will benefit throughout 2023 from the outsized loan portfolio growth of 2022, and we continue to see sequential quarterly growth in the neighborhood of 8%. We expect net interest margin on loans to remain robust. We expect meaningful add to our loan portfolio through our U.S. Receivable Purchase Program. With each passing month, with more discussions with our existing and potential customers for our RPP offering in the United States. We are more confident in the uniqueness and attractiveness of our offering. Case in point, last week we attended KBW FinTech Conference in New York City, providing us with an opportunity to discuss our solution with a number of potential partners, and the response was overwhelmingly positive. Although the approval process for our U.S. bank acquisition is taking longer than expected, it has not in any way changed our belief on the size of the opportunity. In the interim, we made the decision to expand our limited pre-acquisition rollout to better capitalize on the near-term demand I described earlier. As we await the opportunity for broad rollout, notably, we expect to generate a larger spread compared to Canada when we roll it out broadly. Last quarter, I discussed how I specifically designed VersaBank to perform well in good times and even better in more challenging times. A core component of this model, in addition to risk mitigation being at the core of everything we do, is our high value and solvency professional deposit business. As a reminder, we have almost singularly addressed the unserved market opportunity to provide integrated technology to easily enable bankruptcy trustees to park deposits with us. We have the vast majority of the market for personal and small business bankruptcies in Canada. Insolvency has plummeted during the pandemic due to government financial support, reduced consumer spending, and a halt to collection activity, hitting a low of over 7,500 per month for the period April 2020 to February 2022. This compares to an average over the two years preceding the pandemic of over 11,300 per month. As expected, we are now seeing those numbers begin to climb, now up to 9,000 for January 2023, an obvious leading indicator with respect to our insolvency deposit growth. And we are now very recently seeing this flow through in terms of account openings, and quite dramatically. At the same time, we are continuing to add new trustees and partners, further expanding our already impressive market share. This obviously bodes well for the low-cost deposits moving forward. To conclude, as discussed at the outset of this call, we view our results for the first quarter as clearly evidence of the operating leverage inherent in our branchless business-to-business digital banking model and the resulting return on equity generating capability. We continue to grow our loan portfolio in Canada and add the significant additional long-term growth we expect in the United States. We expect to continue to see the torque in our operating leverage. Notably, our U.S. Receivable Purchase Program will be serviced by the same technology centers in London, Ontario and Saskatoon, Saskatchewan that service our Canadian point of sale portfolio. And essentially the same number of personnel. That's operating leverage. With that, I would like to open the call to questions.

Michelle? Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. And if you are using a speakerphone, please lift your handset before pressing any keys. One moment, please, for your first question. Your first question will come from David Feaster at Raymond James. Please go ahead.

Hey, good morning, everybody. Good morning, David. I just wanted to start on, appreciate all the color on the loan growth front. I just was hoping to get maybe some more detail on the U.S. expansion. Glad to hear you're kind of going to be accelerating that. I'm just curious how, you know, you've had good reception thus far, but how's demand in the state's the pipeline of new partnerships and just kind of the roadmap for the U.S. expansion and maybe, you know, where do you think this, you know, that portfolio gets to by the end of the year? I don't know if you have any targets for that.

Well, David, that's what I was saying in the comments. We had purposefully limited our lending activity in the United States to pending receipts of the approval to acquire the Stearns Holdingsford Bank. We just wanted to test the market and get the legal documentation in place and our internal systems in place. And that we did. And we were expecting that we would be able to operate the bank around now. So we just sort of slowed it down. but it looks like it'll be a little longer before we're able to operate the U.S. bank. So we've made the decision to lend directly from our Canadian bank for the time being so as not to lose the momentum that we've been gathering by talking to various potential partners. So to answer your question, there's a huge number of point of – finance in the United States, but let's call them Receivable Purchase Program partners in the United States that are really keenly interested in itching up to our program. In fact, as I was saying at the last visit we had in New York City, KBW, I met many potential new partners who were very keenly interested in signing up. That's why I made the decision to fund it from Canada for the time being. I didn't want to disappoint them, and I like to keep the momentum going. We don't have any year-end targets, but quarter by quarter, you'll start seeing it grow, and I expect we'll have the approvals, and then we'll be able to really ramp up with the U.S. Bank.

