Earnings Call Transcript - VBNK Q2 2022

Operator, Operator

Good morning, ladies and gentlemen. Welcome to VersaBank's Second Quarter 2022 Financial Results Conference Call. This morning VersaBank issued a news release reporting its financial results for the second quarter and year-to-date ended April 30, 2022. That news release, along with the Bank's financial statements 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 that in addition to the telephone dial-in, VersaBank is webcasting the conference call live over the Internet. 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 the 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's management. Actual results could differ materially from our expectations due to various material risks and uncertainties associated with VersaBank's business. Please refer to VersaBank's forward-looking statements advisory in today's presentation. I would now like to turn the call over to Mr. David Taylor, President and Chief Executive Officer of VersaBank. Please go ahead, Mr. Taylor.

David Taylor, President and CEO

Thank you, Michelle. Good morning, everyone. I appreciate you joining us for today's call. With me is Shawn Clarke, our Chief Financial Officer. For those who have been following VersaBank for some time, you may notice a few adjustments to how we describe our business and quarterly results. Firstly, we are now clearly identifying our Digital Banking operations when discussing our deposit and lending business and referring to DRTC for our cybersecurity services and certain banking and financial technology developments. Additionally, we are breaking out our non-interest expenses into their Digital Banking and DRTC components to give a more comprehensive view of each segment. We believe this approach better serves our shareholders and potential investors by providing a clearer understanding of our Digital Banking and DRTC operations and facilitating better comparisons with our industry peers. In our Digital Banking operations, we are presenting net interest margin based on total assets, which includes cash and other assets, as we have traditionally done and as is standard for publicly traded banks in Canada. However, we are also showing net interest margin excluding cash and other assets, following the practices of U.S. banks. Furthermore, we are now reporting our efficiency ratio for our Digital Banking operations only, excluding the impact of DRTC. We feel these changes will help the investment community make more accurate comparisons between our results and those of our peers, including U.S. banks. Lastly, please remember that we report our financial results in Canadian dollars, and all figures in today’s call will be presented in Canadian dollars unless stated otherwise. Now, moving on to the results. In the second quarter of 2022, we experienced ongoing momentum across our business, highlighted by another record loan portfolio in our Digital Banking operations, which grew 34% year-on-year and 11% sequentially to just under $2.5 billion. This growth was significantly supported by our strategic emphasis on point of sale financing, which increased 51% year-on-year. However, consolidated net income for Q2 was affected by expenses related to various investments that we believe will drive portfolio growth both in the short and long term. These included transitory costs associated with preparing to launch our point of sale offering in the United States and the Canadian dollar version of our digital deposit receipts. We also noted a negative impact on the net interest margin in our Digital Banking operations due to our strategy to expand the point of sale portfolio, as our margins from point of sale loans are generally lower than those from commercial real estate loans. Despite this, the point of sale market represents our most significant opportunity for sustainable long-term profitability and more efficient capital use. In DRTC, we are witnessing strong growth with year-over-year increases in revenue and gross profit of 41% and 57%, respectively. Profitability was slightly affected by investments made in preparation for the VCAD launch, including the completion of the SOC2 audit. It’s worth noting that the gross profit for DRTC is included in non-interest income in VersaBank's consolidated income statement. A major highlight in Q2 was the launch of our point of sale business in the United States and the addition of our first U.S. point of sale customer on March 31. This customer is a large North American commercial transportation financing firm focused on independent owner-operators, showcasing the value of our offering in addressing an unmet need in the market with a flexible and economically superior technology-based alternative. We are off to a promising start, and discussions with other potential partners are very encouraging, reinforcing our belief in the uniqueness and demand for our offering. Another significant achievement this quarter was the successful completion of the SOC2 compliance audit for our proprietary blockchain technology, which underpins our digital deposit receipts. Our internally developed technology underwent a voluntary SOC2 audit conducted by an independent national Chartered Professional Accountancy and advisory firm, which validated our non-financial reporting controls related to security, availability, processing integrity, confidentiality, and privacy of our VersaVault. We see this as a considerable advantage from both user and regulatory perspectives, now and in the future. Our digital deposit receipts were created from recognizing the long-term shift towards rapid, frictionless transactions in the digital space. We are continuing to move towards the launch of VCAD in Canada. VersaBank has a long-standing tradition of being at the forefront of banking, especially in terms of technology. Sometimes this means we adhere to conservative timelines, ensuring that our stakeholders fully comprehend these initiatives. I would now like to hand the call over to Shawn for a detailed review of our financial results. Shawn?

