VersaBank

Good morning, ladies and gentlemen. Welcome to VersaBank fourth quarter and fiscal year 2024 financial results conference call. This morning, VersaBank issued news release reporting its financial results for the fourth quarter and year ended October 31st, 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 CDAR Plus and EDGAR. Please note that in addition to the telephone dial-in, Mercer Bank is webcasting this morning's conference call. The webcast is listen-only. If you are listening to the webcast but wish to ask a question in the Q&A session following Mr. Taylor's presentation, please dial in to the conference line, the details of which are included in this morning's news release and on the bank's website. For those participating in today's call by telephone, the accompanying slide presentation is available on the bank's website. Also, today's call will be archived for replay both by telephone and via the internet beginning approximately one hour following completion of the call. Details on how to access the replays are available in this morning's news release. I would like to remind our listeners that the statements about future events made on this call are forward-looking in nature and are based on certain assumptions and analysis made by VersaBank management. Actual results could differ materially from our expectations due to various material risks and uncertainties associated with VersaBank's businesses. Please refer to VersaBank's forward-looking statement advisory in today's presentation. And I would 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 our Chief Financial Officer, John Asmus. And incidentally, one of the beauties of being able to operate throughout all of North America is that I'm talking to you today from Fort Lauderdale. Turning to our financial results, as expected, as a result of preparation for and completion of the closing of our U.S. bank acquisition on August 30th, there was a significant amount of noise in the fourth quarter that impacted our earnings numbers. We have done our best to describe and quantify those to provide a clear picture of the continuing underlying strength of our business model. John will describe these in more detail in a few minutes, but at a high level, these fall into three buckets, which in aggregate total approximately $5.6 million for the quarter and $6.5 million for the year, and tax adjusted reduced EPS by an equivalent of $0.18 for the quarter and $0.20 for the year. These were one-time non-interest expenses, a change in the base of the acquired assets of VersaBank USA, and the impact of holding higher than typical cash balances ahead of the acquisition and funding the U.S. bank upon close of the acquisition. We are also for the first time providing fully segmented financial results that is broken out by Canadian banking operations, our U.S. banking operations, and DRT Cyber. We believe this provides a clearer view of the profitability, efficiency, and return on common equity of the existing Canadian banking business while also allowing you to not only definitively track the growth of our Receivable Purchase Program portfolio in the U.S., but also see the greater efficiency that we expect from that business as it wraps up. When we remove the noise associated with the acquisition, the underlying story for the fourth quarter is pretty straightforward and importantly paints a very positive picture heading into 2025 and the ramp up of our US RPP business. Q4 saw yet another record high of total assets at $4.8 billion. driven by 15% year-over-year growth in our Canadian RPP business, which expanded by 2% sequentially, even as discretionary spending in Canada generally remains soft. Growth continued to dampen by higher than typical putbacks of loans that have gone 90 days in arrears to our partners due to higher defaults among the borrowers, as would be expected in these tougher economic times. As we're made whole on these loans through our cash holdbacks, this higher rate of putback to our partners has no impact on our provisioning for credit losses, which for Q4, as it always is, de minimis. Non-interest expenses were atypically high due to one-time costs associated mainly with the U.S. acquisition. we expect to return to normalized NIEs in the first quarter of 2025 with the addition of the U.S.

bank expenses, including the new leadership team.

As it has been for nearly two years, net interest margin was dampened by the typically inverted yield curve, which lowers our margin. as we raise deposits from the short end of the curve and lend further out on the curve. We are now seeing the yield curve flattened and are very encouraged by this trend. Net interest margin was also impacted by the one times noted above. We feel good about the direction of our NIM in 2025, especially as we start to add US RPP loans

where we expect to realize a meaningfully higher spread.

For the year, we generated record net income excluding the one-time impact of the U.S. acquisition, driven by the strong growth in our Canadian point of sale receivable purchase program. You can see that reflected in our efficiency ratio and our return on common equity. We expect to see new records for all of these metrics next year based on the continued growth of our RPP in Canada and the ramp-up of the RPP in the United States, as well as a couple of other meaningful opportunities that we'll discuss in a few minutes. 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 MDMA for the fourth quarter and full year 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 noted. Starting with the balance sheet, total assets at the end of the fourth quarter of fiscal 2024 grew 15%, year over year, and 7% sequentially to a new high of $4.8 billion. Cash and securities were $525 million, or 11% of total assets, up from 7% in Q4 last year and 9% in Q3 of this year. Book value per share increased to a record 15.35. Our CET1 ratio was 11.24%, and our leverage ratio was 7.38%, with both remaining above our internal targets. Turning to the income statement, as David described, there were a number of one-time items mostly related to the U.S. bank acquisition that impacted the fourth quarter and the full-year results. A number of one-time non-interest expenses The expense of a deferred tax asset due to a change in tax base of the acquired assets of VersaBank USA. Maintaining higher than typical cash balances ahead of the closing of the acquisition, which was exasperated by the impact of a temporary dampening of net interest margin that usually occurs when interest rates decline. And $90 million in funding provided to VersaBank USA at closing of the SBH acquisition. Total consolidated revenue was $27.3 million compared to $29.2 million last year. The year-over-year difference was driven primarily by lower non-interest income from the bank's cybersecurity operations, DRTC, but was also impacted by higher cash assets associated with the funding of the U.S.