That makes sense. And maybe touching on the CRE book, you talked about some of the cautiousness that you might have had the past few quarters. I'm just curious maybe what changed. Is it availability of credit in the market? Where are you seeing demand that provides good risk-adjusted returns for you? And have you tightened underwriting standards in that segment at all?

Well, we operate with a sort of mantra, and it goes like this, bad loans are made in good times. So, quarter over quarter, you'd see me saying we're being quite cautious, because we believed, and quite rightly so, that there was somewhat of a real estate bubble in Canada, and probably all of North America. Prices were way too high, and so we were very cautious in our lending during that period of time. Now we've seen the prices reset and getting down to what we might call a reasonable pricing, which gives us a bit of comfort. And secondly, as usual, it's usually our tactic, our competitors are usually licking their wounds around about this time from finding themselves over-lent on various properties. So that's the reason why the resurgence now in our optimism in the Cree portfolio, lack of competition and pricing coming to reasonable levels. And of course, we have the who's who in the industry as clients. So this is typical for us. I've done this every year, coming out of every recession in my 45 years being a banker.

Okay, that makes sense. And then maybe last one for me. I mean, you've been extremely active in purchasing stock. We're still trading well below tangible. You know, you've got plenty of capital. I'm just curious your appetite for repurchasing stock here and how you think about capital when you've got such strong organic growth at the same time. Just curious your thoughts on capital return, capital priorities, and, yeah, supporting continued organic growth.

Well, we just love buying back our stock at these prices. I mean, it's the best, as Warren Buffett would say, it's the very best investment. It's zero risk. We buy it back. We get the return. Yahoo. I kind of doubt we're going to have that opportunity much longer. I think the market probably wondered if we had something to do with the crypto industry and we got sort of treated the same way as others have. Uh, there's no reason why our stock should drop a blow book with the kind of earnings. So this quarter we've sort of, I think shaken that, that misconception off. Obviously our model is very powerful. It works extremely well. And the earnings we've just produced are leave, uh, most of the industry in the dust. Um, so I, you know, I'd love to buy back, keep buying back the stock, but, um, I can't see the stock staying down to this level much longer with these kind of numbers coming out.

Yeah, that makes sense. Well, congrats on a great quarter. I appreciate all the questions.

Well, thanks, David. Look forward to seeing you sometime in Florida. I'm still in the frozen north here, but I hope to turn the airplane south 180 degrees and head back to Florida.

It's sunny and beautiful out, so come on down.

Yeah, my wife tells me that too.

Your next question will come from Mike Rezanovic at KBW Research. Please go ahead.

Hey, good morning. I wanted to just ask a couple of quick questions on the numbers here. So first on the POS holdback, I think you're down about 5.5%. You were, I think, well north of 10% We're a little bit north of 10 in the depths of the pandemic. Do you have a line of sight as to how low that number might go or any maybe range? Is it range bound? Can it get much lower from here? How do you sort of look at that number going forward?

Well, the number depends on the quality of the receivables that we're purchasing. So it's 100% dependent on the quality. So we don't have any particular overall target. It just by chance sort of settled in at 10% for a while. But the portfolio has migrated over to lower risk assets. There might be something to do with the impending perhaps recession. We're seeing less riskier assets than we did in the past, i.e. now it's moving towards home improvement assets type loans, which generally are a lot less riskier than, say, hot tubs and motorcycles and RVs and that sort of thing. So we're seeing a migration towards the lower risk asset classes as consumers maybe spend less in the luxury items, items they don't really need. Do they really need a new motorcycle when a recession might be coming? Maybe not. But maybe we really need to look at our house and make sure it's insulated property and we've got a really energy efficient furnace now that price and energy costs are higher. So that's the reason. It's just simply a lower risk portfolio than it was when times are buoyant.

Okay. Is it fair to assume that you've incorporated the same level of diligence to reflect a potential downturn, like the 5.5%? It's low because of the mix, but it doesn't mean that you're necessarily not including a bit of a buffer because of the macroeconomic environment maybe not looking so robust anymore.