Shawn Clarke, Chief Financial Officer

Thanks, David. Just a quick reminder that our full financial statements and MD&A for the second quarter and year-to-date 2022 are available on our website under the investors section, as well as on SEDAR and on EDGAR. As David mentioned, all of the following numbers reported are in Canadian dollars as per our financial statements unless otherwise noted. We do offer U.S. dollar translations of our key metrics in our standard investor presentation, which will be updated for the second quarter numbers and posted to our website very shortly. On to Slide 9, the balance sheet. Starting with our balance sheet, total assets at the end of the second quarter were $2.7 billion, up 26% from $2.1 billion at the end of Q2 last year, and up 11% from the end of Q1 of this year. Our cash balance at the end of Q2 was $198 million, or 7% of total assets, down from $272 million, or 13% of total assets at the end of Q2 last year, and up from $155 million, or 6% of total assets at the end of Q1 this year. The year-over-year decrease is a result of deploying our temporarily elevated cash balance into our loan portfolios, while the sequential quarter-over-quarter increase was in preparation to fund new loans in our short-term pipeline. Our total loan portfolio at the end of the second quarter grew to another record balance of $2.45 billion, which, as David mentioned earlier, represents an increase of 34% year-over-year and 11% sequentially. Book value per share increased 8% year-over-year and 1% sequentially to $11.94, with the year-over-year increase due primarily to the impact of our common share offering in September of 2021 and higher retained earnings attributable to net income earned in the current period, offset partially by the payment of dividends over the same timeframe, and the sequential increase being due primarily to higher retained earnings attributable to net income earned in the current quarter, offset partially by the payment of dividends over the same period. Our CET1 ratio was 13.66%, up from 12.52% at the end of Q2 of last year and down from 14.83% at the end of Q1 of this year. Finally, our leverage ratio at the end of Q2 was 11.63%, up from 10.46% at the end of Q2 last year and down from 12.69% at the end of Q1 of this year. The year-over-year increases in our regular capital levels and ratios, as well as changes in our leverage ratio were a function of a number of factors, including our common share offering in September 2021 for total net proceeds adjusted for tax-affected issue costs in the amount of $75.1 million, retained earnings growth year-over-year and in the case of our capital ratios, changes to our risk-weighted assets and composition. Both our CET1 and leverage ratios will remain well above regulatory thresholds. On to Slide 10. Consistent with David's earlier comments on reporting, I’ll begin with an overview of our consolidated results and then proceed to discussing Digital Banking operations and DRTC individually. Total consolidated revenue increased 17% year-over-year and 2% sequentially to $18.6 million, with the increase driven primarily by higher net interest income in our Digital Banking operations, which in turn was driven by strong growth in our loan portfolio. We also generated higher non-interest income at DRTC, I will discuss each of these in more detail in a moment. As David noted earlier, consolidated net income for the quarter was dampened by what were predominantly transitory costs associated with specific growth initiatives, including our U.S. point of sale launch and preparation for the launch of VCAD. As a result, net income was down 14% year-over-year and down 11% sequentially to $4.9 million. Net income was also impacted by higher salary and benefits costs and higher office expenses incurred as our team returned to work at our offices. While these specific transitory costs recognized in Q2 will reduce materially in the back half of the year, we expect to see additional expenses associated with our pursuit of acquiring a U.S. bank. The magnitude and timing of which will depend on our progress toward achieving this objective. Earnings per share for Q2 were $0.17, which is down 32% year-over-year and 11% sequentially. The year-over-year decrease in EPS was disproportionately larger than that of net income due to the higher number of shares outstanding resulting from the issuance of 6.3 million common shares under our U.S. IPO in September of last year. Strong growth in our loan portfolio was driven predominantly by growth in our point of sale portfolio and, to a lesser extent, growth in our commercial real estate portfolio. Point of sale loans grew 51% year-over-year and 12% sequentially to $1.6 billion. The increase continues to be driven mainly by strong demand for home finance, auto, and home improvement