VersaBank

Thank you. Thank you. Good morning, ladies and gentlemen. Welcome to VersaBank's third quarter fiscal 2024 financial results conference call. This morning, VersaBank issued a news release reporting its financial results for the third quarter ended July 31st, 2024. The 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, and if you are listening to a webcast but wish to ask a question in the Q&A session following Mr. Taylor's presentation, please dial into the conference line, 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 companion slide presentation is available on the bank's website. Also, today's call will be archived for replay, both 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.

Good morning, everyone, and thank you for joining us for today's call. With me today is Chief Financial Officer John Asma. I'd like to begin today's call by discussing one of the most important announcements in the history of our bank, the closing late last week of our U.S. acquisition. It's been a long process spanning more than two years since we first announced the transaction in spring of 2022. But this was no mean feat, what we understand to be a relatively rare occurrence in the United States. There were many who thought it wouldn't be possible. However, with a rock-solid foundation based on our branchless digital B2B model, a proven track record of innovation, earnings growth, and no loan losses, and a truly unique risk-mitigated offering in our receivable purchase program, we present to the U.S. regulators with a very compelling proposition. I'd like to take this opportunity to publicly thank all those at VersaBank for their tireless efforts on both the regulatory approval process and the acquisition itself. The incredible team at Stearns Financial for being great partners throughout the transaction and our advisors for their ongoing counsel throughout this initiative. This is a transformational event in VersaBank's growth trajectory. We are now able to bring our unique and highly attractive RPP solution, which has been successful in Canada, to the largest point of sale financing market in the world. With the closing of the acquisition on schedule last Friday, we are now in the process of finalizing our first post-transaction RPP partner in the United States. And on the deposit side, we are now able to raise economical FDIC-insured deposits to fund this program, and we have the mechanisms in place to do that. In a few minutes, I'll discuss how we're able to launch the RPP in the United States This with virtually no capital expenditures, minimal additional operating expenditures, and very low execution risk. Turning to our financial results, preparations for the closing of our U.S. acquisition and broad launch of RPP program in the U.S. gave rise to a fair amount of noise this quarter. We view this in three categories. One, we maintain higher cash balances in preparation to fund the capital requirements of the U.S. subsidiary following the closing of the SBH acquisition. The higher cash balances temporarily depressed our net interest margin, which was already dampened by what we typically experience when interest rates decline. The rates we pay in our Canadian term deposits decrease more slowly than the Government of Canada rate, so there is a period of catch-up. Of course, we benefit in the same way when interest rates were rising. Three, non-interest expenses increased due to acquisition-related costs, some of which were specific to the third quarter and some of which were being incurred ahead of the asset growth and revenue generated by the launch of our U.S. RPP. I will note that there will again be one-time costs in the fourth quarter given the acquisition formally closed in Q4. We achieved another record high for total assets of $4.5 billion, driven by 11% year-over-year growth in our loan portfolio. As expected, we saw a seasonal pickup in the growth in our Canadian RPP point-of-sale business, which expanded 4% sequentially. Even as discretionary spending in Canada generally remains soft, growth also continues to dampen by higher-than-typical putbacks of loans that have gone 90 days in arrears to our partners due to a higher default among the borrowers. This, of course, is exactly how our model is supposed to work. The defaulted loans go back to our partners and we are made whole by the cash holdback. You can see this very clearly in our provision for credit losses, which was zero in Q3.

You can see the continued performance of our business models.

