VersaBank

Good morning, ladies and gentlemen, and welcome to VersaBank's second quarter fiscal 2024 financial results conference call. This morning, VersaBank issued a news release reporting its financial results for the second quarter ended April 30, 2024. 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 Cedar 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're listening to the webcast but wish to ask questions in the Q&A session following Mr. Taylor's presentation, please dial in into the conference line. The details of which are included 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 by 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 Bursa Bank management. Actual results could differ materially from our expectations due to various material risks and uncertainties associated with Bursa Bank's businesses. Please refer to Bursa Bank'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 Bursa Bank. Please go ahead, Mr. Taylor.

Good morning, everyone, and thank you for joining us for today's call. With me today is our Chief Financial Officer, John Asmus. Before I begin, I'd like to remind you that our financial results are reported and will be discussed in 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 the Standard Investor presentation, which will be updated and available on our website shortly. Now on to the highlights. At risk of starting to sound repetitive on the calls, the second quarter results once again showed the operating leverage and our highly efficient branchless business-to-business digital banking model as our loan portfolio continues to grow. 18% year-over-year growth in total assets generated 15% year-over-year growth in net income. And that, combined with a continued focus on management of our fixed costs, drove both a year-over-year and sequential improvement in the digital banking efficiency ratio to a record new 38%, and a 2% year-over-year increase in average return on common equity to 12.4%. Notably, Q2 was a solid quarter for our point-of-sale receivable purchase program business, which expanded by a healthy 1% sequentially, as HVAC home improvement sector, which continues to make up the largest component of our point of sale portfolio, continues to see robust consumer activity. That contributed to another record high for total assets of $4.4 billion, another meaningful step towards our next milestone of $5 billion. And the continued outsized positive impact on our efficiency our profitability and our return on equity. Quarters one and two combined for a strong first half of 2024 with a year-over-year growth in net income and EPS of 25% and 29% respectively. Looking more closely at our Q2 numbers, I will note here that the second quarter is historically the softest quarter for the bank. This is something that hasn't been readily apparent in the last few years due to hyper growth in our point of sale portfolio. Due to the nature of the types of purchases our point of sale partners are financing, we historically see lower activity during the winter months. A milder than normal winter here in Canada, and in particular our most populous market in Ontario, further dampened the number of winter related purchases. And in our cybersecurity service business, Q2 reflects the start of a fiscal year for many of its clients, in contrast to Q1, which, due to the bank's fiscal year end being October, historically benefits from calendar year-end spending by our customers. As was the case in Q1, Q2 also reflected our planned strategy to transition a component of our real estate portfolio from higher-yielding, higher-risk-weighted loans to lower yielding, lower risk weighted CMHC insured loans. As we ramp up these activities, you will see the percentage of CMHC loans increase quarter over quarter. There will be a little more on this later. We are also seeing what appears to be some softness in the macro point of sale financing market due to elevated interest rate environment and softness in certain parts of the economy. This is the result of a combination of slower growth and the rich nation by our partners, as well as higher than typical level of early repayments by our consumers. I'll provide more color on what remains a very positive outlook for our point of sale business in a few minutes. The second item I want to call out in Q2 is net interest margin, which to a large degree reflects the success of our focus on growing point of sale financing portfolio that portfolio is lower risk weighted has lower yielding loans than our real estate portfolio over the past 24 months the proportion of our point of sale financing portfolio has expanded from 66 to now 78 percent that said q2 net interest margins are below our near-term expectations on the lending side we believe these There is still some room for expansion in our Canadian point-of-sale business. And the deposit side, we expect higher than normal broker spreads in our wealth management deposits to moderate. While we expect to benefit from continued expansion of our lower cost insolvency deposit portfolio. The third item of note is that despite the very strong year-over-year growth in net income and EPS, Q2 profitability was dampened slightly by a number of transitory items that masked the underlying performance of your digital banking operations. A significant component of the 7% sequential decrease in net income reflects higher provisions for taxes and a modest increase in non-interest expenses, primarily due to lower than typical expenses in the first quarter of fiscal 2024 at DRT cyber. When we strip away this noise, pre-tax profitability for our digital bank operations was actually up sequentially. And notably, non-interest expenses in our digital banking operation was down 6% year over year and down 4% sequentially. I'd now like to turn the call over to John to review our financial results in detail. John?