receivable financing. As David noted earlier, point of sale continues to expand as a proportion of the overall portfolio, now representing 66% of our total loan portfolio, up from 65% in Q1 2022. Our commercial real estate portfolio increased 10% year-over-year and 8% sequentially to $796 million. This increase is primarily a result of growth in residential mortgage financing. Turning to the income statement for Digital Banking, net interest margin, which, as David mentioned earlier, we are now presenting as a function of only interest-bearing loans, which is excluding the impact of cash and other assets for Q2 was up 3.11%, compared to 3.22% last quarter and 3.55% for the same period a year ago. These declines are primarily the result of our strategy to grow our point of sale portfolio, which generates lower average net interest margins than the commercial real estate portfolio. We are also more aggressive with the point of sale pricing in Q2 this year to take advantage of certain growth opportunities that presented themselves. Net interest income in our Digital Banking operations for the second quarter was $17.2 million, up from $15.1 million in Q2 last year and up 2% from $16.9 million for the same period a year ago. The increases were both primarily a function of higher interest income earned on higher lending assets, offset partially by lower fees earned on the Bank’s CRE mortgage portfolio and higher interest expenses on deposits. The year-over-year trend also reflects higher interest expense in the current quarter attributed to subordinated notes, which were issued at the end of April of last year. Non-interest expenses for the quarter were $11.8 million, compared to $8.3 million for Q2 last year and $10.6 million for Q1 of this year. Both increases were due primarily to higher costs related to the launch of the point of sale business in the U.S. and preparation for the commercial launch of VCAD. We also incurred higher salary and benefits expense attributed to higher staffing levels to support expanded business activity across the bank, higher costs associated with employee retention, and higher office and facility-related costs attributable to our return to work strategy. The year-over-year increase also reflects higher insurance premiums attributable to our listing on NASDAQ in September of 2021. Turning to the cost of funds. Cost of funds for Q2 was 1.38%, which is up 10 basis points year-over-year and 9 basis points sequentially, with the increase due to higher deposit balances and changes in our deposit portfolio mix. Credit quality of our loan portfolio remains very strong. We once again finished the second quarter with no impaired loans and no loans in arrears, which continues to be the case today. For Q2, we recognized the provision for credit losses or PCL in the amount of $78,000, compared to a provision for credit losses in the amount of $312,000 for the same period a year ago, and a provision for credit losses in the amount of $2,000 in Q1 of this year. Our PCL ratio, specifically PCLs as a percentage of average loans, was 0.01% for the current quarter, compared with a 12-month average of negative 0.01%, which continues to be amongst the lowest of the publicly traded Canadian federally licensed banks. Turning to DRTC's income statement. Our cybersecurity services in banking and financial technology development operations, DRTC revenue and gross profit, which were generated entirely by Digital Boundary Group's Cybersecurity Services, increased 41% and 57% year-over-year and 3% and 1% sequentially to $2.4 million and $1.4 million, respectively. DRTC as a whole, however, generated a net loss of $0.5 million in the current quarter, which is impacted by the costs associated with the technology development initiatives that are not yet revenue-generating. This compares to a net loss of $0.2 million in the second quarter of 2021 and net income in the amount of $0.1 million in the first quarter of 2022. The loss in the current quarter was attributable to higher costs related to investment in specific growth initiatives, including the preparation for the commercial launch of the Canadian dollar version of the Bank's Digital Deposit Receipts, as well as higher salary and benefits expenses and higher business development costs. Finally, before turning the call back to David, I thought it was important to note that we remain very mindful of the continuing evolution of the pandemic, the current geopolitical unrest, and the volatility in both Canadian and U.S. macroeconomic conditions, and as a result, we continue to operate at a heightened level of awareness to ensure that our origination and underwriting practices, as well as our broader risk management practices remain highly disciplined and focused. I’d now like to turn the call back to David for some closing remarks.

