VersaBank (VBNK) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to VersaBank's Third Quarter Fiscal 2026 Financial Results Conference Call. This morning, VersaBank issued a news release reporting its financial results for the third quarter ended July 31, 2026. 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 SEDAR and EDGAR. Please note, in addition to the telephone dial-in, VersaBank is webcasting this morning's conference call. [Operator Instructions]. 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 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, Founder and President of VersaBank. Please go ahead, Mr. Taylor.

Good morning, everyone, and thank you for joining us for today's call. With me again is our Global Chief Financial Officer, Nicolas Ospina. And for the first time, Lawrence Chamberlain, our new global SVP, Investor Stakeholder Relations, who joined us full time in August after working for us on a consulting basis for the last 6 years or so. As expected, fiscal 2026 has continued to be a breakout year in terms of top line growth. The third quarter once again saw new records for credit assets, revenue and net interest income with a very strong year-over-year growth. This was once again driven mainly by the momentum in our structured receivable front. In the United States, in fact, our U.S. operations generated nearly 25% of Q3's digital banking revenue. But notably, we have continued to see steady growth in Canada as we continue to increase business with our existing partners and expand our market share. And I am very pleased to report that subsequent to quarter end, for the first time, we surpassed $7 billion in total assets. And in fact, as of yesterday, we were at $7.2 billion. That's up nearly $5 billion over the past 5 years for a compounded annual growth rate of more than 25%. With this year's strong growth, we are increasingly realizing the operating leverage of our cloud-based branchless business-to-business model. with year-over-year increases in net income and adjusted or foreign net income of 53% and 27%, respectively. I will once again note that we achieved these metrics with significantly higher than typical levels of liquidity at this early point to our expansion in the United States, although these are steadily moving back to more historic levels. That said, it was another noisy quarter in terms of costs with the number of items, which total over $4.6 million that are not part of our go-forward cost structure in 2027. These included noncore costs of $3.1 million, which was composed mainly of an additional $2.5 million and reorganization cost that we noted on our last call. There were also $1.5 million in transitory or cost that is cost that we did not adjust for, but that were specific to Q3, as well as $0.8 million related to share compensation resulting from the increase in share value. Nico will go into these in more detail in a few minutes. Looking ahead, as I will discuss a little bit, we expect the broader implementation of AI throughout our organization will not only increase our efficiency, but create significant opportunities for meaningful cost savings going forward. Finally, on the Q3 results, as I have discussed in the past, our net interest margin can vary from quarter to quarter and we saw that somewhat in the third quarter. Much of this is due to the higher than typical liquidity levels, and we, therefore, expect NIM to trend back to the 2.3% range going forward. Of course, we will continue to benefit from more cheaper deposits through increased activity in our insolvency professional business. In Canada, we recently saw