In our year-to-date fiscal 2024 results, with all key metrics trending in the right direction, most notably net income for the first nine months of this year is up 15% and EPS is up 17%. 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 financial statements and MD&A for the third quarter and the nine months are available on our website under the investors section, as well as on CDAR and EDGAR. 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 third quarter of fiscal 2024 grew 13% year over year and 3% sequentially to a new high of $4.5 billion. Cash and securities were $401 million, or 9% of total assets, up from 7% in both Q3 last year and Q2 of this year. Book value per share increased to a new high of $15.23. Our CET1 ratio increased to 11.75%. and our leverage ratio was 8.54%, with both remaining above internal targets. Turning to our income statement, total consolidated revenue increased 1% year over year and decreased 5% sequentially to $27 million. The year over year increase was driven primarily by higher net interest income as our digital banking loan portfolio continues to grow, while the sequential decrease was mainly due to the impact of temporary dampening of cost of funds as Canadian interest rates fall, which was exasperated by the higher cash balances. Consolidated net interest expenses were $13.5 million, up from $12.9 million last year and $12.2 million for Q2 of this year. The primary year-over-year and sequential increases were due to costs related to the U.S. bank acquisition and preparation for the launch of our Receivable Purchase Program in the U.S. As David noted, we will see additional acquisition-related costs in the fourth quarter returning to a normalized cost structure in Q1. Consolidated net income for Q3 decreased 3% year-over-year and 18% sequentially to $9.7 million or $0.36 per share with the decrease driven by the factors described above. Our loan portfolio grew to a new record $4.05 billion. at the end of Q3, driven once again by our point of sale receivable purchase program, which increased 16% year over year and 4% sequentially to $3.2 billion. Our receivable purchase program portfolio represented 80% of our total loan portfolio at the end of Q3, up from 78% at the end of Q2. Our real estate portfolio contracted 9% year-over-year and 10% sequentially to $745 million as we continue to transition to CMHC insured loans, which is because they are 0% risk-weighted and require no regulatory capital.

We have current commitments outstanding of $570 million with

$125 million outstanding at the current time, which we anticipate growing over the next several quarters. As a reminder, our real estate portfolio is primarily mortgages and construction loans for residential properties.

We have very little exposure to commercial use properties. Turning to the income statement for our digital banking operation.

interest margin on loans, that is excluding cash and securities, was 2.41%. That was 28 basis points or 10% 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 34 basis points year-over-year or 13% and decreased 22 basis points or 9% sequentially to 2.23%. Q3 net interest margin reflect the continued growth of the Receivable Purchase Program portfolio, which is comprised of lower risk weighted, lower yielding, but higher ROCE assets than commercial real estate, as well as temporary increases in cost of funds as due to the decreases in interest rates in Canada. Cost of funds for Q3 was 4.17%, up 55 basis points year over year, and down four basis points sequentially. The temporary upward pressure from interest rates is being offset by the benefit of continued expansion of our low-cost insolvency professional deposits, as insolvency activity in Canada continues to steadily increase. Our provision for credit losses, or PCL, in Q3 remain negligible at 0% of average loans compared to 0.02% last year and with a 12-quarter average of 0%.

Before turning the call back to David, a quick review of our cybersecurity business, DRT Cyber.

On a standalone basis within DRT Cyber, Digital boundary group revenues for Q3 increased 8% year-over-year to $2.5 million, and gross profit increased 5% to $1.9 million, both due to higher services agreements. Sequentially, both were down slightly, primarily as a function of the timing of service engagements. DBG remained profitable within DRTC. DRTC's net loss of $106,000 in Q3 of this year was comparable with a net loss a year ago and an improvement from a net loss of $162,000 in Q2 of this year.

I'd now like to turn the call back to David for some closing remarks. Thanks, John. As we enter the U.S.