bank.

Consolidated non-interest expense was $19.4 million compared to $12.4 million last year and $13.5 million for Q3 of this year. The quarter included $3.3 million in one-time costs that were mostly associated with U.S. bank acquisition. The $3.3 million brought total acquisition-related one-time costs for the year to $3.7 million. As a reminder, DRT cyber expenses are included in our consolidated NIEs and total 2.6 million and 9.4 million for the quarter and year respectively. Finally, as David noted, we will see NIEs return to a normalized level in Q1. Excluding one-time NIEs and other one-time impacts, the impacts I just described, consolidated net income for the quarter was $10 million or $0.38 per share, and consolidated net income for the year was $45 million or $1.69 per share.

Looking at our digital banking operations,

which with the close of the U.S. acquisition on October 30th now consists of our Canadian banking operations and our U.S. banking operations. As David mentioned, these are broken out in our press release and MD&A, but for the sake of brevity, I will discuss the combined results as the U.S. banking operations had limited, although positive, contributions. Our loan portfolio grew to a new record of 4.24 million at the end of Q4, driven once again by our point of sale receivable purchase program, which increased 15% year over year or 2% sequentially to 3.3 billion. Our RPP portfolio represents 78% of our total loan portfolio at the end of Q4, down from 80% at the end of Q3, As David noted, RPP growth was dampened for both periods due to higher amount of putbacks. Our real estate portfolio contracted 12% year over year to $788 million as we continue to transition the portfolio towards CMHC insured loans. We are starting to see a ramp up of the program, which drove a 6% sequential increase in the real estate portfolio. We currently have commitments of close to $600 million, with the loans outstanding of over $210 million, which continues to grow monthly, almost doubling since the end of Q3. As a reminder, our real estate portfolio is primarily business-to-business mortgages and construction loans for residential properties. We have little exposure to commercial-use properties. Turning to the income statement for our digital banking operations, net interest margins on loans, that is excluding cash and securities, was 2.34%. That was 35 basis points or 13% lower on a year-over-year basis and 7 basis points or 3% sequentially, mainly the result of an atypical inverted yield curve adversely affecting POS margins and and the change in the real estate portfolio to CMHC-insured loans. Net interest margin, including the impact of cash and securities and other assets, was 2.12%, which was impacted by the higher cash balances as well as the $90 million in capital provided to the U.S. digital banking operations from the Canadian Digital Bank. Net income, excluding one-time impacts The digital banking operations for the quarter was $10 million, or $0.38 per share. Net income for the Canadian banking operations was $9.5 million, or $0.36 a share. And net income for the U.S. banking operations, which for the quarter includes the contribution of only the acquired sterns holding for bank operations, was half a million dollars, or $0.02 per share. Turning to our credit losses, our provision for credit losses or PCL in Q4 remained negligible at negative 0.01% on average assets compared to negative 0.02 last year and with a 12-quarter average of 0%. I'd now like to turn the call back to David for some closing remarks. David?

