VersaBank (VBNK) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to VersaBank's Fourth Quarter and Year-end Fiscal 2023 Financial Results Conference Call. This morning, VersaBank issued a news release reporting its financial results for the fourth quarter and fiscal year ended October 31, 2023. 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 the SEDAR+ 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 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 1 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 Shawn Clarke, our Chief Financial Officer. Before I begin, I'd like to remind you that our financial results are reported and will be discussed on this call in our reporting currency of Canadian dollars. Those interested, we provide U.S. dollar translations for most of our financial numbers in our standard investor presentation, which will be updated and available on our website shortly. Now for the results. Another record quarter capped off another record year for our bank as we realized the significant and increasing operating leverage in our branchless business-to-business, partner-based digital banking model with the continued growth in our loan portfolio. 94% year-over-year growth in net income was more than triple that of our healthy 29% growth in our loan portfolio. And that drove an 86% increase in average return on common equity to nearly 14%. Looking more closely at our fourth quarter performance. Our results once again show the predictability and momentum of our business. Those of you that have followed VersaBank for some time, will have heard me say that the $4 billion mark for total assets was the point in which we begin to see the operating leverage in our digital banking model. That can clearly be seen in Q4 numbers. With total assets crossing $4 billion mark during Q4, ending the quarter and the year at $4.2 billion, we are seeing the outsized positive impact on efficiency, profitability and our return on equity. Continued steady growth in our loan portfolio due primarily to the continued strength of our point-of-sale receivable purchase program drove very healthy sequential revenue growth of 9%, which contributed to 20% growth year-over-year. We achieved this growth while holding noninterest expenses flat. In reality, it was down a bit, which drove our digital banking efficiency ratio to 45% from 51%. As I noted last quarter, this level of efficiency already leads the vast majority of North American banks. Fourth quarter return on common equity saw a big jump up to 13.58%, up 243 basis points sequentially and 626 basis points year-over-year. This was always my vision for a branchless business-to-business partner-based digital bank. Our ability to grow revenue while holding noninterest expenses is the engine that drives and will increasingly continue to drive earnings growth, return on equity and value for our shareholders. Importantly, we are really just beginning to realize the true efficiencies of our model. Our highlights for fiscal 2023, year very much mirror those for the fourth quarter. Our digital banking efficiency ratio for 2023 improved to 43% from 55% as we grew revenue by 31% while holding noninterest expenses to just a 1% increase. And that, with the benefit of solid profitable growth from our cybersecurity subsidiary translated into an 86% increase in net income and a 99% increase in earnings per share. Return on common equity for the year improved substantially to 11.75% from 6.61%. The vast majority of our 2023 growth was driven by the continued solid performance of our Canadian point-of-sale receivable purchase program. We continue to expect solid growth for the foreseeable future. We're also seeing continued incremental growth from the limited U.S. launch of our receivable purchase program. While still off a small base, this growth is indicative of the uniqueness and attractiveness of this offering. The real opportunity in the U.S., however, remains the broad national rollout of our solution, what remains an underserved market. It will supercharge our expected growth. We continue to advance the approval process for our proposed acquisition of U.S.-based Stearns Bank Holdingford, which will provide the U.S. license to enable us to undertake this broad rollout. We understand and respect the protracted nature of the process and remain encouraged by our interactions with the regulators to date. Should we receive the approval we are seeking, we know that they're well worth the wait. I'd now like to turn the call over to Shawn to review our financial results in detail. Shawn?

