VersaBank

Good morning, ladies and gentlemen. Welcome to VersaBank's first quarter fiscal 2025 financial results conference call. This morning, VersaBank issued a news release reporting its financial results for the first quarter ended January 31st, 2025. That news release, along with the bank's financial statements, MD&A, and supplemental financial information are available on the bank's website in the investor relations section, as well as on Cedar Plus and EDGAR. Please note that in addition to the telephone dial-in, Vrsa 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 into the conference line, the details of which are included in this morning's news release and on the bank's website. For those participating in today's call by telephone, the accompanying slide presentation is available on the bank's website. Also, today's call will be archived for replay both by telephone and via the internet beginning approximately one hour following completion of the call. Details on how to access the replays are available in this morning's news release. I would like to remind our listeners that the statements about future events made on this call are forward-looking in nature and are based on certain assumptions and analysis made by VersaBank management. Actual results could differ materially from our expectations due to various material risks and uncertainties associated with VersaBank's businesses. Please refer to VersaBank's forward-looking statement advisory in today's presentation. I would now like to turn the call over to David Taylor, President and Chief Executive Officer of VersaBank. Please go ahead, Mr. Taylor.

Good morning, everyone, and thank you for joining us for today's call. With me is our Chief Financial Officer, John Asma. Before I begin, I will note that you will see a change in a number of terms we use to describe our business. With the start of a new fiscal year and the context of the evolution of the bank including the U.S. bank acquisition, we have taken the opportunity to update the manner in which we are describing our asset and deposit classes. The first quarter of fiscal 2025 has been a tremendously busy and eventful one in terms of moving our strategy forward. We signed our first RPP partner in the United States following the U.S. bank acquisition. We completed a very successful $86 million capital raise, including full execution of over-allotment option to support our U.S. RPP opportunity. We aligned the structure of DRT Cyber to position our digital deposit receipts for renewed opportunity and our cybersecurity service business for planned divestment. And we accomplished all of this as we achieved yet another record for total assets. Let me start with signing of our first US partner post US bank acquisition. We are thrilled to partner with Watercress Financial, a rapidly growing point of sale originator of home improvement loans in the US. Watercress has proven track record of originating high-quality consumer loans through its expanding network of contractors nationwide. It's no accident that our first partner finances home improvement sector, as that has been our biggest driver of significant growth in our Canadian business in recent years. Immediately following the agreement, we provided our first tranche of funding and shortly thereafter our second, Importantly, the program is functioning just as it should and meeting both our partners and our expectations. We expect our funding with Watercraft to steadily expand throughout the year and contribute meaningfully to U.S. growth this year. We are working with multiple other firms in our robust pipeline to add them as our next partners, and we are confident that these can be finalized quicker now that we have been through this one. Moreover, with the program now formally functioning in the United States under our U.S. license, we have further evidence of its value for potential new partners. John will run through Q1 numbers in detail in a few minutes, but I want to highlight a few items to provide some perspective on the quarter. One, from a consolidated perspective, the quarter reflects the startup nature of the U.S. operations. That is essentially full costs ahead of any generation of revenue and profits from our US RPP. Specifically, we had close to a full cost load, but a de minimis revenue as we signed our first US partner only at the very end of the quarter. Two, our Canadian digital banking operations continues to demonstrate the power of the operating leverage in the business. in particular the power of receivable purchase program at scale to drive efficiency and return on common equity. I will note here that our Canadian banking operations bear the vast majority of our corporate overhead costs, including our public company costs, so as an indicator of its true potential efficiency and return on equity of our U.S. business, it is actually significantly understated. and as the U.S. business is expected to be even more efficient than the Canadian business at scale. Three, I noted on our last call that there are a number of favorable trends that we believe will support incremental expansion of our net interest margin in 2025. While NIM on credit assets continues to be dampened by the lag effect of the atypical inverted yield curve that existed throughout fiscal 24, we began to see small sequential increases in NIM on credit assets in Q1. This was driven to a large extent by the cost of funds catching up to yields as market interest rates declined. Notably, with an outsized proportion of term deposits coming due in the near term, as well as continued expansion of our insolvency trustee deposits, we expect further declines in our cost of funds in the near term. And finally, our EPS for the quarter reflects the significantly higher number of shares outstanding in Q1, as a result of our December capital raise. In fact, the weighted average shares of Q1 was 12% higher than Q1 last year. And this is, of course, ahead of being able to put that capital to work. as we have now started to do. As a reminder, this provided a 30% increase in our capital base, which we deploy it approximately 12 times or more at around 2.5% spread. That is very accretive. I'd now like to turn the call over to John to review our financial results in detail. John?