Well, thank you, John. 2025 promises another year of growth in our loan portfolio and profitability, driving continued improvements in our efficiency ratio and return on common equity as we continue to capitalize on the operating leverage in our business model. We have a strong foundation in our Canadian digital banking operations, where we are very proud to lead the publicly traded banks in net interest margin, which is even more impressive given that we don't give anything back for loan losses. We expect continued steady growth in Canada with our Receivable Purchase Program expanding in line with 2024, and some upside should interest rates continue their downward trend as is forecast. And we expect to begin to see the contribution of our growing CMHC-insured loan business in our opportunistic real estate portfolio. As a reminder, these are zero-risk weighted loans requiring no capital and delivering a very nice spread. We also expect to see continuation of several favorable trends that support net interest margins. As noted earlier, we are starting to see the flattening of the yield curve, which will be beneficial to the spread of our RPP loans. In addition, we should continue to see favorable impact of our low-cost insolvency professional deposit business in Canada as bankruptcies continue to steadily trend upward. We are moving aggressively forward in U.S. RPP opportunity. We are in the process of moving our first U.S. partners from our pilot program to First Bank USA balance sheet. More importantly, we expect to add our first post-acquisition partner eminently and others to follow in due course. I will note that it does take some time to finalize these contracts and onboard new partners. However, we do expect the pace of new additions to accelerate going forward. We have a robust and growing pipeline as our discussions with both potential partners and others in the industry continue to validate that our RPP is both unique and very attractive solution for a company. who finance big ticket and services at the point of sale. To support what we expect, the very active REMPOP in 2025, earlier today, we announced that we are transitioning the team responsible for the success of the Canadian RPP to the U.S. opportunity. This team of Nick Christo, appointed Chief Credit Officer for the U.S., Mike Dixon, appointed SVP RPP in the US have been fundamental to the growth and success of the RPP in Canada since inception 14 years ago. And along with Mike Robinson, appointed VP RPP US, who has been integral to the program for the last seven years, are responsible for 27% compounded annual growth rate over the last five years. more than $9 billion in financings for point-of-sale lenders, and of course, no losses. They join a formidable team whose collective experience and expertise will be invaluable as we scale up the US RPP program in the multi-trillion dollar US point-of-sale market. As a reminder, overall, we expect our US RPP business to benefit from even greater efficiencies than we achieve in Canada due to the lower personnel requirements on both the deposit and lending sides. We have a lot of bench strength in Canada, and we are proud to also announce the appointment of David Toms as SVP Point of Sale Financing, Versa Bank Canada, and Saad Inam, Chief Credit Officer, Versa Bank Canada. Congratulations, guys. We will grow our U.S. RPP business as quickly as our balance sheet capacity permits. Given the significant anticipated demand, we will at least initially be syndicating RPP loans to other U.S. banks. Under this model, we earn our typical RPP spread on the portion of the loan, and our partner earns the same spread on the other portion. and we earn a fee expected to be around 1% from our partner banks. The cash holdbacks will reside on our balance sheet and the risk profile is unchanged. In fact, we gain some diversification as to our partners. You can think of this simply as VersaBank additionally white-labeling RPP to generate greater profitability. And just as a reminder, we do expect the RPP spread to be as much as 1% higher in the U.S. than in Canada. One final note before we open the call to questions. Those of you who have followed VersaBank for some time will know that within our wholly owned Washington, D.C.-based cybersecurity firm, DRT Cyber, we developed what we believe to be the world's first, in our opinion, the world's most secure digital vault, VersaVault. as well as, to our knowledge, the world's first digital deposit receipts, which can be issued by banks themselves. We believe these technologies have a tremendous value, enabling U.S. banks to provide state-of-the-art access to the emerging world of digital commerce. Thus, we are very encouraged by the favorable stance of President-elect Donald Trump and his proposed administration with respect to digital currencies and what it will mean for our Made in America solution. Our digital deposit receipts are on Algorand, Ethereum, and Stellar blockchains, and are SOC2 Type 1 compliant using VersaVault.

With that, I'd like to open the call to questions. Operator?

Thank you, Mr. Taylor. Ladies and gentlemen, if you would like to ask a question, please press star followed by one on your touch-tone phone. You will then hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by two. And if you're using a speakerphone, please lift the handset first before pressing any keys.

One moment, please. And your first question will be from Tim Switzer at KBW. Please go ahead.

Hey, good morning, guys. Thank you for taking my questions. Good morning, Tim.

Could you provide an update on how the conversations with new partners in the U.S. are going, and how many partners should we expect to be fully launched over the next few quarters?

Well, we have very productive discussions with one U.S. bank as a partner, and we've tested the The data flow, it works exceptionally well. So we'd expect very soon to have our first RPP, new point of sale partner, and we'll also have a partner bank sharing in those loans. So I said eminently, and we're just in the paper stage where dollars are... are working hopefully as quickly as they can to put that one to bed. With respect to additional partners, there's been about 30 or so that we've been talking to, and I think the constraint has just been how fast we're going to be able to do the paperwork to sign them up.

Okay, great. Related to that, how should we think about the origination trajectory in the U.S. and the balance sheet growth over the course of the year? Is it a gradual acceleration, kind of evenly each quarter, or is there a point in the year where you think it really starts to significantly change?

Well, it's sort of quantum jumps in growth, depending on how fast we sign off the partners. Right now, we're looking to have on balance sheet about $250 million by 2020. by the end of the year, and that would be sharing at least 50% with other banks. So in total, as an administration, about $500 million. And it may grow a lot faster depending on how quickly we can get the paperwork done.