Thank you, David, and Good morning, everyone. Before I begin, I will remind you that our full financial statements and MD&A for the fourth quarter and the full year are available on our website under the Investors section as well as on SEDAR 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 fourth quarter of fiscal 2023 grew to a new high of just over $4.2 billion. It was up 29% from $3.3 million at the end of Q4 of last year and up 6% sequentially from $4 billion at the end of Q3 of this year. Cash and securities at the end of Q4 were $230 million or 7% of total assets, which is unchanged from both Q4 last year and Q3 of this year. Our total loan portfolio at the end of the fourth quarter expanded to another record balance of $3.85 billion, an increase of 29% year-over-year and 5% sequentially. Book value per share increased 13% year-over-year and 3% sequentially to a record $14. These increases were the result of higher retained earnings as well as fewer shares outstanding due to our share repurchase program, offset partially by dividends paid. Our CET ratio at the end of the quarter was 11.33%, down from 12% at the end of Q4 of last year and up from 11.15% from Q3 of this year. Our leverage ratio was 8.30%, down from 9.84% at the end of Q4 last year and down from 8.53% at the end of Q3 of this year. Both our CET1 and leverage ratios remain well above our internal targets. Turning to the income statement. Total consolidated revenue for the quarter increased 20% year-over-year and 9% sequentially to another record of $29.2 million. The increase was driven primarily by higher net interest income from our digital banking operations, primarily due to the strong growth of our loan portfolio. Consolidated noninterest expense was $12.4 million for the quarter, down from $13.8 million for Q4 of last year and down from $12.9 million for Q3 of this year. The year-over-year decrease is a function of lower salary and benefit expenses as well as lower costs incurred in the current quarter attributable to the regulatory process associated with the VersaBank's proposed acquisition of the U.S. financial institution. The sequential decrease was due primarily to certain costs specific to Q3 that were not repeated in Q4. Consolidated net income for Q4 increased 94% year-over-year and 25% sequentially to $12.5 million. Consolidated earnings per share for Q4 increased 104% year-over-year and 24% sequentially to another record $0.47, benefiting in part from a lower number of shares outstanding due to our share repurchase program. During the 2023 fiscal year, repurchasing canceled over 1.3 million common shares, bringing the total number of shares purchased as of the end of fiscal 2023 to just over 1.5 million. Our Q4 profitability continued to by far contributed to by far the best year in the history of the bank, with fiscal 2023 net income increasing 86% compared to 2022 to $42.2 million, while EPS increased 99% to $1.57. Primary driver of growth in our loan portfolio was once again our point-of-sale financing business, which increased 30% year-over-year and 4% sequentially to $2.9 billion. I should note here that the completion of a planned portfolio sale early in the quarter had the effect of reducing quarter-over-quarter PoS financing portfolio growth by approximately 2%. Our point-of-sale portfolio represented 75% of our total loan portfolio at the end of Q4, down just slightly from Q3 of this year. Our commercial real estate portfolio expanded 24% year-over-year and 10% sequentially to $898 million at the end of Q4. This increase was due primarily to increased loan origination activity in select markets that are aligned with the bank's concerted loan origination strategy in this space. I should note here that our commercial portfolio is 90% composed of loans and mortgages, which are financing residential properties, predominantly multiunit in nature, and we continue to have very little exposure to commercial use properties. Turning to the income statement for our digital banking operations. Net interest margin on loans or that is excluding cash and securities, was 2.69%. That was 34 basis points or 11% lower on a year-over-year basis, but unchanged sequentially. Net interest margin overall, including the impact of cash, securities and other assets decreased 27 basis points year-over-year or 10% and decreased 3 basis points or 1% sequentially to 2.54%. Q4 net interest margin was again dampened by a spike in market rates return deposits relative to the Government of Canada rates during the quarter. And I will note that despite some volatility in term deposit rates over the course of the year, net interest margin was essentially in line with that of last year. Noninterest expenses for digital banking for Q4 were $11.4 million, down slightly from $11.5 million for Q4 last year and up from $10.8 million for Q3 of this year. The sequential increase was a function primarily of higher fees related to intercompany technology and cybersecurity services, which were disproportionately high in Q4 and are expected to return to normalized levels in Q1 of fiscal 2024. Cost of funds for Q4 was 3.86%, up 141 basis points year-over-year and up 24 basis points sequentially. The bulk of the year-over-year increase is a result of the higher interest rate environment, although the increase in our cost of funds since the Bank of Canada began increasing its benchmark rate at the beginning of fiscal 2021 remains significantly below the policy rate increase of 475 basis points. Cost of funds were somewhat elevated in Q4 due to the spike in market rates for term deposits, as previously discussed. Our provision for credit losses or PCLs in Q4 remained very low at just 0.02% of average loans compared with a 12-quarter average of 0.00%. Turning now to DRTC. As a reminder, beginning in Q1 of this year, revenue for DRTC includes income from digital banking operations associated with the delivery of various technology development services in addition to the contribution from our cybersecurity services business, Digital Boundary Group or DBG. Let me start with DBG's stand-alone results. DBG's revenue for Q4 increased 21% year-over-year and 46% sequentially to $3.4 million, driven by continued growth in service engagements. Gross profit increased 50% year-over-year and 45% sequentially to $2.6 million as DBG continues to realize efficiencies in the business. DBG remained profitable on a stand-alone basis within DRTC. Total DRTC revenue, including revenue derived from services provided to digital banking operations increased 108% year-over-year and 83% sequentially to $3.7 million. DRTC's net income of $1.2 million was an improvement over a net loss of $486,000 a year ago and a net loss of $99,000 in Q3 of this year. With that, I would now like to turn the call back to David for some closing remarks. Dave?