Thanks, David. Before I begin, I will remind you that our full financial statements and MD&A for the second quarter and first half of the year are available on our website under the Investors 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 the balance sheet. Total assets at the end of the second quarter of fiscal 2024 grew 18% year-over-year and 2% sequentially to a new high of $4.4 billion. As David noted earlier, Q2 is historically the slowest quarter for growth due to seasonality on both the digital banking operations and cybersecurity services businesses. While we continue to experience some temporary dampening of our results due to our strategy to transition a portion of the real estate portfolio to CMHC insured mortgages, which will contribute to higher return on common equity. Cash and securities were $303 million or 7% of total assets. Consistent at 7%, in Q2 of last year and up slightly from 6% in Q1 of this year. Book value per share increased to a new high of $14.88. Our CET1 ratio increased to 11.63%, and our leverage ratio was 8.55%, both remaining above our internal targets. Turning to the income statement, total consolidated revenue increased 7% year over year, but decreased 1% sequentially to $28.5 million. The year over year increase was driven primarily by higher net interest income as our digital banking loan portfolio continues to grow, while sequential decrease was mainly due to seasonality, as well as the temporary dampening of revenue, excuse me, due to transition of a portion of the real estate portfolio to CMHC-insured loans. Consolidated net non-interest expenses were $12.2 million down from $12.7 million last year and up slightly from $12 million for Q1 of this year, as management continues to focus on managing the fixed expenses line across the business. Consolidated net income for Q2 increased 15% year-over-year to $11.8 million and decreased 12% sequentially. As David mentioned, notwithstanding this healthy year-over-year growth, Q2 profitability was slightly dampened by a number of transitory items that masked positive sequential growth in the pre-tax profitability for our digital banking operations. Consolidated earnings per share increased 18% year over year to $0.45, benefiting from a lower number of shares outstanding due to the buyback program we had in place during fiscal 2023. The loan growth grew to just over $4 billion at the end of Q2, driven once again by our point-of-sale receivable purchase program, which increased 23% year over year and 1% sequentially to 3.1 billion. Our point of sale portfolio represents 78% of our total loan portfolio at the end of Q2, up slightly from the end of Q1. Our real estate portfolio expanded 1% year over year and was flat sequentially at 828 million as we transitioned to CMHC insured loans. As a reminder, our real estate portfolio is primarily mortgages and construction loans for real estate properties. We have very little exposure to commercial use properties. Turning to the income statement for digital banking operations, net interest margins on loans, that is, excluding cash from securities, was 2.52%. That was 47 basis points or 16% lower on a year-over-year basis and 11 basis points or 4% sequentially. Net interest margin overall, including the impact of cash, securities, and other assets, decreased 33 basis points year-over-year or 12% and decreased 3 basis points or 1% sequentially to 2.45%. As David discussed, Q2 net interest margin reflects the strong growth of the POS financing portfolio, which is comprised of low risk weighted, lower yielding, but higher ROCE assets than commercial real estate, as well as the transitory impact of the transition of the real estate loans to higher return opportunities. Cost of funds for Q2 was 4.21%, up 94 basis points year over year and up 22 basis points sequentially. Cost of funds was again somewhat elevated in Q2 due to the raised rates for term deposits. We continue to expect to increasingly benefit from the continued expansion of our insolvency professional deposits. as policy activity in Canada continues to steadily increase. Our provisions for credit losses, or PCLs, in Q2 remain negligible at 0% of average loans compared to 0.03 last year and with a 12-quarter average of 0.01%. I'll now briefly turn to DRTC. On a standalone basis, digital boundaries group Q2 revenue increased 8% year-over-year to $2.8 million, and gross profit increased 5% to $2 million, both due to higher service engagements. Sequentially, both were down, reflecting the seasonality in the business, as our fiscal Q2 coincides with the start of many customers' fiscal years. during which they are often planning and ramping stages of their budgets, projects, and deliverables. DBG remained profitable within DRTC. DRTC's net loss of $162,000 in Q2 of this year compares with a net income of $433,000 last year, with the difference mainly due to higher expenses and higher people costs to support past and expected expansions in business activity. The decrease from net income of $435,000 in Q1 of this year was primarily due to some positive compensation adjustments in the comparable quarter. I'd like to turn the call back to David for some closing remarks. David.