Is that fair? Well, yeah. Absolutely. We generally run around at least three times the amount of losses that our clients would show. And that's what we had at the depths of this bear in the pandemic. The intrinsic losses that our models pointed to for our portfolio would have been just around numbers, $30 million, and we were holding about $100 million in cash holdbacks. That's generally where we run, but these are ballpark figures. It's done a lot more scientifically than that. Each individual portfolio is looked at and reviewed on a continuous basis, and we're always adjusting the cash holdbacks, depending on our view of what's in store for our partner and the overall economy.

Mike, one other piece of color you might want to keep in mind is that, as David mentioned, no change in our risk assessment process or the management process there, but in some cases, some of our seller partners post LCs as opposed to cash. So the risk, the volume there is still there, the protection is still there, but just the structure of the holdback is modified slightly with some of our partners.

Okay, that's super helpful. Thanks for that, Culler. And then just a quick one on your insolvency deposits down in the quarter. And we have seen the number tick up, both on business and consumer. It is gradually normalizing. I think I was a little bit surprised that the number wasn't up sequentially, just given that trend. Or is it maybe just the nature of the size of an average insolvency smaller today than it was? What's driving the number coming in lower? And then as a quick follow-up to that, how important is this as a funding mix shift on your margins going forward?

Well, the good news for us, the bad news for Canada is that we're opening more new accounts to receive the deposits on liquidation of the unfortunate businesses and consumers that are going bankrupt. So we're opening more accounts, but these are sort of empty buckets that take about two years to fill up, and then they're used to, they're dispersed to the creditors. So really, you're just seeing the lag effect. We're seeing more insolvencies now, even in the figures earlier, and we're opening up a lot more accounts. Now, we have most of the trustees in Canada dealing with this, so kind of the leading indicator is what's the new volume of account opening, and a lot more have been opened since the close of our fiscal year. So it's just simply the lag effect. I expect the insolvency deposits will reach a record high for us because we have a larger piece of the market share now than we had a few years ago, quite a larger piece. And already we're seeing the new accounts be opened at an increasing pace. So it's just simply the lag. Now, how important are these to our net interest margin? Well, they're pretty important. We pay on average about prime minus 2.8 on the insolvency deposit, something like that. And that's a good, stable, low-cost funding source. But frankly, I don't see that impacting our margin. Our margin has always, of course, been the industry-leading margin in Canada. We're 1% higher than most banks. I think the margin will stay the same. What could impact the margin, which is really positive because it has a tremendous boost to return on equity, is our instant mortgage app is getting ready to roll out. And that gives us access to lower margin conventional mortgages and CMHC mortgages. They're lower margin, but the risk weighting, of course, CMHC is zero, 35% on conventionals. So you might see that possibly, of course, come depressed margin a little, but it certainly won't be repressed from return equity. Return equity will continue to grow at the rapid pace you see it growing at.

Thank you for the call.

You're very welcome. Thank you for getting your note out so quickly. Mike, what time do you get up in the morning?

A bit too early these days with bank earnings, but hopefully that normalizes. Yeah.

Ladies and gentlemen, once again, if you would like to ask a question, please press star 1 at this time. Your next question will come from Stephanie Wu at LoadRock Research. Please go ahead.

Hi. Hello. Good morning, guys. I'm Stephanie. On for Craig.

Hi, Stephanie.

Hi. Congrats on the quarter. So this quarter, I see surprising sequential growth in the point-of-sale loans given the economy backdrop. And I think you guys also alluded to in the – comments that going forward probably won't see the same type of growth going forward. Maybe just a little bit more color on the Canadian side of point of loan growth. That's my first question. And second, is it correct for me to assume that the U.S. expansion is going to be helpful for the NIM to go back to 3% going forward? Thanks.