Thanks, David. Before I begin, I will remind you that our financial statements and MD&A for the first quarter are available on our website under the investor section, as well as on 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 first quarter of fiscal 2025, grew 15% year-over-year and 3% sequentially to a new high of just under $5 billion. Cash and securities were $545 million, or 11% of total assets, up from 6% in Q1 last year and level with Q4 of last year, ahead of expected deployment in Q2. Book value per share increased to a record $16.03. Our CET1 ratio increased to 14.61%, and our leverage ratio was 9.67%, with both remaining above our internal targets. Total consolidated revenue was $27.8 million compared with $28.9 million last year. The small year-over-year decrease was driven by lower overall net interest margin as well as lower non-interest income. Consolidated non-interest expense was $15.7 million compared with $12 million in Q1 of last year and $19.4 million for Q4 of last year, which included one-time expenses mostly related to acquisitions. The year-over-year increase reflects incremental operating costs associated with VersaBank USA operations and higher operating costs to support current and anticipated increased business activities ahead of any revenue generation. As a reminder, DRT cyber expenses are included in consolidated net interest expense and totaled $3 million for the quarter,

which were elevated and I will describe in a moment.

Looking at the income statement on a segmented basis, the vast majority of revenue was of course driven by our digital banking operations, and within that, our Canadian banking operations, as we didn't fund our U.S. partner until the end of the first quarter. Revenue for the Canadian business operations was $23.8 million, up slightly from Q4 of last year. Net income for the Canadian banking operations was $8.8 million, or $0.30 per share. Revenue for US banking operations was $2 million, and income from the US banking operations was $103,000. Within DRTC, the cybersecurity component generated revenue of $2 million, up from $1.9 million in Q1 of last year. Net loss was $757,000, impacted by higher operating expenses related to the onboarding support costs for new cybersecurity offerings. Within DRTC, digital media revenue was $342,000, and net income was $33,000. Our credit asset portfolio grew to a new record $4.35 billion at the end of Q1, driven once again by our receivable purchase program, which increased 10% year over year and 3% sequentially to $3.4 billion. Our RPP portfolio represents 79% of our total credit asset portfolio at the end of Q1, up slightly from the end of Q4. David previously mentioned changes to the naming of our asset categories. One of those changes was to simplify the commercial real estate portfolio and public sector and other portfolio to the combined multifamily residential loans and other portfolio. Our multifamily residential loans and other portfolio grew 5% year over year to $928 million. We are seeing the ramp up of our CMHC insured loan program, which drove a 2% sequential increase in multifamily residential loans and other portfolio. We currently have $231 million outstanding at the end of the quarter. As a reminder, our multifamily loans and other portfolio is primarily business to business mortgages and construction loans for residential properties.

we have very little exposure to commercial use properties.

Turning to the income statement, our digital banking operations, net interest margin on credit assets, that is excluding cash and securities was 2.36%. That was 27 basis points or 10% lower on a year over year basis and two basis points or 1% higher on a sequential basis primarily due to the lag effect of a typical inverted yield curve that existed throughout 2024, which dampened the RPP portfolio margins. Net interest margin, including the impact of cash securities and other assets, was 2.08%, which was primarily due to higher than typical liquidity in the first quarter of fiscal 2025, but still remaining among the highest of the publicly traded Canadian Schedule I banks. Our provision for credit losses or PCL in Q1 increased this quarter to 0.09% on average credit assets compared to negative 0.01 last year and with a 12 quarter average of 0.02%. The increase this quarter was due to changes in forward looking information used in our credit risk models. I'd now like to turn the call back to David for some closing remarks, David.