Okay. And if I can get one more, please. What is the expense outlook for next year? Once we exclude some of the one-timers you guys reported, are most of the costs associated with running the U.S. business now in the run rate, or is there kind of another lift to the expense base as some of these customers come on?

Most of the expenses are now in the run rate in that we've hired almost everybody we need to run the U.S. They may have a couple more... to put on, but the heavy hitters are already on board.

Perfect. Okay. That's all for me. Thank you, Dave. Thanks, Tim.

Next question will be from David Seaster at Raymond James.

Please go ahead, David.

Hi. Good morning, everybody. Good morning, David. I'm joining today, thankfully. I love it.

That's great. You know, one thing that you touched on was, you know, given the governors, the growth governors on the U.S. expansion, you know, y'all are going to be syndicating some loans out to be able to support the growth, but, you know, not necessarily have it all on balance sheet. I'm curious where you are in the build out in that process and the platform and whether you've started to test that yet.

Well, we built it. It's called AMS 3.0. That's short for Asset Management System 3.0. In Canada, we use AMS 2.0. It's in the cloud facility in Des Moines, Iowa, at the Azure facility, and it's fully functional. It's also, on the syndication side, it's also able to parse each individual loan. to the component parts so that we'd retain on our balance sheet, our partners would retain. So that's all set to go. We're just waiting for the finalizing documentation for the first brand new point of sale partner. Hopefully, that's very soon. And then the data starts to flow representing the loans being parsed for us and for our first community bank partner. Okay.

And then you touched on some of the differences too between kind of the small ticket opportunity and the larger ticket opportunity. I'm curious maybe where are you focused in the U.S. currently? Like where do you see the most opportunity here? Is it in the smaller ticket or maybe some of the larger stuff?

It's mainly the larger stuff, although our software is capable of dealing with tiny loans too. But the sweet spot is the larger ticket items such as home improvement, new HVAC systems, that sort of thing. I think the United States would be quite similar to what we experienced in Canada. About 50% of our point of sale portfolio is home improvement. Okay.

And then, you know, last one for me, you know, on the, you know, you talked about 100 basis point better spread in the States. Do you see more opportunity? Is that on the funding side or is it on the loan yield side? And then, you know, just kind of to the funding side, you touched on, you know, the election and the potential tailwinds maybe for some digital currencies. Curious question. you know, if there's any interest in bringing back CADV, you know, in that opportunity.

Well, good point. We've seen on the test market we did in the United States, we got better yields and we got lower cost of funds to give rise to that approximately 1% additional spread. So it was both on the yield and on the funding side. With respect to DRTC's technology that We announced about four years ago. We were quite proud of it. We have what we call VUSD and VCAD, our digital deposit receipts on Algorand, Stellar, and Ethereum. And we had it SOC 2 reviewed and obtained SOC 2 Type 1 rating. So that technology is all set to go. But as Paul Masson said, George Orwell said, no wine before it's time. I thought the regulatory environment wasn't mature enough to receive that product, but it appears with the Trump pending appointees and it looks like a favorable environment for digital commerce that this product that we have that's been tested and actually fully functional would be sort of wonderful for the smaller FIs in the United States to use. And DRG stands ready to provide that service for them. With respect to our own bank, we have such wonderful access to cheap deposits through the large brokerage firms. There isn't a lot of need for us to adopt that. And we have our work sort of cut out for us, expand the RPP program. But DRTC cyber could provide that service to other small banks, community banks that don't have this, the waterflax as we do, to very cheap funding. So it'd be a product for DRTC. And sometime in the future, it may be something that our U.S. bank adopts too, but there isn't any burning need for our bank to adopt it.

Okay. And then maybe if I could squeeze one more in. You touched about increased putbacks to your partners in Canada. And we're really validating your business model. Uh, and that's great. You've had no credit issues, but I'm curious, maybe how has this impacted the partners in Canada and the health of their balance sheet and their ability to absorb those losses so far?

Well, so touch wood, they, they've all been able to do that. Uh, we, we tend to pick the strongest, uh, point of sale partners. Uh, we can, we can, and, uh, they, they, they've been, uh, dealing with it. It's sort of the inevitable downturn. Some people in Canada are calling it a recession. And considering our trustee deposits have increased by 20% year over year, that's a big number. That means a 20% increase in bankruptcies. We probably are in a bit of a recession. But our partners have stood up. They seem to be fine. They're all sort of eagerly awaiting perhaps a jumbo decrease in the overnight rates at Bank of Canada that might be announced on Wednesday. So generally speaking, our model has held up wonderfully, and it's just slowed growth with record high putbacks this year. And our partners seem to be in good shape. And if the Bank of Canada drops, the rates, as people are hoping and predicting, then that might return us to that upward sloping yield curve again, where we were scoring about 300 basis points in net interest margin. So sort of stay tuned. I hope Wednesday's good news for the case. That's great color.