Yes, and I appreciate that people are likely surprised that our loan growth is continuing at 8% per quarter, where the other banks in Canada, some are underwater, some are up here. And that's probably because the market that we're targeting, our partners are targeting, is in the home improvement area. And as I was saying earlier, with energy costs going up, folks are quite rightly looking at, um, at getting new siding, new insulation, new furnaces, more efficiency. And that's been a sort of a bonanza for our, our, our partners to, um, provide that type of financing. So, uh, discretionary purchases, I was saying earlier, boats, cars, motorcycles, well, that's, that's really dialed down. But, um, thankfully we're nicely diversified across the entire country and across all the industries. And we're seeing, uh, Substantial significant growth in the point of sale on the home improvement in particular. So that's Canada. And in Canada for loan growth too, keep in mind that we've been working for quite a while on this innovative new program we call Instant Mortgage. That's an app that enables a developer who's selling homes to have his potential purchasers punch some numbers in and come back with a very quick approval for their conventional mortgage or their CMHC mortgage and such. So we expect to see some growth in that area. And we're comforted somewhat in that the market price of housing in certain communities seems to have dropped back to relatively reasonable prices. So unlike other lenders, unfortunately, we're lending in the bubble and maybe their loan-to-value ratios are have gone a lot higher than they were hoping for. Now we're getting in, uh, sort of at the right time, but carefully. And, uh, so that'll boost Canadian loan growth too. Um, in the U S, uh, the, the cost of funds, the United States is, is a good bit less than, uh, vis-a-vis Canada, uh, relative to the risk-free rate. Uh, so we, we see 4% net interest margins as being, uh, quite possible. Uh, and, um, That will, as time progresses, that will boost our overall NIM. Just keep in mind our NIM on loans, overall NIM on loans is north of 3%. And on our treasury assets, it's about 1%. So if rates continue to go up or rates went up, we get a little bit more in our treasury assets. So the overall NIM improves. But then again, as I was saying, depending on how much in CMHCs and conventionals our instant mortgage app delivers, that will tend to depress NIM, but it'll increase ROE because these are really, really high ROE-type assets. They absorb, in CMHC's case, no capital, and in conventional mortgage case, 35% risk weighting. NIM might slide back a bit depending on all these factors. It might hold. It won't change much, but ROEs should be increasing pretty dramatically.

Okay. Thank you so much. Best of luck on the U.S. expansion.

U.S. expansion? Basically, Stephanie, the approval to get the U.S. bank is a little slower than we'd expected. We're working... well with our U.S. regulators and the Canadian regulators. And, you know, we expect it halfway through this calendar year. But in the meantime, there was so much interest for our product amongst U.S. point of sale companies that we thought, well, you know, we should just roll it out anyways directly from Canada and satisfy the demand. Just get it going. We hate to see So really ideal partners wanting to deal with us and us not doing it. We made a strategic decision to slow it down. But now we said, you know what, we'll hitch our program up to some of our U.S. partners and let it get going.

Great. Thank you so much. Congrats again.

No problem, Stephanie. Look forward to seeing you. Is it tomorrow?

I'll be in Toronto. I think you've got a video, a camera. You want to take a picture of me or something?

Your next question will come from Trevor Reynolds at Acumen Capital. Please go ahead.

Hey, guys.

Hi.

Good morning. Just a couple quick ones. I think most of them have been touched on, but in terms of the asset classes that you're seeing demand for in the U.S., would they be similar to what you're seeing in Canada, or just maybe a little bit of insight on that?

There's no real theme to it. The U.S. is a huge market, and we're interested in all asset classes. It's just what we see in Canada, too. We've got a trucking firm now on board. We've got another one coming up that has medical equipment. We're looking at recreational products. For us, we're sort of agnostic to asset classes. We look very carefully at the skill of our partners with respect to lending. So basically, if they're good lenders, the asset class is somewhat irrelevant. If they're not good lenders, it doesn't matter what asset class, and we don't have to do them. There's no saving them if they haven't got their credit adjudication sorted out.

Okay. And then just on the instant mortgage app, you mentioned it's close to being ready. What's the timelines on that being rolled out, and what sort of – What sort of growth are you expecting on that?