David Taylor, President and CEO

Thanks, Shawn. The second quarter was once again demonstrative of the accelerated growth of our Digital Banking loan portfolio led by our point of sale financing business, where demand for types of goods and services are financed using our solution, remain very strong in Canada, and we expect continued momentum throughout the remainder of the year. We also expect to see continued near-term growth in our commercial mortgage portfolio, specifically related to financing for residential housing properties as the macro conditions remain favorable. That said, we expect the growth to be somewhat moderated from our view earlier this year. With anticipated continuing strong portfolio growth in Canada, we expect the investments we've made in Q2 to begin to yield results in the second half of the year. Notably, we expect to begin to see the contribution from the rollout of our point of sale financing offered in the United States, which we believe has even more potential for near-term contribution than our previous call at the end of February. When we were first analyzing the potential for our offering in the United States, we viewed it as an attractive third option for consumer financing firms alongside their existing bank and public market finance. With public capital much harder to come by, we believe there will be even more demand for our point of sale offering. On the deposit side of Digital Banking, we anticipate continued growth in deposit funding for the remainder of the year, driven primarily by insolvency professionals as the volume of consumer bankruptcies and proposal restructuring proceedings is forecasted to increase significantly due to the continued tightening of monetary policy by the Bank of Canada. In fact, some experts have predicted that we may move from a period of record-low bankruptcies to a period of very high bankruptcies. We are already seeing a significant increase. In our cybersecurity services business, we have a solid momentum, with more than 40% year-over-year growth in revenue, as I mentioned earlier, and we expect this will continue in 2022. All of this points to a solid back half for 2022 and outsized growth potential for 2023 and beyond. And with that, I'd like to open the call to questions. Michelle?

Operator, Operator

Thank you, sir. Your first question comes from Greg MacDonald of LodeRock Research. Please go ahead.

Greg MacDonald, Analyst

Thank you. Good morning, David. Good morning, guys.

David Taylor, President and CEO

Good morning.

Shawn Clarke, Chief Financial Officer

Hi, Greg.

Greg MacDonald, Analyst

Guys, I want to—I have two questions. The first is kind of a macro one; we just came through earnings season for the big six banks as well, and big bank CEOs who were normally conservative seem to be a little more optimistic on the economic outlook than the market is. I wonder, David, if you could speak to that overall as an issue, i.e., are you seeing things differently than what some of the economists are? And then secondly, in context, of course, your main area of growth focus in terms of point of sale and multi-unit residential real estate loans?

David Taylor, President and CEO

Thank you, Greg. In our limited scope offering, we are still experiencing significant growth this year and likely into 2023, particularly in point of sale financing, as there remains high demand for big-ticket consumer items. However, as we move into 2023, I anticipate that the tightening measures, including an additional 50 basis points, will impact demand. Based on my experience with past recessions, purchases of items like hot tubs or motorcycles typically decline when a recession occurs, and these are the types of products we finance. While we are currently growing at around 50 percent and I don't foresee an end to that this year, the economic situation could dampen growth heading into 2023. Regarding our real estate construction, there is still strong demand for residential units on the outskirts of major centers, and we continue to play a small role in that area. I believe we have managed to maintain our portfolio size with a bit of growth.

Greg MacDonald, Analyst

Yes. And there are longer cycles involved in that area as well. Okay. Thanks for that color. The second question specifically on point of sale, really good growth sequentially up 12% to your point. Can you talk a little bit about the trends in terms of consumer spending? Can you talk specifically to the decision to be more aggressive in pricing in Q2? I think you defined it in the press release going after certain high growth opportunities? Thanks.

David Taylor, President and CEO

Yes. And so primarily our growth in this area is in the home improvement sector and that's what's carrying through. So, that's the component of our point of sale that we see the largest growth. Now, going forward, I think that will probably start to dissipate too, leading into 2023, as I said earlier, I would expect that to slow down somewhat. The pricing concessions that we've given to some of our major partners are primarily in that area. And what we're doing now is expanding our market share in Canada. I think we're very close to being the largest point of sale financing company in Canada. So, it was a little bit of pricing concession, but it results in a lot of volume and we expect we'll have a lot more volume going forward due to that pricing concession.