that deposit base reach 1 billion for the first time as we both expand that business and insolvencies in Canada continue to increase. More specifically, the SRP business in the United States, we continue to steadily build momentum during Q3 with increased business from our existing U.S. partners to have the addition of new partners. Q3 saw another $220 million in new fundings with a subsequent $127 million since the end of Q3. That brings us to more than $72 million in new fundings year-to-date as of today. Q3 saw the initial contribution from our most recently added SRP partner in the United States another wholly owned subsidiary of ECN Capital. This latest partner is expected to contribute at least $300 million in additional US SRP funding annually, but both we and our partner believes the program could go well beyond USD 500 million per year-end funding. I will note, again, this quarter, the vast majority of additional fundings in the U.S. were through our original more profitable SRP as demand for our core solutions continues to exceed our expectations. Our growth in the United States continues to prove out the efficiency of our U.S. operations with an efficiency ratio, excluding noncore write-off associated with the branch sale for Q3 up 37%, and we continue to remain on track for our year-end goal to be in the low 20s. Clearly, as expected, SRP has rapidly taken its rightful place as a uniquely attractive alternative funding option for point-of-sale finance companies in the United States, reliable efficient, economical, all benefits of our proprietary technology. During the quarter, we took the value proposition of our SRP to an entirely new level with the launch of an AI-enabled real-time version of SRP which enable our partners to finance their loans with even more efficiency, cost effectiveness with lower risk, instead of our partners having to accumulate warehouse and batch or loans over a period of time, typically as much as 30 days or more, these loans can now be funded individually as they are made. This effectively eliminates the need for our partners to warehouse multiple receivables over a period of time. That is they can finance individual loans within just hours reducing the overall financing cost and the need for warehouse financing. The cost savings and lower equity requirements are significant, and it eliminates the interest rate risk that our partners are exposed to during the warehousing period. During the quarter, following a successful pilot program, one of our largest SRP partners finance it became the first to implement our real-time SRP in Canada. And I'm pleased to report that earlier this week, ECN Capital one of our first U.S. SRP partners became the first to implement real-time program in the United States. Feedback on our real-time solution has been overwhelmingly positive, and we are seeing considerable incremental demand from both existing and prospective new partners. Including in Canada, where we believe it will generate significant incremental growth to the solid performance we are achieving this year. but to ensure we are fully maximizing this opportunity and doing so rapidly as possible. We are privileged to have point-of-sale financing industry veteran, Modes, rejoined First Bank as part of our SRP team. With a particular focus on specialized large partner opportunities for our real-time SRP in the United States market. [indiscernible] has had a very busy first 1.5 months and has initiated discussions with numerous new prospect partners. With that, I'd now like to turn the call over to Nico to review our financial results in detail. Nico?