Thanks, John. The outlook for strong near and long-term growth in VersaBank remains very favorable. We expect improved sequential growth in our point-of-sale financing portfolio with the benefit of seasonally higher summer sales, as well as a ramp-up in loan originations in our CMHC-insured finance facilities in our real estate portfolio in the third and fourth quarters. As of April 30th, we had commitments of nearly $440 million, which is a very solid start and a number we expect to continue to steadily grow. Notably, only a small amount of these commitments has yet been drawn down actually by our loan partners, meaning that we expect to begin to see the growth in this portfolio starting in the second half of this year and accelerating into 2025. Notably, as the Canadian banking industry sees the impact of sustained elevated interest rates and some softness in the economy, the advantage of our branchless business-to-business digital banking model really comes into focus. For several quarters now, you have heard me give the caveat that any comments around our short-term growth potential of our point-of-sale business with economic impact We may be seeing some of that now. While this may slightly delay reaching our next total asset milestone of $5 billion to Q1 of next year, it doesn't impact the resulting operating leverage or the benefit to the return on common equity as we expand our portfolio. On the deposit side, insolvency deposits grew sequentially for the fourth consecutive quarter as Canadian consumer and small business insolvencies continues to increase. According to Statistics Canada, insolvencies in Canada in April of this year were up 24% from April last year. Consumer insolvencies were up 23%, while business insolvencies were up more than 60%. Accordingly, we are continuing to see the number of accounts in our insolvency deposits increase from already record high levels by 18% year-over-year and 4% sequentially. As a reminder, these accounts are opened prior to the funds being deposited, so they are a very solid leading indicator of future expansion of our deposit base. As we continue to benefit from the operating leverage from growth in Canada, we look forward to a decision from the U.S. regulator authorities with respect to our proposed acquisition of a U.S. bank. A favorable decision will be transformational, enabling us to drive our assets to multiples of growth from Canada alone and fully capitalize on the operating leverage of our branchless B2B digital banking model. I'm pleased to report that I do not have an update on the potential timing of a decision from a U.S. regulator. That's because based on the information we have to date, we continue to anticipate a decision before the end of this month. That said, the timeline remains at the discretion of the regulators, and we respect their prerogative to adjust as necessary for the integrity of the process. With that, I'd like to open up the call for questions. Operator?

Thank you. And ladies and gentlemen, we will now begin the question and answer session. To ask a question, you may press the star, then the number one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press the star, then the number two. One moment, please, for your first question. And your first question comes from the line of David Pfister with Raymond James. Please go ahead.

Hey, good morning, everybody.

Good morning, David.

I just wanted to start out on the organic growth side. You talked about the softness in Canada, some of the risks to achieving that $5 billion asset level this year, but you were also pretty bullish on partner additions in Canada, expansion in the U.S., and the pipeline's healthy. I'm just curious, how do you think about the organic growth trajectory within that point-of-sale business, the pipeline of partner additions in both Canada and the U.S.? ? And then are you looking to expand products? I know HVAC has kind of been a key driver, but is there an opportunity to expand the product set to potentially help accelerate growth? Just kind of curious your thoughts on that side.