Well, the app itself was developed many, many months ago, and the systems are in place. People are ready to go. But there's been a few regulatory issues that we've been working through with the regulators, and we hope to have those resolved in about a month. And we have a partner lined up to the Mortgage Administration for us, a wonderful, wonderful partner that's worked with us in other areas. So everybody's all set to go, and there's a fair amount of demand. It's in the order of hundreds of millions of dollars. So, you know, a consumer just starting up, I mean, I'd look for, as long as we can get it going in the bottom of the ton, I'd look for at least a couple of hundred million in a year.

Got it.

And just remind me, who would be the primary people looking at this, the instant mortgage?

Usually new homebuyers. The app's designed to be resident in the sales office of the developer selling the units. So it's designed as a sales tool. It's an adjunct to our point-of-sale program. We just thought real estate... Home purchases was the largest point of sale market, certainly in Canada and the States. So we would develop this app to aid in that program, to aid in the sales process. So, you know, when somebody wants to buy a house and they haven't negotiated a mortgage with one of their traditional banks, we say, not to worry, a bunch of numbers in here, and before you know it, you'll be approved for one of those types of mortgages. So it's designed to help our customers that we already deal with for the most part by doing their financing for the construction of the residential units. It's designed to help them in their sales process by taking that hurdle to closing a deal, i.e., I haven't got financing yet. And we say, okay, here you are. Here's your financing. So there was nothing like that in North America when we came up with it. There's still nothing like it in Canada, but there's something like it in the United States that works really well. And it's just disappointing to me that it took so long to get all the regulators on side to let Canadians enjoy this sort of convenience. And again, the mortgage committed a bit earlier and at the point of sale.

Great. And then just last one, just on the digital currency issue. Maybe just some insight on where that sits, whether it's on the back shelf for now or what the plan is with that moving forward.

It's on the back shelf. The digital deposit receipt that we developed is fully developed. We think eventually banks will use blockchain as a new channel for deposits. I think it's inevitable. But given the... regulatory environment north and south of the border. And given all the busy good work we have on our point-of-sale business that really, really pays, we decided to leave this one on the shelf. And we don't have any particular time to take it off the shelf. It would be sometime maybe in the future when regulators say, hey, maybe that was a pretty good idea you guys want to bring out to market. I yell when regulators ask me to do it. because obviously we love diversifying our deposit base, we embrace technology, but we've sure got a lot to do with our core business, our spread business that's growing with leaps and bounds. We're actually using artificial intelligence to enhance the efficiency in our bank. For me, that is the layup. There's areas in our bank that artificial intelligence seems ideally suited We're working with artificial intelligence people to improve our bank's overall efficiency so we can scale even faster. That torque I was talking about, I think we'll be putting numbers out maybe in a year that banks thought were impossible.

Understood. Thanks a lot for your time.

Thanks for taking my questions.

Well, thank you, Trevor. Look forward to seeing you a little later on at the AGM. We'll send you an invite out for that.

That's coming up.

Your next question comes from Brad Ness at Coral Capital. Please go ahead.

Great, thanks. Hey, guys, how are you doing?

Very good, Brad. Although I'm in the frozen north right now, I got my Willie socks on.

Sounds good. Well, I'm going to jump into things. You had quarterly expenses, non-interest expenses at $12.3 million in the quarter. Is there any one-time kind of transitory expenses in there?

There's a little bit left from the previous year, but not a whole lot anymore. $12.3 million probably... run rate for us now. It's like I said, a little bit of hangover from the past, but there's pluses and minuses going forward.

Okay. And what type of growth should we see in that number, kind of excluding a U.S. acquisition?

Well, we're not looking for any growth in the upcoming year.

Do you think it holds flat in the whole year?

Yeah. We've already absorbed the additional salary increases that came about by hiring some new employees in key areas, of course. Also, just the general wage increases that I guess post-pandemic gave us all, inflationary increases. That's already in the numbers. There's a potential for a little bit of a decline in that 12.3, but I think I wouldn't think about it that way because there's kind of a lot of moving parts involved.

Okay, got it. And in light of continued upward pressure on interest rates, do you think you can continue to maintain that interest margin on loans above 3%? Yeah.