Greg MacDonald, Analyst

I see. So that was a strategic decision made based on funding partner relationships and things like that. Is that the way I should read it?

David Taylor, President and CEO

Yes, absolutely. It was with a slight reduction in pricing that gave rise to a significant increase in volume. And as you know, we have a lot of capacity; our balance sheet capacity is almost double our size with the capital we have for those types of assets, and we like them. They are designed for high scalability and very low risk. So, that's the Canadian market and then we've got the U.S. market, of course; it’s about the beachhead transaction. We're looking at another one fairly soon, and the thesis that we walked into the states with was that we thought this would be a popular new product. It's holding very well. In fact, pricing is better in the states than in Canada. Partially it's a result of the meltdown in the capital markets area where a lot of point of sale companies were getting cheap money, and partially due to the convenience of being able to hitch directly up to our bank and get timely, economical, reliable financing.

Greg MacDonald, Analyst

Okay. Thanks, David. That's good color.

David Taylor, President and CEO

Thank you, Greg.

William Wallace, Analyst

Hi, thanks for taking my question. I had a few questions I wanted to ask this morning, if I could, and maybe just straight away following up on the previous line of questioning. I'm guessing since you only have one partner, you probably aren't willing to quantify where you are with U.S. point of sale as of the end of the fiscal quarter, but what I am wondering is if we kind of just think about this conceptually, if you are going to try to enter the U.S. more aggressively, you're also pricing more aggressively in Canada. Can the U.S. pricing offset the negative impacts of the Canada pricing or are we more likely to see, as rates rise in your trustee deposits come off of their floor? It seems like we could be setting up for margin compression rather than stability or even expansion in the near term. So, can you just kind of help us? I mean, we see the growth potential. I'm just trying to kind of get a sense of the bottom line impact once we start to see this transition into the U.S. versus what you're doing in Canada with pricing?

David Taylor, President and CEO

Well, it's a good question, Wally. This has, of course, competing forces at play on our net interest margin. One is the sort of bonus that we get as the Bank of Canada increases its overnight rate. We're positioned to gain a little bit more net interest margin. I think our statements showed approximately $5 million additional net interest income in the 12-month period with a 100 basis point increase. And we've seen it – I think as of today, we'll probably see the 100 basis point increase. So, that tends to widen our net interest margin somewhat. The U.S. market, as you said, is wider than the Canadian margin and we are only giving up a few basis points when we talk about aggressive pricing. So, looking at those components, it tends to mean a wider margin. And as you know, we've started reporting as U.S. banks do. So, I'm thinking around a 3%, 3% plus margin is in the works, although the other forces at play could move it around temporarily quarter-by-quarter. With respect to the Trustee deposits, even though they're coming off their floor, I think on average now we're paying about 30 basis points. I expect the volume of Trustee deposits will increase dramatically as we are coming off of 35-year low bankruptcies. We've still been building deposits as we've been signing up the last few insolvency firms in Canada, but it could very well be we're going into a 35-year high for insolvencies. That would mean a lot more deposits coming out of that area. As I say, today there are only 30-40 basis points in total. So, it really is still a very economical way for us to raise key deposits and the volumes could double in the upcoming year. It would be hard to see with the market penetration we now have in that industry. I'd say we're already seeing the signs of the increased interest rates on the marginal borrowers in this country. You're starting to see credit card debt attract higher provisions. You're starting to see subprime attracting higher provisions. It's already coming in. So, on one side, I'm not a happy guy for Canada's economy, but on the other side, it means a lot of deposits from the Trustees.

William Wallace, Analyst

Those deposits, how are they priced? New deposits that come on.

David Taylor, President and CEO

They're priced over prime, so they're floating rates and there's various pricing which we're dealing with. I think, what's evolved. But on average, I would say, prime minus three, prime minus 2.75, somewhere around there, all-in. So, you know, an economical source of deposits.

William Wallace, Analyst

So, the way you can get benefit to margin is, if the acceleration in growth in those deposits is able to offset the need to fund out of your wholesale channel, its pricing, and even though it floats with a beta of one, you get a higher spread on those versus the wholesale?