market with our point-of-sale receivable purchase program in a meaningful way, we still field a lot of questions around how and why we're able to do what we do in our RPP with no loan losses to date. Let me take a minute to walk through the model. For those viewing our presentation, our graphic uses an example of a home hot water heater loan, but the model works for virtually any good or service that can be financed at the point of sale. As part of our master agreements with our RPP partners embedded in the economics of every loan we purchase, is what we refer to as a cash holdback, an amount of cash that we hold on our balance sheet as a deposit. These cash holdbacks are aggregated in a pool for each partner. The amount of these cash holdbacks is based on a multiple of historical default rates for similar types of loans and borrowers, the key word here being multiple. In other words, the cash holdbacks are multiple times in excess of what would be considered a worst-case scenario. With our partner acting as administrator of the loan that is exclusively dealing with the end customer, we receive monthly payments until the loan is repaid. If and when a loan goes 90 days in arrears, we automatically return that loan to our partner to deal with the collection. At the same time, we automatically debit the partner's cash holdback account, making us whole on the loan. One might ask, why would a point-of-sale finance company want to work with us if they retain the lending risk? There are several reasons, all of which are rooted in our proprietary software, which is the foundation of our RPP value proposition for our partners. One, the economics make sense. Because the efficiency of our branchless digital B2B model, there is enough margin for both the bank and our partners to do very nicely. Two, we typically provide our partners with 100% of the value of the loan compared to, say, 70% to 80% through their conventional financing sources. That means less need for their own capital and significantly higher return on equity for them. Because we can purchase loans on demand even daily, we significantly reduce their liquidity needs. And I will note here that our goal is to advance in real-time purchasing. And four, our software automates everything. It's seamless and it just works. Importantly, we are looking to replace all of our financing of our potential RPP partner. Oh, excuse me. Importantly, we're not looking to replace all the financing of our potential RPP partner. Funding diversification on their part is smart. We just want to be an additional, convenient, economical source of funding that will allow them not only to grow their business faster, but also more profitably. It's definitely a win-win. The other question I get is how can you possibly do this with no CapEx? hardly any additional OPEX, and very little risk. Because our RPP business essentially operates in the cloud, expansion to the U.S. requires little more than signing up with Microsoft at their U.S. Azure data center, which was done months ago. We can facilitate U.S. deposit raising and U.S. RPP lending from our existing technology centers in Canada. With our U.S. acquisition license, we are just erasing the border. Yes, we will have a de minimis amount of additional OPEX in the U.S., primarily for our leadership team. And we plan to add few dedicated U.S. RPP account people as we ramp. But these amounts are negligible relative to the revenue we expect business to drive over the long term. Our U.S. Receivable Purchase Program opportunity, alongside our anticipated continued steady growth in Canada is expected to generate strong sustainable expansion of our loan portfolio for the years to come. It will enable us to further capitalize on the significant operating leverage in our model to drive growth in profitability and the return in common equity and efficiency that is among the very best in North American banking industry. Continued growth in our POS RPP in Canada alone will push us past the $5 billion milestone. In addition to RPP POS growth, we expect near-term expansion in our real estate portfolio, which exists to capitalize on decades of experience in this sector to generate additional returns with very low risk. We are in the process of transitioning much of this portfolio to zero-risk weighted CMHC insured loans. mean they require no regulatory capital, which will further enhance our return on common equity. Finally, with respect to net interest margin, while we do expect to see some continuing short-term pressure as interest rates in Canada decrease, we will also continue to benefit from the expansion of our insolvency professional deposits as bankruptcies in Canada continue to trend upward. We also expect a higher net interest margin contribution from our US RPP portfolio due to more favorable economics for the solution there. To conclude, despite the acquisition-related noise, our third quarter results continue to demonstrate the considerable operating leverage in a very low-risk nature of our branchless digital B2B model, a model that we have proven out in Canada and that we are very confident we will see the same success in a much larger, faster-growing U.S. market. With that, I'd like to open the call to questions.

Operator?

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star, followed by the number 1 on your touchstone 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 number two. If you're using a speakerphone, please lift the handset before pressing any key. Again, should you have a question, please press star one on your telephone keypad. One moment, please, for your first question. Our first question comes from the line of David Feaster from Raymond James. Go ahead, please.

Hi, good morning, everybody. Congratulations on closing the deal. Thank you, David. So we've got the deal is now closed. I was hoping maybe you could start with just how conversations are going with new partners in the U.S., how demand's trending and maybe the growth trajectory that you're expecting. And then just remind us of those better economics on the RPP program in the states that you were alluding to.