Thanks, David. Before I begin, I will remind you that our full financial statements and MD&A for the third quarter are available on our website under the Investors section as well as on SEDAR and [indiscernible] all the following numbers are reported in Canadian dollars are per our financial statements unless otherwise noted. Starting with our balance sheet. Total assets at the end of the third quarter of fiscal 2026 grew 26% year-over-year and 7% sequentially to a new high of just under $6.9 billion. Cash and securities was $624 million or 9% of total assets, down slightly compared to the end of Q2 2026. I and I will reiterate here, David's earlier comment about this number still being higher than our historical levels of around 7% as a result of our entry into the United States. Book value per share increased to another record of $17.45. Our CET1 ratio was 11.5% and our leverage ratio was 7.6% and both down meaningful year-over-year and remaining comfortably above our internal targets. The year-over-year change is mainly due to putting capital to work for growth in the U.S. SRP portfolio following our capital raise in December 2024. Our strong growth in assets drove total consolidated revenue to a record of $38.8 million up 23% year-over-year and 1% sequentially. Noninterest expenses or NIEs for Q3 were $25.2 million. As David noted, NIEs for Q3 included $3.1 million in noncore expenses, $2.5 million of additional costs related to the reorganization project and $0.6 million for the write-off of capitalized software costs following the sale of our sole physical branch on May 1 of this year. Consolidated NIE, excluding the onetime costs were $22.1 million compared to $17.4 million in Q3 last year and $20.8 million for Q2. As David also noted, Q3 included approximately $2.3 million pretax in additional transitory costs that are not part of our run rate cost structure. This was composed of $0.8 million in share-based long-term incentive award driven by the bank's strong share price performance during the quarter. as well as $1.5 million in other transitory costs that were specific to the quarter, and the bank does not expect to recur. And as a reminder, the RTC cyber expenses are included in the consolidated and totaled $2.6 million in Q3, more or less in line with last year. Reported net income was $10.1 million year-over-year increase of 53% and from $6.6 million for the third quarter last year. And consolidated earnings per share was $0.31 compared to $0.20 last year. Excluding the $3.1 million noncore NIEs I mentioned earlier, consolidated adjusted net income was $12.3 million or $0.38 per share, with adjusted net income increasing 27% year-over-year. Again, that number includes $8 million pretax in share-based compensation resulting from our share appreciation and our transitory cost of $1.5 million pretax. Looking at our income statement on a segmented basis, revenue for the Canadian digital banking operation was $27.6 million, up 4% year-over-year. I will remind you that our bank corporate expenses flow to our Canadian Banking segment. And as a result, reported net income include those reorganizational costs. Canadian Banking net income for Q3 was $6.6 million. However, that number is dampened by the $1.8 million after-tax impact of the onetime costs associated with the reorganization. Revenue for our U.S. banking operations was $9.3 million, up 18% sequentially and 199% year-over-year, primarily due to the ramp-up in the U.S. SRP. That drove a 10% increase in net income sequentially and an 803% increase year-over-year to $3.9 million as we see the U.S. operating leverage take effect. Q3 net income was impacted by $400,000 after-tax costs related to a software write-off resulting from the sale of the branch I described earlier. Digital Media net income was $114,000 compared with net income of $23,000 for the third quarter last year and net income of $351,000 for the second quarter. Within DRTC, the cybersecurity service component generated revenue of $1.9 million with net loss of $578,000 pretty much in line with last quarter. Our credit asset portfolio grew a new record just shy of $6.2 billion at the end of Q3, driven once again by our structured receivable program which increased 40% year-over-year and 11% sequentially to $5.2 billion. Our SRP portfolio represented 85% of our total credit assets at the end of Q3, up from 82% in Q2. Our multifamily residential loans and other portfolio decreased 10% year-over-year and 5% sequentially to $934 million as we continue to strategically transition to more higher yield higher risk-weighted uninsured loans to lower year lower risk-weighted insured loans. As a reminder, our MRO portfolio is primarily business-to-business mortgages and construction loans for residential properties we have almost no exposure to commercial use properties. Now turning to the income statement. Our digital banking operations, net interest margin on credit assets that is excluding cash and securities was 2.44%. That represented a decrease of 11 basis points year-over-year and 27 basis points sequentially. Although I will remind you that our Q2 NIM is typically the highest of the year due to normal seasonality. The increase in NIM reflect higher than typical GIC term deposit rates relative to government of Canada bond yields, the replacement of retail deposit with broker deposits resulting from the sale of the bank only physical branch in the U.S. as well as our decision to maintain greater liquidity amid a challenging Canadian economy. It also reflects lower traded asset yields in Canada due to a shift in our grade asset mix resulting from the continued growth in our SRP portfolio as well as our strategic shift in our Enbrel loans I just mentioned. Overall NIM, including the impact of cash, securities and other assets, was 2.9%, a decrease of 6 basis points year-over-year and 14 basis points sequentially for the same reason I noted above. Our NIM still remains amongst the highest of the publicly traded Canadian Terry licensed banks. Finally, our provision for credit losses in Q3 continue to be the minimum as a percentage of our credit assets and in fact, was negative at 0.02% and meaning we had a recovery of credit losses during the quarter. This compares to a positive 0.03% from Q2 with the recovery primarily due to a sale of the brand assets to stores and updates in the forward-looking information used by the bank in its credit risk models. I would now like to turn the call back to edit for some closing remarks. David?