David Taylor, President and CEO

Yes, absolutely. Yes. That's right. We expect the trustee to average around a billion, and it's only $600 million, $700 million right now. So, this is a historic low for those types of deposits in Canada. And there's a bit of a lag effect, of course, when you come up with 35-year lows, it takes six or seven months before you start to see the insolvency deposits. So…

William Wallace, Analyst

Okay. Now, in the U.S. entry, you mentioned, I believe you said you feel like you have one potential new partner. To aggressively grow in the U.S. how many new partners do you need? And what does the pipeline look like? It seems like it's taking a while to sign one partner as we thought maybe after the first one you'd have the model and the agreements, the master purchase agreement would be good for all the interstate commerce rules, etcetera. Can you talk a little bit about your expectation of how that partner base might grow in the U.S. and why it seems to be a longer pipeline than maybe we had anticipated, as far as getting these deals signed up?

David Taylor, President and CEO

Mainly the slowdown was just the haggling over the legal documentation issue. In Canada, we have what we call a master purchase and sale agreement, just kind of a central document. And that did take a while to get sorted out to comply with U.S. law, and that we did sign the first deal. I think we've got about $35 million right now on that deal. The next one is right behind it. The documentation holds. So, the next one will be signed up very soon and then be funded shortly afterwards. So, it's coming along. These are just sort of beachhead transactions for us to get used to the U.S. and for our lawyers to tidy up the documentation. I think with the lack of funding coming out of the capital markets, this is what we experienced in Canada too when we initiated this program many years ago. It means that there's huge demand for alternative sources of funding for point of sale companies. So, now we've got the paperwork taken care of. We've got a couple of example transactions. I can see opening up the floodgates and I expect there will be a huge demand for us. The constraint will be human resources and putting together the funding sources in the United States, of course. And I think everybody knows that we're planning to acquire a U.S. Bank to enable the funding of U.S. dollars for these types of transactions. So, we get the beachheads established, and then, thankfully, again, I sound like a grim reaper here, the capital markets are not providing the economical funding or the very cheap funding or the unbelievably cheap funding they were providing for point of sale companies. So that just means tremendous opportunity for us. So, I would say, you're going to see it rapidly increase towards the end of this year as our point of sale team ramps up in the states.

William Wallace, Analyst

You mentioned the commitment as a potential obstacle to quickly signing on partners. Let's discuss the expense line. You and Shawn highlighted in the prepared remarks that there are several temporary expenses related to VCAD and U.S. point of sale entry, but these have not been quantified yet. Additionally, there was a comment regarding the expectation of higher expenses associated with pursuing a U.S. Bank Charter. Please clarify the base expense by removing any elevated one-time expenses for M&A and those related to VCAD and point of sale entry. What is the run rate expense, and how should we anticipate it to grow in the future?

David Taylor, President and CEO

Shawn, you've got some number on that, I think.

Shawn Clarke, Chief Financial Officer

Sure. Sure. Well, if you look at our 25% of our costs, the quarter-over-quarter increase could be attributable to some of the new initiatives that David and I discussed over the course of the call. Do we expect those costs as we mentioned are expensive to ramp down, but currently we expect expenses associated with our pursuit of a U.S. acquisition to ramp up. We expect those costs, you'll see incremental increases quarter-over-quarter through the third quarter, the fourth quarter, and we expect, if we’re successful, including the acquisition or closing the acquisition by the end of our fiscal period, we would expect to see those costs drop off mid to late Q1 of 2023.

William Wallace, Analyst

Right. But drop off to what? To 25% of the increase in the second quarter? So, we take out 250,000 roughly to get to a run rate of about $11.5 million?

David Taylor, President and CEO

That'd be a decent level. One of the issues will be though, as David mentioned, we're still working on in terms of our projections is what will be additional staffing requirements as a function of our potential U.S. acquisition and, of course, in supporting the U.S. POS initiative. So, I think a run rate of 25% of where we are right now, quarter-over-quarter would be a very conservative view in terms of where our non-interest expenses will be over the course of 2023. Again, you'll see it ramp up over the course of 2022 and ramp back down, but I think we're still trying to come to grips with what the resource requirements will be to support the existing POS business, the growth of that business, and the integration of that business with a potential U.S. bank acquisition.