Thanks, John. 2025 is off to a great start and unfolding on plan. Looking ahead, we expect another year of solid growth in credit assets. We will increasingly benefit from the operating leverage of our business model as those assets scale. We still expect minimum of low double-digit growth in our Canadian assets with potential upside from increased consumer spending in the lower interest rate environment. That said, we could see this growth dampened if the recent tariff situation is prolonged and it meaningfully impacts consumer spending in Canada. We expect to begin to see a more meaningful contribution of our growing CMHC-insured multifamily residential loan business in our opportunistic real estate portfolio. These zero-risk weighted loans require no capital and generate a very attractive spread. We are still targeting a billion dollars in commitments by the end of fiscal 2025, although the pace of drawdowns on commitments to date has been slower than expected. Each of these will drive greater efficiency, growth in profitability, and higher return on common equity as we continue to capitalize on the operating leverage of our business models. We also expect to see the continuation of several favorable trends that support net interest margin. The yield curve has returned to its normal upward slope. While there's still a lag effect in the very near term, we will see benefit thereafter increasing in 2025. In addition, we should continue to see the benefit of our low cost insolvency trustee deposit business as bankruptcy activity in Canada continues to increase. In the United States, we're off and running with our first partner, post-US bank acquisition, with a benefit of US dollars 86 million in capital we raised in December. We have a robust and growing pipeline as our discussions with both potential partners and others in the industry continue to validate that our RPP is both unique and very attractive solution for companies who finance big ticket goods and services at the point of sale. We will grow our US RPP business as quickly as our balance sheet capacity permits. And I will note here, at this time, we do not expect tariffs to have any negative impact on the ramp up of our US RPP business. In fact, the uncertainty in the markets could make our RPP solution even more attractive as alternate sources of funding get more expensive. Finally, we continue to be very encouraged by our favorable stance of the Trump administration on digital assets, which we believe will be very beneficial for our proprietary digital deposit receipts, or DDRs for short. We are now actively pursuing this renewed opportunity, Our DDRs are highly encrypted digital assets based on a one-for-one on actual deposits that combine the safety of a traditional banking with the efficiency, cost-saving, security, and flexibility of blockchain technology. This uniquely provides superior security, stability, and regulatory compliance compared to conventional alternatives. Importantly, our DDRs are backed by the bank's very own military-grade cybersecurity technology, which we call VersaVault. We have a tremendous head start having successfully completed the pilot program with our proprietary DDRs provided a secure representation of federally regulated bank deposits on the Algorand, Ethereum, and Stellar blockchains. Our DDRs have the potential to be an ultra-low-cost source of deposits funding for VersaBank. as well as any bank that uses our technology, while enabling consumers and businesses to confidently engage in rapidly developing field of digital commerce. To pursue this opportunity, we have transferred the intellectual property and other resources related to DDRs to our wholly owned subsidiary exclusively for DDR assets. The name Digital Meteor is indicative of the potential for DDRs to significantly disrupt the conventional banking deposit framework. With that, I'd like to open up the call for questions. Operator?

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by the two. And if you are using a speakerphone, please lift the handset before pressing any keys.

The first question comes from Joe Yanchunas at Raymond James. Please go ahead. Go ahead, Joe. Joe, please unmute your line. You are live. I apologize. Well, good morning. Let me start over.

So the digital deposit receipts, it sounds like a very exciting opportunity. How should we think about that kind of in the near term? And can you quantify the level of these deposits, say, by year end that you would consider a success?

Well, Joe, what we have in mind is piloting the project again in the United States. We completed the pilot project for what we call VCAD or CADVs, being a digital representation of deposits with our bank in Canada. And now that we have a national bank license in the United States, we plan to do a similar pilot project very soon actually. We're working with the regulators to put that together. Once we've had a successful pilot project, then we'll start raising deposits in this fashion, probably towards middle to the end of the year. And I think it's an extremely attractive product. It's sort of like the modern day checking account where one of our depositors can pay for some goods or services rather than write an old-fashioned paper check but transferred a digital deposit receipt that, of course, would be insured in that it's a deposit with a national bank to another person's wallet and thereby change that business. Sort of like having a certified check because... Obviously, they are drawn on our bank, and our bank's deposits attract FDIC insurance. So I think towards the end of this year, you'll probably see it rolled out. But right now, the plan is just to start a pilot in the United States.

Understood. Well, certainly look forward to seeing how that matures and grows over time. And then shout out for me.

Yep.

we can just pivot over to the non-interest expenses. Should we think about, you know, this being the current run rate kind of moving forward where we're at right now?