Thank you, Shawn. Those of you who read the entirety of our news release this morning will know that with the conclusion of fiscal 2023, we are undertaking a strategic realignment of certain roles within our senior management team to ensure we're prepared to move forward immediately and aggressively should we receive the relevant regulatory approvals to broadly launch our RPP financing solution in the United States. My partner on these calls for the last several years, Shawn Clarke, will move from his current role of CFO to the newly created role of Chief Operating Officer. During his decade and a half with VersaBank, Shawn has made tremendous contributions to our growth and success in a variety of capacity, including roles in corporate development, technology, risk and of course, finance, including holding the titles of Chief Risk Officer, Senior Vice President, Operations; as well as Chief Operating Officer of a subsidiary of the bank. In addition to his normal course CFO duties over the course of the past years, he has been integral to the development of the business plan and the implementation of the strategy for the RPP in the United States as well as the U.S. regulatory approval process. As COO, he will help lead our charge into United States. Taking on the CFO role will be John Asma, who has served as our Treasurer for the past 1.5 years and who previously served in a variety of senior executive roles with the bank, including Senior Vice President and Treasurer, Senior Vice President, Structured Finance and Treasurer, Senior Vice President, Credit and Treasurer. In his recent tenure as Treasurer, John has been instrumental in enhancing our return on treasury balances as well further mitigating risk and enhancing liquidity as well as expanding our base of business development. John's financial acumen and discipline will serve the bank well as we increasingly realize the operating leverage of our business. Finally, Chintan Shah who has been a valuable member of our treasury team for the last 2.5 years, most recently as Assistant Treasurer, will become Treasurer. Chintan has spent the majority of his career in the treasury function and has worked closely with John towards that group's many accomplishments over the past several years. I have the utmost confidence in his ability to take on the bank's treasury role and continue to drive the success of this critical aspect of our business. 2023 was by far the best year in the history of our bank. It is demonstrative of the execution of the plan that I put in place years ago with the recognition that technology could be used efficiently to address underserved banking markets, leveraging intermediaries to limit costs and mitigate risk and drive outsized returns on common equity and value for our shareholders. It marks a new chapter in the evolution of our growth trajectory. As we look ahead into 2024, we remain comfortable with our highly stable, low-cost funding sources, very sticky deposits derived through our wealth management partners, all of which are term deposits and our low-cost bankruptcy trustee partners. Each has excellent visibility into deposit maturities with very limited risk on expected to withdrawal. I will note here that we may see some fluctuations in our net interest margin in 2024 based on cost of funds. As Shawn noted earlier, net interest margin and in turn revenue were again this quarter dampened by a period of elevated rates in the term deposit receipt market. It appears to be the function of a continuing uncertainty around the banking sector in North America, which has an impact on smaller banks. Therefore, it may be the case that we see more volatility going forward. All other things being equal, we expect interest margin for the year to be in the range of this year's standard. The number will depend to some degree on the success of our continuing effort to add low-cost funding sources as well as the low capital requirement opportunities we might pursue that would drive return on equity, but dampen net interest margin. Importantly, with the momentum and the efficiency of the business and the fluctuations in interest margin, will only have a small impact on our profitability. And I will note here that we continue to have by far the largest net interest margin among the publicly traded banks in Canada. In terms of insolvency deposits, as expected, recent data shows consumer insolvency is up 26%, and business insolvency is up 42% compared to last year. This increased activity should drive the continued expansion of our low-cost deposits and of course, will support net interest margin. Should we receive the regulatory approvals that enable us to broadly roll out the RPP in the United States, we are well prepared to begin the low-cost deposit taking in U.S. dollars to fund that program. Last quarter, I discussed our near-term asset milestones and how we reach those milestones, we'll increasingly benefit from the inherent operating leverage of our business. Having surpassed the $4 billion milestone in the fourth quarter of 2023, we are now focused on our next milestone, $5 billion, and the additional outsized growth and efficiency, profitability and return on equity that our model will generate. That $5 billion milestone represents 19% growth from the $4.2 billion as of the end of fiscal 2023. As I noted earlier, during 2023, we grew assets by 29%, driven primarily by our point-of-sale receivable purchase program business. Accordingly, we expect to achieve this next milestone during 2024 calendar year based on just the continued growth of our existing business, as always, barring any major unexpected economic shocks. We are seeing some signs of potential slowdown in the broader economy due to the current interest rate environment. However, we are seeing resiliency in the sectors in which we participate, hence our confidence in the outlook for next year. Should we receive regulatory approval for our U.S. acquisition and be able to broadly launch our RPP in 2024, that would present potentially significant incremental growth depending on the timing, and that could push as well past the $5 billion milestone. At the same time, we expect only a modest increase in noninterest expenses for 2024, more or less in line with inflation, excluding any costs that could be related to the closing of our acquisition. And that, by virtue of a simple, straightforward mouth I described in our last call, translates into a disproportionate improvements in efficiency and expansion on our return on equity. Provisions for credit losses should, of course, remain de minimis. The result of our highly mitigated lending practices, in particular, the holdback novel for our point-of-sale receivable purchase program for loans and leases. Finally, we are seeing solid momentum in our cybersecurity services subsidiary, which we expect to continue throughout the next year. Our strong reputation for results, along with increased visibility efforts are driving growth in our client base, while engagement with existing clients expand as they see the unique value we have to offer. As just one example this year, we began working with a major North American financial institution and quickly became one of their top-tier cybersecurity testing partners. This remains a tremendous opportunity in this rapidly growing market, and we expect continued growth and success going forward. To conclude, 2024 is expected to be a year that takes our efficiency, profitability and return on equity to even higher levels, further demonstrating the strength and the scalability of our business model. We will see more of each revenue dollar drop to the bottom line as we continue to mitigate risk throughout every aspect of our business. This is our recipe for delivering sustainable long-term shareholder value. With that, I would like to open the call for questions. Operator?