William Wallace, Analyst

Okay. Okay. So if I take, I just want to make sure I'm 100% understanding. The expenses went from $10.6 million to $11.8 million. 25% of that increase is what you would consider transitory. So, 75% of that increase is staffing, etcetera that's here to stay. And from there, once we get past whatever costs are around pursuing a U.S. bank charter, you're trying to figure out how much growth from there will be required to support growth in the U.S.?

David Taylor, President and CEO

That's correct.

William Wallace, Analyst

And then obviously if you buy a charter, that will come with more expense. Sure. I understand that. I'm just trying to get to the base run rate to think about from a modeling perspective. So, the pressures are pretty meaningful. Last quarter, you suggested that the first quarter run rate was probably a decent run rate. So, where's all the creep coming from? Is it U.S. point of sale? Is it are you expanding resources in Canada? You're having to pay people more to keep people, just kind of help quantify why there's so much creep.

David Taylor, President and CEO

All of the above. So, a big thing for us is we're seeing across the Defense Services industry's retention of people. It's very difficult in hiring new folks terms of incremental wage increases to bring new staff on board. We are struggling to acquire new staff as it is and seeing, in our view, notable increases in base wages in terms of bringing those folks on board, signing bonuses, etcetera. Retention amounts for folks that are already with us are key to our success in the future. So, salaries and benefits certainly are a big driver of those – of that cost base. So the expenses are quite frankly investing in new and maintaining existing staff, as well as trying to deal with the costs associated with researching, sourcing, and working to identify and potentially acquire a U.S. charter has been a little more expensive than anticipated. But we think the benefits on the other side will be disproportional.

William Wallace, Analyst

Okay. And I've kind of hijacked this call. I'm sorry, I just have one last question. David, why is it taking so long to get VCAD launched officially? It just seems like every time we talk, it should be any week now, it’s taking months. So, any comments there?

David Taylor, President and CEO

Yeah. That's a good question, Wally. I had believed that it would be fairly soon, but it is taking longer. I guess one of the factors is with the meltdown in the stable coin industry has created a fair amount of, obviously, nervousness or concern amongst regulators. And even though our Digital Deposit Receipts saw apples to orange comparisons to the stable coins that have turned out not to be that stable. We're in an atmosphere of nervousness that has slowed down the final launch of the program. Ironically, considering our Digital Deposit Receipt, is positioned to be the safe harbor for folks that have misguidedly thought they were putting their money in something stable. Nevertheless, there's a fair amount of nervousness out there.

William Wallace, Analyst

So, is that just a guess that there's a chance that the regulators just don't allow it to launch?

David Taylor, President and CEO

I think that is always a chance. I certainly hope not, and I think the generation millennials and Gen Z have shown that they really want this kind of deposit vehicle as they've gone to non-bank issuers to get something they thought was stable. A statistic that I saw recently was that there’s a tiny bit of retention when a baby boomer's wealth moves on to the millennials, when the boomers finally expire. So, the new generation wants this type of deposit deals. They want to do this kind of banking, and the mainline old-school banks really haven't reacted to that. There are some banks in the states, but of course, they are definitely the same way we do, but it’s left kind of void in the marketplace for those younger people who don’t want their grandfather's banking. And we have the product we believe is ideally suited for them. So, I hope the regulators see that, because unfortunately, if you don't, the baby boomers and such are the Gen Zs find themselves going to unregulated entities and then in some cases suffering.

William Wallace, Analyst

Hey, well, fingers crossed, I guess. I'll step out and let somebody ask the questions. Thanks, Dave.

David Taylor, President and CEO

Well, thanks Wally. Good questions.

Bradley Ness, Analyst

Yes. Hello, guys. Just following – hello. Yes, following Wally's question line here. So, on the VCAD, what do you think it'll take to get the regulators comfortable? You guys have a great relationship with your regulators, so you should be pretty dialed in here?