Thanks, Nico. As I noted earlier, just till 2026 has been a breakout year in terms of top line growth, which is expected to further accelerate next year based on both the continued expansion of our SRP in the United States as well as this year's introduction of our revolutionary real-time SRP. Fiscal 2027, however, will be the year when the true power of our model in terms of both growth and operating leverage comes into focus for our investors. In fact, we are seeing so much near-term demand for our core SRP that during the third quarter, we made the decision to at least in the short term, limit the amount of funding through our lower spread purchased securitized SRP. It's simply a more efficient and more profitable use of capital. You will recall that in the fourth quarter call last year, we estimated that fiscal 2026 SRP fundings in the United States would be composed of roughly 60% of our profitable core FRP and 40% would be our lower spread purchased securitized SRP. As of today, that ratio stands at 90% core SRP and just 10% securitized SRP. That translates to around $650 million in core SRP year to date with well in excess of the $600 million represented by our 60% of our target $1 billion. As a result of limiting our purchase to securitize Corp, we are now anticipate that we will reach our $1 billion target of additional fundings since October of last year, sometime before the calendar year-end. This positions us very well for our new U.S. SRP target, at least USD 3 billion in additional fundings in the United States in fiscal 2027. That's the equivalent of more than CAD 4 billion and alone represents 60% growth in our credit asset portfolio. Two important points here. One, we believe there is significant potential upside to our target of $3 billion in additional U.S. fundings. The demand there, especially with the addition of our real-time enhancement; and two, we believe our real-time enhancement will accelerate growth in Canada through both additional business with our existing partners and the addition of new partners. In fact, we believe that the growth in our Canadian operations will continue to lead the Canadian banking industry and significantly outpaced growth this year. The operating leverage benefits of [indiscernible] are enormous, of course. The other side of the operating leverage equation is cost. Like Q3, fiscal 2026 on hold has been a noisy year in this respect. Not only have we had costs associated with the reorganization, as I noted earlier, we have incurred significant costs during the transition that we do not expect to repeat going forward. Even with these expected growth at most, we think our core noninterest expenses will be in line with this year. excluding the $10 million costs associated with the portion of DRTC, we plan to divest to even further capitalize on our operating leverage, we are undertaking the numerous AI-based initiatives across the broader organization to drive even greater efficiency as we grow while further strengthening our risk profile. As a fully digital bank with our own proprietary core banking software, we are well positioned to realize significant benefits from increased implementation of AI. Our opportunities in the rapidly developing digital asset industry continue to come into focus. Both stable coins and bank-issued [indiscernible] deposits are gaining widespread acceptance and the ecosystem is taking shape. As this early stage for the industry, we are being deliberately thoughtful and prudent in our approach to these opportunities with a focus on long-term value. With our unique and proprietary technology that has been consistently validated by other leaders in the industry further strengthened by our status as a federally licensed bank in both the United States and Canada, we are very well positioned to capitalize on this revolution in the banking and payment systems. Before I open the call to questions, a quick update on our reorganization. The week after next, we will hold a special meeting of our shareholders to vote on and approve the reorg for which our Board has unanimously recommended shareholders vote in favor. The materials associated with the special meeting are available on our website. In parallel, we are preparing to request the requisite regulatory approvals, specifically from the Fed in the United States and the Ministry of Finance in Canada. Our target, subject to these approvals is to have the reorganization completed by the end of October 2026. I will note here that we expect to incur an additional roughly $4 million in noncore costs related to the reorganization in the fourth quarter of this year. We expect the realignment of our corporate structure to a standard U.S. bank framework to drive meaningful additional value for our shareholders as we align our structure and financial reporting to those with which global investment community are more familiar, potential future stock index inclusion and improved access to capital if needed. To further accelerate our growth as well as significant cost savings. And finally, on the topic of divestiture of fiber security business, we had been looking at some additional potential alternatives to meet the best requirement that we divest this business by September of this year. Last quarter, we asked the Fed for an extension. That was granted last week, such that we have now until August 30 of next year to exit. We are proceeding accordingly. And with that, I would like to open the call to questions. Operator?