As I was saying, there's a few factors. Generally speaking, yes. You note that our cost of funds is about 1.5% less than the same-term government Canada bond. We have a really nice, efficient gathering network in Canada. And we've got, sooner or later, we know that those buckets I was talking about, those insolvency accounts that we've opened, are going to fill up with cheap deposits. So that helps. The thing that could depress NIM a little, which is kind of good, really good actually, is the instant mortgage CMHCs and conventionals. Because they have less NIM. They're approximately 2% all in after administration costs. So that would depress NIM on a weighted average basis. But because the very little capital they absorb, it really boosts ROE. So henceforth, you're going to start seeing me talk more and more about ROE. I mean, obviously, we all know. that know about banks, that ROE is highly correlated to percentage of book value, market value, percentage of book, and highly correlated. Last analysis, it was 0.86 as they are. So my mission is to move ROE up as fast as it can so that stock starts trading where it should. In fact, I like to see it as an outlier on the positive side because of the trajectory. So NIMS, Hovering around three, could go up a little bit, down a little bit. But ROE should really start moving.

Great. And when I do think about ROE, at the end of this year, it sounds like you're excited about artificial intelligence, what it can use due to your efficiency in the backroom. You're excited about capital efficiency and instant mortgage. And with continued strong loan growth and limited expense growth, I mean, is 17% ROE something that we should be looking forward to by the fourth quarter?

Well, let me say this to you, Brad. I brought the team down to lovely Fort Lauderdale for a strategic planning session, and there was one metric I had on probably every slide, and it was ROE. And the target I gave the staff was 18%. Some of them choked, some fell off their chairs and such. But, you know, the building, the bank days are over. We've got the bank built now. And that's a realistic number. Whether we get that by the end of this year, i.e. the last month, October, whether the month shows 18 or not, I don't know. But it's going to be moving up every month now because it has to. Tax costs stay the same and revenue is growing exponentially. by 8% a quarter because our loans are growing by that. There's a little plus and minus there too, depending on what central bankers do and how high they put rates. It could just dampen demand. But as I was saying earlier, Canadians and I think their US counterparts are quite rightly looking at energy costs and saying to themselves, hey, how do we save a few bucks on heat in our house? And that's a wonderful market for our point of sale business. So all in, Brad, yeah, realistically, I said 18, and 18 looks definitely what our model will turn. So 2024, you know, we should be clicking our glasses together and saying the team did it for me.

Great, thanks. Last question here. On your cyber initiative, or I'll just call it the cybersecurity initiative. I'm always waiting for like a breakout quarter where revenues just jump, you know, exponentially and kind of continues on a really strong path. And it's just, I continue to wait for that. What's going on with cybersecurity and, you know, what type of growth expectations should we assume?

Well, the breakout quarter I'm waiting for too. And, um, So here's what you can expect. Next quarter and the quarter after, there'll be good growth in DRTC based on the new products and the customers and sort of how we're onboarding new customers. But to get a breakout, frankly, I think we've got to have a reseller signed up, somebody who's got a huge customer base and wants to resell these products for us. I mean, we don't have a sales force that can... produce 10 times revenue growth. Somebody else could. The type of products we have are state-of-the-art. They work for our bank. They're fantastic. I mean, some of the customers we've onboarded are the who's who in North America, of course. I think you know some of them. So you've got a first-class product. Oh, it's tough. In-house developed suite of wonderful products. I think other FIs throughout North America would do would be really happy with our suite. You know, we're only a few people, and right now our focus is mainly on the bank, growing the bank's NIM business.

Gotcha. Okay, great.

Thank you. Well, Brad, it's really good to hear from you. Are you still in the D.C. area?

I am. I am. So let me know when you're here.

One of these days, I'll show up in person and say hello. We're heading that way pretty soon.

Sounds great.

Thank you. Okay. See you.

There are no further questions from the phone lines. At this time, I'll turn the conference back to David Taylor for any closing remarks.

Well, I'd just like to thank everybody for dialing in and listening to us. It's an exciting quarter, of course, and I very much look forward to... Talking to you next quarter. Stay tuned. This little bank is what we consider an airport, I'll say. Passing your safety belts. We're cleared to take off. Thank you. Bye.

Ladies and gentlemen, this does conclude the conference call for this morning. We would like to thank everyone for participating and ask you to please disconnect your