VersaBank (VBNK) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the VersaBank Fourth Quarter and Fiscal Year 2024 Financial Results Conference Call. This morning, VersaBank issued a news release reporting its financial results for the fourth quarter and year ended October 31, 2024. That news release along financial statements, MD&A and supplemental financial information are available on the bank's website in the Investor Relations section as well as on SEDAR+ and EDGAR [Operator Instructions] 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 Asma. 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 our preparation for and completion of the closing of our U.S. Bank acquisition on August 30. 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 3 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 onetime noninterest 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 ramps 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 U.S. 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 put backs of loans that have gone 90 days in arrears to our partners due to higher defaults among the borrowers as could be expected, in these tougher economic times. As we've made hold -- as we're made hold on these loans through our cash flowbacks, this higher rate of put backs to our partners has no impact on our provisioning for credit losses, which for Q4 as it always is, de minimis. Noninterest expenses were a typically high due to onetime 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 our U.S. bank -- with the addition of the U.S. bank expenses, including the new leadership team. As it has been for nearly 2 years, net interest margin was dampened by the typically inverted yield curve which lowers our margin as we raised deposits from the short end of the curve and lend further out on the curve. We are now seeing yield curve flattened and are very encouraged by this trend. Net interest margin was also impacted by the onetimes noted above. We feel good about the direction of our NIM in 2025, especially as we start to add U.S. RPP loans where we expect to realize a meaningfully higher spread. For the year, we generated record net income, excluding the onetime 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 I will 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 MD&A for the fourth quarter and full year are available on our website under the Investors section as well as on SEDAR 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 onetime items mostly related to the U.S. bank acquisition that impacted the fourth quarter and the full year results. A number of onetime noninterest 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 USD 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 noninterest income from the bank cybersecurity operations DRTC, but was also impacted by higher cash assets associated with the funding of the U.S. bank. Consolidated noninterest 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 onetime costs that were mostly associated with U.S. bank acquisition. The $3.3 million brought total acquisition-related onetime costs for the year to $3.7 million. As a reminder, DRT expenses -- DRT Cyber expenses are included in our consolidated NIEs and totaled $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 onetime NIEs and other onetime 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 30 now consist 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 little -- or had limited, although positive comp contribution. Our loan portfolio grew to a new record of $4.24 million (sic) [ $4.24 billion ] 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 a higher amount of put backs. 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 are -- 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 real estate properties -- sorry, 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 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 onetime impacts for 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 $0.30 -- $0.36 a share. And net income for the U.S. banking operations, which for the quarter includes the contribution of only the acquired Stearns Holdingford Bank operations was $0.5 million 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 this forecasts. 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 0 risk-weighted loans for requiring no capital and delivering a very nice spread. We also expect to see a continuation of several favorable trends that support net interest margin. 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 the U.S. RPP opportunity. We're in the process of moving our first U.S. partners from our pilot program to VersaBank 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 companies who finance big ticket and services at the point of sale. To support we expect the very active ramp-up 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 Kristo, appointed Chief Credit Officer for the U.S., Mike Dixon appointed SVP RPP in the U.S. 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 U.S., who has been integral to the program for last 7 years, are responsible for 27% compounded annual growth rate over the last 5 years, more than $9 billion in financings for point-of-sale lenders and of course, no losses. They joined a formidable team whose collective experience and expertise will be invaluable as we scale up the U.S. RPP program in the multitrillion dollar US point-of-sale market. As a reminder, overall, we expect our U.S. RPP business to benefit from even greater efficiencies than we achieve in Canada due to 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 Thoms as SVP point-of-sale financing, VersaBank Canada; and Saad Inam, Chief Credit Officer, VersaBank 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 our RPP loans to other U.S. banks. Under this bottle, 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 expecting 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 gained 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 develop 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 we will -- it will mean for our made in America solution. Our digital deposit receipts are on Algorand, Ethereum and Stellar blockchains and our SOC 2 Type 1 compliant using VersaVault. With that, I'd like to open the call to questions. Operator?

[Operator Instructions] And your first question will be from Tim Switzer at KBW.

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 kind of 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 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 working, hopefully, it is quickly as they can to put out one to bed. With respect to additional partners, this has been about 30 or so that we've been talking to. And I think the constraint has been how fast we're going to be able to do the paperwork to sign them up.

Okay. Great. And 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 pick up?