Yeah, well, the reception we've had in the United States is tremendous. And some partners have patiently waited for us to finally be able to operate in the States. And one we're working with right now to conclude and get them operational. There's a multitude of others that will be signing up over the course of the next year. they've been convinced for the last few years that it's going to work very well for them. So a super reception in the United States and one already in the hopper, a very patient one that stuck with us through the process that maybe in a month or so will be fully operational. The economics in the U.S. are slightly better than Canada in that the U.S. bank cost of funds runs about 1% lower than the equivalent rate in Canada, particularly recently in that our deposit rates in Canada, as I was mentioning, are a bit sticky. They don't come down quite as fast as banking Canada rates. So theoretically, there's about a 1% improvement in the RPP program in the US versus Canada. And we've been averaging, say, approximately 250 basis points in Canada. fairly significant improvement in profitability in the States.

That's terrific. And to that point, you know, I was hoping you could touch on, on, um, you know, the funding growth side and in the States, you know, you just talked about the lower deposit costs. Could you just touch on the timeline? I mean, like, can you immediately with deal closed, start driving deposit growth here in the States and just walk through your strategy, uh, for, for funding growth and, uh,

in the U.S.? The answer is yes, we can immediately start raising deposits. In fact, we already are at our retail outlets in Holdingford, over the counter of course. Thankfully, we have recently signed up with your company, Raymond James, to supply us with deposits. There's another large company brokerage firm that we have the documentation to sign between the two, your company, David, and the other one, gives us tremendous reach into the deposit market. So those two, yours is signed, and the other one is likely to be signed today sometime. That's plenty of deposit access for our little bank. I'm sure over the course of the year, there'll be more signing up with us, but with you and the other one that is more than we could possibly ever use.

That's great. I love to hear it. And then just one quick modeling question. You called out some one-time costs in the quarter. Could you quantify those and maybe, you know, quantify what was in this quarter and some of the one-time charges you might expect next quarter?

Well, it was about $700 or so thousand dollars that was directly associated with the U.S. acquisition in Q3. be consulting fees. An ongoing expense will be additions to our payroll. This would be the hires of the senior people in the United States to run the shop. There was also a picnic celebration that we had in Canada at my farm that had a bit of a bill on part of the $700. So those were direct expenses associated with the U.S. acquisition. Then there'd be miscellaneous type expenses, a lot of travel costs, meetings, and then additional board members with fees and such that start to go through in the quarter. The other thing that impacted us this quarter that John alluded to was with the Bank of Canada dropping rates, the Canadian deposit rates fall with the banking Canada, but they lag. So it's happened this quarter. We're raising about $120 million additional over and above what we normally raise in deposits in order to fund the U.S. acquisition. So we're raising just at the wrong time because the banking Canada dropped the rates and our deposit rates hadn't quite dropped. That being the Canadian deposit market hadn't quite dropped in lockstep with it. So we probably all in squeezed our margin and it costs us in the order of about $600,000 in additional interest expense. But, of course, it goes away. The rates are almost caught up again now. But I suppose we just had another drop in the bank account. So hopefully our deposit rates catch up faster than they did the last time.

And based on the disclosures, it's about a three-month lag, is that right?

Yeah, and we've got a nice graph for you, Dave, if you want to have a look. We graphed this. It's painful to see it, of course. And it didn't used to be like this. Years ago, I've been banking 47 years, and it used to go like it was tied together with a steel bar. But for some reason, the Canadian deposit market sort of lags. which means that we banks pay a little more than we should be paying in the short run while the deposit rates catch up with the reduction of bank account rate. Okay, that's helpful. Thanks, everybody. Well, thank you, Dave. Looking forward to seeing you downstairs. I'm in the Windy City today, and it actually isn't windy. It's a beautiful, beautiful day out looking out on the lake here, clear blue skies.

Thanks again.

Thank you. Everyone, just a reminder, should you have a question, please press star followed by the number 1 on your touchstone phone. There seems to be no further questions at this time. I'd now like to turn the call back over to Mr. Taylor.

Well, I'd like to thank everybody for joining us today and I look forward to speaking to you at the time of our fourth quarter. And for those that are attending the Raymond James Conference here in Chicago, I look forward to talking to you downstairs in a few minutes. So long. Over and out.

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.