Thank you. Ladies and gentlemen, we now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of David Feaster from Raymond James.

I just wanted to start on kind of the pulse of the market and the growth outlook. If I'm hearing you correctly, it's great to hear the update of the $5 billion target given the starting point and the growth that you're seeing, it seems obviously pretty achievable. I'm just curious, it sounds like that's exclusive of the Stearns deal. And so I'm just kind of curious kind of how you think about the growth trajectory and the contribution from the U.S. RPP program that you've been rolling out as a part of that.

Well, just purely based on Canada, in the quarter we just completed would have been about 6% prior to the sale of that $64 million portfolio. So we're running in Canada about 6% a quarter. And I don't see any dampening of that. We're planning for a lot of home improvement loans where folks looking for more energy efficient furnaces and other devices to save costs. So it doesn't appear that just the Canadian market will deliver I think much less than, say, about a 25% growth being say, approximately 6 and a bit per quarter. We have got 3 customers now in the United States. And the product is very keenly being thought after. So it looks like despite not having the U.S. banking license, at this point, that will be additional growth on top of the Canadian market. Now we're in a fairly unstable world and as I said in the talk, you could see a shock or 2 and consumers tend to stop buying at that point and cocoon on a little bit. But presently, that's the run rate, 6% or so per quarter in Canada and some further growth in the United States.