Thanks, everybody. Thank you.

Ladies and gentlemen, a reminder to please press star one on your telephone keypad should you have any questions. Next question will be from Andrew Scott at Roth Capital Partners. Please go ahead, Andrew.

Hey, good morning, guys, and thank you for taking my questions. First one for me, you guys saw a return of growth in your CRE portfolio. I know you guys have been recently kind of right-sizing that portfolio, maybe changing up the mix. Can you kind of talk about how you feel about the portfolio, where it is now, and then maybe provide some additional color on that? the CMHG portfolio?

Absolutely. So this portfolio is almost all composed of loans on residential properties. And there's two types. One we call conventional loans. So these are the normal loans that banks have made over the years that are risk-weighted fairly highly. This would be multifamily, normally construction, apartment blocks construction, and some low-rise. And because of the high risk weighting, and there's a little additional risk involved, we're running a loan-to-value ratio around 60% on these. We pivoted over to CMHC-insured construction mortgages. And this seems sort of wonderful in that they're zero percent risk-weighted, so don't absorb any CET1 capital, and match really nicely against our floating rate trustee deposits. On average, we pay about, say, prime minus 285 on those, and we earn maybe prime minus 20 on the CMHC. So we're making about a 265 basis point spread on a zero risk weighted asset and no capital required. That's the portfolio that John talked about. We have 600 million right now and committed facilities to draw down in 2025, almost double that we had last quarter. We're looking at probably that figure increasing by the end of 2025 say to $1.5 billion or maybe even $2 billion. So it's a really wonderful opportunity for us to help with the construction in Canada but not take, well, hardly any risk for the government insured and get a really good rate of return.

Great. Well, thank you for the additional color.

And then second one for me, you've kind of expanded on this earlier, but, you know, as you look out in 2025, can you kind of just talk through the pipeline of business activity for DRTC?

Well, DRTC's cybersecurity business has been growing quite, by the sign-up of new customers, quite dramatically. We've signed some really big well-known names, and the revenue hasn't flowed into the statements yet, or not all of it. It's starting to come in. So this increased demand for DRTC's cybersecurity product amongst the big players, the brand name retailers and other financial institutions. But the product that we have in DRTC that we just sort of kept under wraps for a while, depending on a more favorable regulatory environment is the ability to issue digital deposit receipts. So this is the state of the art. And I was just at a conference where a very smart individual pointed out there's a huge difference between a stablecoin that's backed up by an asset or a deposit held by somebody else and an actual digital deposit receipt which represents a deposit held by a real bank. And we developed this technology about four years ago and proved it all out and tested it and had it audited. But we just kept on the shelf until the right time. But it looks like it is the right time. So we could host this for thousands of community banks in the United States and bring them to this new state-of-the-art way to raise deposits, let their customers have the deposits in e-wallets and such, and transact business in almost negligible season, almost instantaneous. It's a state-of-the-art payment vehicle, state-of-the-art deposits. For example, say you bought Bitcoin at $1,000 and you see that $100,000 and you'd like to swap it into a bank deposit. Well, that can be done seamlessly in your e-wallet with... with our VUSD product or VCABS, courtesy of our technology and our VersaVolt. And I think time is right. I was quoting George Orwell a while back saying, no wine before it's time. And that's why we just didn't promote it or just kept it on the shelf. Because the regulatory environment had to mature and regulators had to get the rules in place. I think regulators would like banks to issue these types of products rather than the unregulated entities that have, in some cases, got into trouble in the past. So it's a service for DRTC to provide, and I'm pretty excited about it.

I think it's something that a lot of community banks will want to take us up on. All right, yeah, that sounds like a wonderful opportunity. Congrats on the growth and thanks for taking my questions. Well, thank you, Andrew. Look forward to talking to you later on.

Ladies and gentlemen, again, a reminder to please press star followed by one should you have any questions.

And at this time, Mr. Taylor, we have no other questions. Please proceed.

All righty. Well, I'd just like to thank everybody for joining the call and look forward to talking to you at the end of the next quarter. Stay safe and so long. I'll have to put some suntan lotion on here. Being a cloud-based bank and a U.S. operation now, I've got the luxury of operating anywhere in North America. And today, it's a very sunny day in Lauderdale. Thank you. Bye.

Thank you, sir. Ladies and gentlemen, this does indeed conclude the conference call for today. Once again, thank you for attending. And at this time, we ask that you please disconnect your lines.