Well, first of all, in Canada, there tends to be a dampening effect of the winter months on consumer purchases and even in the HVAC projects that people undertake. So this half year, we saw the impact of that. In previous years, we've had such rapid growth, it sort of overwhelmed the tendency of Canadians not to get onto car lots and entertain new purchases, hot tubs and barbecues and such. So for the second half of the year, I do expect to see a resurgence in consumer purchases. And we're already seeing that in May. It's a fair amount from April. So that's just sort of a typical Canadian thing. The other thing about the Canadian consumer is, according to the stats people, they tend to have some savings. So they tend to be a little more enthusiastic about buying in what might be seen as recessionary times than otherwise. So for the half year coming, I see a bit of a resurgence. It would be a better half than the last half. Now, with respect to new products, yes, indeed, we are having a look with some new partners that have some innovative point-of-sale type financing products, really cool ones. I won't talk about exactly what they are now, but really cool, ideally suited for our bank's models. So we're looking at that going forward, too, in Canada. And in the States, as I was saying, we're hopeful the regulator comes to a decision by the end of this month. But if not, you know, there's a fair amount of moving factors in the United States now. I just saw a recent report from the Fed about... large, huge quantity of large bad loans in the portfolio. So I hope they come to a positive conclusion by the end of this month. And that, of course, allows us to bring our product to the United States where we think there's tremendous demand for it. Okay, that's great.

And then, you know, you did touch on some of the softness in the labor market in Canada and some of the softness there. I'm curious, obviously your credit's phenomenal, right? But I'm curious about how has credit of the underlying receivables for your partner been? Has there been any change there? And how are the retailers, your partners doing just given some of the softness that you talked about? You know, are you having any issues from the health of their balance sheets just as the consumer may be weakening a little bit?

Yeah, well, yes, we definitely are seeing that. Our partners are experiencing higher than they have in the past of defaults. And it's in various sectors. Retail purchases slowed down, which translates through to us to less volume. And it also has another sort of ironic – impact on us that is sort of odd, an odd characteristic of our bank versus all the other banks. When our partners experience more defaults, given the way we structure the arrangement, that means we put the defaulted loans back to them more rapidly than we would otherwise. So it reduces the net increase in the portfolio because defaults to us mean repayments. We're repaid as loan defaults. So we've experienced higher than average repayments in this last half than we would otherwise because of the higher than average defaults in our partners' portfolios. So that sort of illustrates how our model is different than other banks. Other banks, you know, presently are whining about credit issues and they're putting up larger provisions as they should for the credit losses. And we don't because we have our partners cash standing guard against the loss for us. But that does mean more rapid repayments as it's not going to see how we debit their account and see a reduction in portfolio. So that had an impact on the growth in credit. in the, in Q2 also.

Okay. All right. That's helpful. And then maybe last one, just could you touch on the funding side? Um, I'm curious what you're seeing there. You talked about some of the tailwinds on the, um, you know, the, the trustee side, uh, which is great. Um, but you know, funding costs are continuing to rise. I'm curious, where do you think we are there? Are you seeing, are you seeing things starting to stabilize? Um, just kind of curious how you think about, um, you know, funding your growth trajectory looking forward and ultimately the impact on the margin?

Well, I hate to use the word kind of great with respect to insolvencies because, you know, obviously that means a lot of poor folks are 60% increase in small business insolvencies and 20-odd percent increase in consumers. Not good for these businesses. for the economy, but it's very good for our deposit growth. As I was saying earlier, it's a leading indicator. The more accounts we open, the more insolvency there are, the greater that portfolio of deposits grows. It's getting to record levels now, but I see that continuing on for the next year or two because there's a fair lag effect. The accounts are opened. And then they fill up with the proceeds of the liquidation of the estates. It usually takes about a year and a half, two years. So we're starting to see the beginning of it. And I would expect the insolvency deposits to peak at around a billion dollars Canadian over the course of the next eight, nine, 12 months. It's... It's sort of getting back to normal levels. Sad times for Canadians, but we designed this deposit business as a counterbalance to recessionary times for our bank. Makes sense. Thanks, everybody.