Well, it's sort of quantum jumps in growth, depending on how fast we sign up the partners. Right now, we're looking to have on balance sheet about $250 million by the end of the year. And that would be sharing at least 50% with other banks. So in total, assets under 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 the next year. Once we exclude some of the onetimers 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?

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

Next question will be from David Feaster at Raymond James.

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

Well, we've built it. It's called AMS 3.0, that's short for asset management system 3.0. 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 of that we've retained on our balance sheet and our partnership retain. So that's all set to go. The -- we're just waiting for the -- finalizing the 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 -- and 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. That I think United States to be quite similar to what we experienced in Canada, about 50% of our point-of-sale portfolio is home improvement.

Okay. And then last one for me. On the -- you talked about 100 basis point better spread in the state. Do you see more opportunity? Is that on the funding side? Or is it on the loan yield side? And then just kind of to the funding side, you touched on the election and the potential tailwinds maybe for some -- from digital currencies. Curious if there's any interest in bringing back CAD V 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 spreads. So it's both on the yield and on the funding side. With respect to DRTC's technology that we announced about 4 years ago, we're quite proud of it. We have what we call VUSD and VCAD, our digital deposit receipts on Algorand, Stellar and Ethereum. And we had a SOC 2 reviewed and obtained SOC 2 Type 1 rating. So that technology is all set to go. But as Paul Masson -- as 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 appoint -- or pending appointees and it looks like a favorable environment for digital and 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 we're -- DRT 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 DRT Cyber could provide that service to other small banks, community banks that don't have this -- the wonderful access we do to very cheap funding. So it would 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 put backs to your partners in Canada. And we're really validating your business model, 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, [ touch wood ], they've all been able to do that. We tend to pick the strongest point-of-sale partners we can. And they've been dealing with it. It's sort of the inevitable downturn some people in Canada are calling a recession. And considering our trustee deposits have increased by 20% year-over-year. That's a big number for -- I mean it's a 20% increase in bankruptcies. We probably are in a bit of a recession. But our partners have stood up seem to be fine. They're all sort of eagerly awaiting perhaps a jumbo decrease in the overnight rates at Bank of Canada that's -- that might be announced on Wednesday. So generally speaking, our model has held up wonderfully and it's a slow growth. With a record high put backs 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 is good news for the Canadian economy.

[Operator Instructions] Next question will be from Andrew Scutt at ROTH Capital Partners.

First one for me. You guys saw a return of growth in your CRE portfolio. I know you guys been recently kind of rightsizing 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 the CMHC portfolio?

Absolutely. So this portfolio has almost all composed of loans on residential properties. And there's 2 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 will 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 of around 60% on these. We have pivoted over to CMHC insured construction mortgages. And these are wonderful in that they are 0% risk weighted, so don't absorb any CET1 capital and match really nicely against our floating rate trustee deposits. On average, we pay about a prime minus 285 on those. And we are maybe prime-minus 20 on the CMHC. So we're making about 265 basis point spread on a 0 risk-weighted asset, an no capital required. That's the portfolio that John talked about that we have a $600 million right now in 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 hardly any risk because the government insured and get a really good rate of return.

Great. And then second one for me. You've kind of expanded on this earlier. But as you look out into 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, but -- or not all of it is 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 pending 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 asset or deposit held by somebody else and an actual digital positive receipt, which represents the deposits held by a real bank. And we developed this technology about 4 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 and e-wallets and such and transact business in almost negligible fees, and almost instantaneous. It's state-of-the-art payment vehicle, state-of-the deposits. For example, say you bought Bitcoin point of $1,000 and you see it at $100, and you like to swap it into a bank deposit. Well, that can be done seamlessly in your e-wallet with our VUSD product or VCAD [ courtesy ] of our technology and our VersaVault. And I think time is right. So I was quoting George Orwell a back saying, no wine before it's time. And that's why we just didn't promote it or it just kept on the shelf because the regulatory environment had to mature and regulators had to get the rules in place. And 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 the service for DRTC to provide. And pretty excited about it. I think it's something that a lot of community banks will want to take us up on.

All right, yes, that sounds like a wonderful opportunity. Congrats on the growth.

[Operator Instructions] And at this time, Mr. Taylor, we have no other questions. Please proceed.

All right. 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 your conference call for today. Once again, thank you for attending. And at this time, we ask that you please disconnect your lines.