Our first question comes from Joe Yanchunis from Raymond James.

Good morning. So in your prepared remarks, you said the NIM should trend back towards 2.3% kind of range as liquidity normalizes. What you need to have happened for that to occur? And how much of that recovery is driven by lower liquidity, better deposit mix or stronger SRP yields? And are you expecting that the NIM to return to those levels in the fourth quarter?

Yes. Joe, the liquidity, we've been maintaining, of course, it was partly due to our beginning operations in the United States. So we just are prudent to maintain a lot more cash. And with the with some anomaly happening in Canada with our deposit rates increasing to about 70 basis points over the same term government [indiscernible]. That means the liquidity actually cost us a few basis points, maybe 10%, 15% negative. And now that we're well established in the United States, we can bring our liquidity levels back down to around 5%, 5.5%, which means we won't be losing money on liquidity. In the past, we didn't actually lose money in liquid. We actually made a few basis points. So it's important for us to get it down. And with respect to timing, gee, we're growing so rapidly now. We put on about $300 million since the end of the quarter, July 31, at we're up to $7.2 billion right now. from what was 6.9% or so. Nico? Yes. So it's coming on fast and furious. And those are high-yielding traditional SRP rather than the purchased once where we only made it maybe 80, 90 basis points on our homegrown SRPs, we make about 250 or so. So I'd say NIM will get back to around 230 for next quarter and the rest of the year. for the Canadian listeners, we're still about 50% better NIM than the entire banking industry in Canada, and it's even better than that. And that most of the banking industry all banking industry is providing extraordinary expected loss provisions. And you might note that ours is averaging close to 0, it was 2 basis points the last fall. So not only do we have the widest margin in the country by far, where we get nothing back for loan losses either. So while we're obsessing on NIM, a space that we're incredible in the country where most of our assets are situated. It gets better in the States because that anomaly over risk-free rate in the state is only 10, 15 basis points over U.S. treasuries. So as we start booking assets in the states, as we're predicting at least $3 billion more going on to [indiscernible] just gets better and better. It's sort of amazing I know the markets kind of missed it, but we have revolutionized the $1 trillion aspect security market by bringing on this real-time purchase program. We not only do our clients get their money back right away not happen to wait 60, 90 days to package up and pay accountants, investment bankers and lawyers. They also run a huge interest rate risk while they're doing this, and rates move up, that means their portfolio dropped. With us, they get locked the rate in virtually in 10 minutes. One big firm said to me once a day, it would be great, Dave. So I mean, I kind of find an odd that we're obsessing on like a few basis points in margin. We just brought something out that renders the traditional aspect security method obsolete. It's interesting that, that seems to be missed. But however, it's always the case where an innovator, you bring something out brand-new and folks take a while to catch up. When I came out with a branchless bank model in 1993, it really told me that was impossible and couldn't be done in everyone else. And here we are again with the adoption of to this traditional ABS market and revolutionizing it, which you think that's what you'd be looking at. I guess it's when the horse and buggy came out horse and buggies were means of transportation, someone came out with their own mobile. It was still folks that needed to have versus and by a and stuff like that to keep going until full icon. Sort of a long-winded one there, Joe.

I appreciate the color there. But I just wanted to drill down on the expected growth in fiscal '27. So you're expecting at least $3 billion of growth in the U.S., which would effectively take you to $4 billion exiting the next fiscal year. So how much of that target is already effectively spoken for through existing partners like finance at CN? And how much is still dependent on signing new partners?

I'd say about half through the existing and the other half of prospects that we're already talking to. And I've doubled the size of the team in the United States than the SRP team the addition of more [indiscernible] and Luke. So more hands at the pump, and I may add another to it also, it's a huge market in the United States, and the center we got on the books, the better. I mean if you look at $3 billion to, say, 250 basis point spread and used an effective tax rate of about 25%. That's about $1.75 a share increase in U.S. dollars that we just put out there. That's just the United States and Canada might be able to do the same that's hedged my bet, call it, Canadian dollars. Because our existing partners in Cana, including finance it on some of the huge ones, I mean, they're signed up as fast as they can to get real time working for them. So saying they want to run interest rate risk. Why should you and they'll have to get the money back right away. And because of our borrowing, they don't have to have an onerous sort of debt-to-equity ratio to contend with and get their capital back faster, there are we going through the roof. The element interest just -- sorry -- when I say revolutionary, that's what [indiscernible] said when he was I was receiving this undeserved award for a Canadian financial executive of the year. Most said, this is a revolution to the industry. So I'd say you're coming back on board, right? Yes, it's great. And I may bring another team into but -- so [indiscernible] $3 billion in the United States additional and maybe another CAD 3 billion just from our existing partners. And there's a few more just signed up, I think, 2 or 3 more to sign up in Canada, too.