Thank you. And once again, if you would like to ask a question, please press the star one. Your next question comes from the line of Mike Rizvanovic with KBW Research. Please go ahead.

Hey, good morning. David, I wanted to ask you a quick question about the mortgage renewal cycle, not in terms of the direct impact, obviously, but just the indirect impact. If we do have higher rates for longer or just maybe call it rates settling at a higher level, Even if the Bank of Canada starts a cutting cycle, there's no necessary guarantee that mortgage renewals won't be painful for a lot of borrowers. So in the context of a deleveraging cycle potentially in Canada on the consumer side, what are your thoughts on how that could impact the demand for POS for you? Obviously, it's been a very, very resilient book. Your growth has been phenomenal there. A little bit of a slowdown this quarter, but... If we do get this dynamic where Canadians are just not borrowing as much, what's the downside on your view with respect to how much you could grow POS?

Well, definitely have a damping effect. Last year, we grew POS by about 30%. At the beginning of this year, I was hoping for around 20%. I'd say it'd be a little less than that even now. Yeah, those factors do dampen POS purchases, you know, just antidotally. You're not going to the motorcycle shop to buy a motorbike if you just had to renew your mortgage at twice the rate than it was before. So it definitely has a dampening effect. But, you know, we still have the potential to grow in the order of around 15% year-over-year. Mind you, that's half of last year.

Yeah, that's helpful. And then maybe just a quick one, a numbers question on the margin. A bit of compression, I think five straight quarters now. You've seen it come down quite a bit here. And I apologize if I missed it in your prepared remarks, but any color you can provide on margin trajectory, just in light of what you're seeing on the deposit side, the gross yields, are you looking at some sort of level of stability in the coming quarters, or is there upside, more downside? What are your thoughts on the numbers?

Well, there's a number of factors, some expanding margins, some contracting the margin. The CMHC mortgage portfolio serves to contract our margin in that we're probably averaging on about only 175 basis points on our CMHC construction mortgages. These would be conventional construction that would be, say, 300 basis points. So the faster we we book CMHC mortgages, the more compression that we'll see. Mind you, concern there's no capital used in the CMHC loan. The return equity figure does well with the addition of CMHCs. But that serves to compress our margin. And then as we move more into higher the percentage of point of sale, is of our total lending portfolio. That serves to compress our margin, too. Now, on the other side, the inverted yield curve that we've suffered with for quite a few years down in Canada, they may be coming – that might – I'm just wishful thinking here, but that might be dissipating a little bit. You may see the yield curve flattening out a little bit. And we tend to fund in the short end of the yield curve, and our loans tend to have a duration on the longer end. So we get pinched on that a little. So, you know, if there is a god over there that looks after bankers, maybe that yield curve will sometime in the future start sloping upward again. And that helps. You have those two factors that compress the margin, which are actually pretty good because, you know, the more CMHCs we book, even though the margin's down, that's a wonderful low-risk new source of net interest income for the bank. And more POS is better, too. But if the yield curve would straighten out and head up as it traditionally does, it'd be positive for us.

That's very helpful. Thanks for your insights.

You're very welcome. Thank you.

And there are no further questions at this time. I would like to turn it back to Mr. David Taylor for closing remarks.

Well, I'd like to thank everybody for joining us today, and I look forward to speaking to you at a time of our third quarter. Today, I've actually... I'm very lucky and blessed. I'm sitting here in New York City speaking to you from the New York Athletic Club and looking forward to meeting some potential investors here in this fabulous city. It's a beautiful day looking out over Central Park. So I hope you all have a wonderful day. And if you have any further questions you want to ask me, you can drop me an email. I'm always happy to talk to you. my investors and potential investors. Thank you again.

Thank you, presenters. Ladies and gentlemen, this concludes today's conference call. Thank you all for participating. You may now disconnect.