Yes. No, that's great. And again, the U.S. license is kind of icing on the cake above that. But could you maybe talk about the loan sale and kind of the drivers behind that, what you sold and kind of what drove that sale?

Yes. Somebody requested the repurchase of receivables that we had recently sold to us due to some internal background requirements. And the actual yield on that portfolio was somewhat anemic compared with the rest of our portfolio. So it made sense from a perspective to increased profitability, and it made sense for them and that they wanted to repatriate their loans that recently put on. So it was a win-win. And we don't do much of that. It was just sort of anomaly somebody asked for it. We looked at the numbers and said, did that makes sense?

Okay. No, that's great. And the CRE growth was a little bit higher, kind of accelerated in the quarter and just kind of reading your commentary and listening to you, it sounds like you're a bit more cautious on the CRE space. I'm curious what drove the kind of the higher pace of growth there? And just how you think about credit quality and underwriting at this point just given the higher rate environment kind of where LTV and debt service is at these higher rates?

Well, the CRE growth was probably just a result of the accelerated construction during the warmer summer months. So it would be just a natural result of the construction loans that we have in place drawing down more rapidly during the summer. My view on the market is that it's one that deserves a lot of caution going into. And we're emphasizing government insured construction mortgages now that is in Canada, there's government's insurance company called CMHC, and they have a wonderful program for ensuring residential construction mortgages. And we're planning in 2024 to take full advantage of that. I don't see much else in 2024, noninsured mortgages, for example, I just assume stay in the comfort of the CMHCs. And additionally, there's a much more favorable risk weighting. The assets are risk-weighted at 0 versus 70%, 100%, 150% on some of the other asset categories. So it's a very efficient use of capital, and we're still providing financing for our customers who are trying to make up the need, the tremendous need for residential units in Canada. You're probably aware, we've had a lot of immigration into Canada. It's a very popular country, but it's created a huge demand for residential units. And our customers are developers that we've been banking, in my case, personally, not 46 years, doing their best to sort of fill that need. And we're thinking the CMHC vehicle is the best way to do that.

That makes sense. And maybe switching gears to DRT Cyber. Nice to see the uptick in revenues and expense control was really impressive. I know there was some timing issues with last quarter. But I'm just curious how the pipeline is trending. You talked about the major win that you had here in the States. But I'm just curious kind of how the pipeline is at DRT Cyber and just how you think about that business going forward?

Well, the pipeline has increased quite significantly in the last while, the month of November, I've just seen the numbers. And it's way up over the last year November. So in the last quarter or so, we've seen kind of a significant increase in demand for our product. I'm not sure why that has made just nervousness of these terrible people out there hacking everybody. And we have a premium product, particularly in the area of penetration testing and app testing. So in the last quarter or so, we saw a big increase, and it looks like it's continuing right on.

How do you think about expansion of that business? I mean, are there any other new products or innovations or just add-on services that you're looking to expand into?

Yes. There's a few that we developed off the shelf that would be RAVEN, our anti-spam software filter. prevents employees in the corporation sending e-mails to those that have gone the unsubscribed list, for example, also it screens incoming spam emails. We like that product. It was in-house development, and we're rolling that one out. We have our machine learning capability that we are actively promoting our customers use. It's the sort of early warning that some hacker is trying to find their way in, give some, as you'd expect, kind of alarm bells that something unusual is taking the system or trying to get our customers to use that. Those that have this test periodically, that's fine, but it would be nice that they also had their system, a big brother looking over at all the time to it. So we've got that product to roll out. There's other products that are right now presently unutilized, that being the VersaVault, using that has tremendous applicability in the digital world. It's tactically, we're keeping that one sort of unoccupied with digital assets while we're in the process of our bank application. I'm expecting sometime in the future, not too distant future, we'll hopefully see the green light on that. And then it might be the DRTC, should become the property of some other entity with a strong relationship for the bank. And then products like VersaVault can come back to life. Right now, it's probably incompatible with the bank. But I'm sure there's other, as a stand-alone company, DRTC, but have quite a bit more value than sitting as a sub of the bank, because then those other products could be utilized.