Yeah, I would, uh, maybe even a little bit more. Um, the one thing that impacts our, our, uh, financial statements is the, is the exchange rate and that, um, the expenses we have in the United States are, uh, a lot more expensive now in terms of Canadian dollars. And the salaries, of course, the salaries we were paying on the 14 people we assigned to the U.S. bank in terms of Canadian dollars are a lot more expensive. But yeah, that's what I would do. I'd run today's rate plus a little more maybe, and that's a good number to estimate.

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

Well, the first account we signed, Watercress, took a little while to plow through the legal work. But shortly after signing, we did the first draw, about $10 million. We did another draw after that, about $15 million. And I think it looks like there's a lot more to come. So I would look at it as gathering momentum. The next one's in the hopper and the legal work shouldn't take anywhere near as long. So the original targets I gave for the year were in the order of, I think it was 290 million US. I think that's easily attainable just with a few RPP partners. And there's quite a number lined up.

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

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

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

Well, it's sort of a matter of doing the paperwork. We have what we call a master purchase and sale agreement. It's a fairly hefty document. Our partners and their lawyers have to become familiar with it and interact with us. That's sort of what we experienced in Canada too. It's a unique new program and it takes a little while to understand how it all operates. But it's just simply do the paperwork. Everybody seems keen and excited. In fact, we've talked to some partners have huge potential. Some of them dealt with us in the past in Canada. So they're familiar with the bank. They're familiar with the personnel actually. Uh, so I, it'll just, uh, do like you did in Canada. It'll just start, uh, gathering momentum and, um, got a little bit of help. The alternate, uh, alternative, uh, financing is, um, uh, securitizations. And, uh, uh, I guess, unfortunately due to market conditions, securitizations are getting a little more expensive. Uh, this sort of a flight to quality again, um, which, which plays into our hand. Uh, but, um, Of course, it's not so good for the stock market and investors.

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

Well, as we start to approach our budgeted figure, we'll be sharing the loans through the syndication model with other community banks and maybe some investment firms. We're well underway with that, with the program. The software is developed, the software works, and is easily able to look after it. And we've been working with some large investment banking firms to... package the participation into a security that hopefully has a decent bond rating. I'm looking for about a double A, considering our bank is single A unsecured, which gives a favorable risk weighting on a participant's balance sheet, about 20% versus 75, 100. So I'll make the product even more attractive With respect to management fees, we've been targeting around 1%. It remains to be seen. We haven't concluded a transaction yet, but the more attractive the product is, i.e. bond rating and risk weighted at a very low level, the better fees we'll be able to earn, obviously, and the market conditions, too. When the market's frothy, Rates are narrow, and we have to sharpen our pencils. And when the rates, as it seems to be happening now, increase, applied to quality versus higher risk debt, then we do better.

Great. Thank you so much. Thank you.

And the next question comes from Andrew Scutt at Roth Capital Partners. Please go ahead.

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

Yeah, thanks, Andrew. Yes, last year around this time, we were whining about our deposit rates, that would be Canadian deposit rates, increasing on a margin over the same-term government Canada bond. And they got to sort of historical highs, 80, 90 basis points, so same-term government Canada bond. So those GICs in Canada, they call them GICs or CDs, are going through the system now. They're maturing. So the unusually high margin we were paying over the risk-free rate is diminishing in 2025. So that gives us quite a tailwind on margins. Historically, we run around a 3% margin. And so you can start to see it inching up a little bit, but we've only had the beginning of the maturities of those higher-priced GICs go through. The other thing that's helpful for us, but not so helpful for the rest of Canada, is that there's been a huge increase in bankruptcies, about 26% year over year. It might even be a lot higher in the next few months. And while that doesn't bode well for the Canadian economy, dampens consumer enthusiasm to buy things and such, it certainly provides us with a lot more economically priced deposits. So all in all, keeping those things in mind, our margins should widen back up to where they used to be, running around three.

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

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

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

Oh, thank you. Look forward to seeing you soon, Andrew, in California.

I'll be seeing you in California, right? Thank you. We have no further questions.

I will turn the call back over to Mr. Taylor for closing comments.

Well, I'd like to thank everybody for joining us today, and I look forward to speaking to you at the end of our second quarter. Thank you very much.

Have a good day.