I mean you're talking about truly explosive growth here. At what point does additional capital become necessary to support this runway?

Well, if we get our dream come true, we'll be risk weighting our homegrown aspect securities the same as if we had purchased them under the new Basel III rules, which is 20%. At that -- if we can get that done, I hired a guy to make that happen, [indiscernible], it used to be with bank analyst at KBW has come on board for that mission. If we can get that put to bed, which is quite realistic and figure in Basel III allows for it. And why would you homegrown ABS' be risk way different and why the purchase from somebody else or once we sold to somebody else. So then we're a 20% risk weighted. And then there's no need for any more capital. At that point, we're generating capital at a fast and furious rig. And we self-fund some investment bankers. Although it is a trillion-dollar market. So with that, maybe we'll be back. We're already looking at 1% of a $1 trillion dollar market in the near time -- near future for $10 billion. But I can't see anybody using anything else than what we've got on the table. Why run those monster risks with interest rates. And why not get your money back in your pocket. Why not give your shareholders some of their money back? You don't need all the equity that you've got spurring business the same rents. So that would be dreaming in Technicolor, but I have heard to guy, and we are underway with that. And Basel III did change and it did allow for it. And it makes sense. I mean, why would a regulator want let your risk weight your asset of 20% just because you bought it from somebody else, when it's identical to the one you've homegrown. All right.

Our next question comes from Tim Switzer from KBW.

Go ahead, Tim. We're here in the fog in Canada here. I've got an eco beside me here, he traveled all the way up from St. Pete's to find it just as foggy and steamy and hot here in Canada.

Lucky you, Nico. A quick follow-up on your comment about the risk weighting here. What's the process like for getting a lower risk weighting on your RPP loans? And like is there any time line on when you think you can get approval for that?

Well, I'm guessing sometime mid-2027 our [indiscernible] program would be in place. That would be the assets that we have are risk weighed the same as those that we would purchase. It would go through -- we make a presentation to OCC to have our assets risk-weighted in that fashion. So I'm [indiscernible] mid-2027. There are some phases in between where we can probably get most of that effect on a lot sooner. There are methods in Canada, in particular, to employ kind of an insurance policy on your assets and get a much lower risk weighting. Other banks have already done and news. So the regulators who are familiar with it. And then there are some companies that our approach so that would take the B tranche on their own books. And that's already gone through the regulatory works and been improved. So the dog went to having the Holy Grail is maybe mid 2027. I hope it's sooner, if you like a real good guy in the job June you listened. And the other phases, the first one on the insurance, maybe I'll get that in a bit sooner if I got a month or 2 from now.

Okay. Interesting. And then your comment about 2027 core expenses should be in line with this year. Just given all the one-timers and transitory costs, what's the base we should be using for 2027? Or like if you can provide a dollar range, that would be helpful.

On 19.8% or something like that.

19.8%. This is kind of like the run rate that we have right now, Tim.

Can you repeat that?

19.8, Tim. The other thing I keep them back to remind us as we put it out there, we fully endorse AI in this bank. And of course, it was really easy for us as we all tech anyway. And there's a lot of savings coming. I mean, obviously, just demonstrating what we can do with AI on the real-time purchase program that phenomenal. And there's lots of other areas are back that are our team is looking to using AI to make themselves much more efficient. I'll give -- put it out there. It might take a week in the past to compose a credit application for a new SRP customer. I say a week. And that would be a portion that be our guys really good working really hard on that. That could be done now in less than a day with AI.

Okay. If I heard you correctly, you said 19 8, so that would be about CAD 70 million annualized.