Absolutely. Terrific. Well, I appreciate the questions.

Well, thank you, David. Look forward to seeing you in the sunny Florida one of these nice days.

Absolutely. It's gorgeous out...

I'm planning to head down there just before Christmas. So hopefully, in the new year, we can catch up.

Let's do it. Thank you.

[Operator Instructions] We have our next question coming from the line of Ian Gillespie.

And congratulations on the quarter, the year and the realignment of management responsibilities, all super initiatives. A couple of questions. One, you referred to the positive interactions with the U.S. regulator. I am curious whether there is extensive back and forth currently? Or are they asking for more information or they have all the information they need and it's just going through their own particular process?

Well, good question, Ian, and thanks, it was quite a vindication of that model, I put together about 30 years ago, seeing it finally unfold and starts to deliver the numbers that should deliver. With respect to your question, there's very little back and forth between us and the U.S. regulators for the last few months, we feel we've answered all the questions they had about our banking business. There's just been some sort of tidy up in the last while of asking about our major shareholder. That's kind of routine, I understand for these types of things where we have a U.S. or we would have a U.S. bank holding company as they are a tidy up questions is nothing changed sort of thing. So for months, we haven't really interacted with the U.S. regulator anything about the bank.

Presumably, you've kept us the up-to-date so that you would be able to pull that trigger as soon as you do receive the go ahead. Do you have to, in any way, renegotiate the deal with Stearns Bank just because of the protracted period of time it's taken?

No, there's no requirement for that. Stearns has been working well with us throughout this longer than we thought recently a period of time. We're both keenly interested in putting the deal to bed and looking forward to other transactions that we can do together. We've got some on the drawing board right now. I expect a wonderful relationship going forward that's starting some. Overall, we're just being patient. I know you were once in the governments in the regulatory world and patience is the virtue that you can use on these things. And if a regulator does want more information, the bank endeavors to provide it, anything it's uncertain afternoon.

And presumably, you wouldn't anticipate any problems with us at this end?

No. No. I think from us is perspective, it just allows us the bank to diversify and grow in a market that's probably is quite conducive to our product. We've got sort of over the last year or so, nothing but positive remarks back. OSFI's of course, doing the job they always do. And I'm sure about this. But further publicly, I can say I've just seen green lights recently.

And last question. Is there currently an approved NCIB or you are kind of holding off on that until you see what happens?

It's on pause. We've submitted the NCIB, but we asked to OSFI to pause it in that we'd like to see the final shape of our capital post closing. And these numbers are fairly I think remarkably significant. I would expect the stock not to stay, maybe I'm doing optimistic. A 3/4 of books, it was a bargain and obviously, Turbocharge star ratings, APS, we got almost a double. But I can't imagine that, that sort of bargain state not much longer with the kind of numbers we're posting.

Well, that's great, David. You're starting to sound more and more like one of those greedy bankers. All I can say is keep up the good work.

Yes. I don't apologize for that, while I got my banker hat on. But yesterday, we were at the Salvation Army giving some back. Of course, it's Christmas time, and we're doing our part there, too.

Yes and…

Yesterday. But today, I've got it squarely on my head...

Thank you. This concludes our Q&A session. I'd now like to turn the call back over to Mr. Taylor for final closing remarks.

Well, I'd like to thank everybody for listening in and the good questions I received. I wish you all Merry Christmas and the happy holidays. Stay safe, and look forward to talking to you at the end of Q1. Hopefully, we have more good news to share. And should you have any questions in the meantime, we're just an email away. We're happy to answer questions on the slide to again, happy holidays, as long. Thank you.

Thank you then. 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.