David Taylor, President and CEO

Well, Brad, I believe it will take some time, and the global issues I mentioned have also affected Canada. However, I think it’s just a matter of time. We are providing our regulator with as much information as possible about the product. We believe it is a safe and secure option for Canadians to invest their hard-earned money rather than risking it with unregulated so-called stable coins, some of which have led to significant losses. We aim to assure our regulators and ourselves, as a bank, about the positives of safety and security. Nevertheless, we have entered a period of significant nervousness, and it was surprising to see some of these so-called stable coins lose their value entirely. This situation has startled the global regulatory community.

Bradley Ness, Analyst

Okay. I don't know why they were so concerned about the algorithmic stable coins when they're not really regulating stable coins, because your stable coin is not algorithmic, so I don't know why regulator would be concerned. But let me just jump on…

David Taylor, President and CEO

Yeah. Let me emphasize for a second if you like. Yes. Ours isn't a stable coin, and so to speak, it is a Digital Deposit Receipt. It can function as a stable coin if it becomes prevalent and popular. But it's issued by a bank. And all of our deposits are Digital. We've been digital since I created that method of issuing deposits in 1993 with telephone modems, so rudimentary systems. They're all Digital. It's just these are highly encrypted Digital Deposit Receipts, and then, you know, they get that Appalachian crypto, which some people think is wrong. It's something wrong with that. No, it's highly encrypted, and that's what we like. And all our data is encrypted, but this is more instructed. Sorry to interrupt there, Brad, but for anybody else listening, that's our point of view as a bank. We're planning to issue something super secure and super encrypted.

Bradley Ness, Analyst

Got you. Thank you. Remind me what I should think about profitability goals. Let's just say in fiscal 2023, it seems like recently I've been involved for a year and the more you grow, the lower your profitability gets. So, just remind me what I should expect for like 2023. What are your goals?

David Taylor, President and CEO

Well, a net interest margin north of 3%, calculated the way U.S. banks do, I think is reasonable and should be slightly better than that, but I think that's a reasonable margin for us to hold on to in the point of sale business where we're expanding. And as we've seen from the past results, we're adjusting Canada, we've been growing 50%. Moving into the states, and it's all dependent on our success in acquiring a U.S. lending platform. I would say 50% growth would be easy for us to do even despite perhaps an impending recession, as I was saying earlier, for the market in the United States is so large, and the point of sale companies are – a lot of them are finding themselves having the well run dry when it comes to funding. So, I would say you could expect that type of top-line growth in assets, mainly point of sale, of course, with that type of 3% type spread. As Shawn was saying earlier, the dampening effect is primarily associated with our endeavors to launch VCAD, to acquire a U.S. Bank, to list on NASDAQ, retain staff. So, those are things that you do to build your business. And so yes, we're spending money to build the business for the future, which I think should be heartening. In the past, those types of expenses might have been capitalized years ago, but now they're right for us to expense. So, it does hit our income statement, but these are expenses that we're incurring for future growth. If we were to stand still, yes, you wouldn't see any of that. We probably wouldn't have to have as many staff either. No.

Bradley Ness, Analyst

Okay. So, what I'm hearing is the major profitability metric you're focused on in 2023 is the net interest margin above 3%. And a lot of banks talked about, like, they would rather, you know, they're focused on, like, return equity here. It brings for sure growth. So, it sounds like that's not as important, so maybe the sub 6% ROE is something we should expect going forward?

David Taylor, President and CEO

As we make use of our excess balance sheet capacity, return on equity naturally increases significantly. We’re positioned to grow our asset mix and can potentially double our size, which has a substantial effect on ROE. What you're seeing aligns with our stated strategy—we entered the states, launched our point of sale program, and have made progress in legal matters, marketing, and travel. Now, we’re focused on the U.S. Bank acquisition to enhance our lending platform that offers affordable U.S. dollar-denominated deposits while continuing to lend across the states. However, this process does incur expenses related to travel, consulting fees, and legal costs.

Shawn Clarke, Chief Financial Officer

Brad, I think your comment about 6% ROE is not a reasonable target as we move through this development phase. We would think that we would start to see those returns start to expand in the backend of 2023, assuming we're a key driver there would be in terms of, we were successful in the completion of a U.S. acquisition and able to get that business online and contributing to the consolidated results. So, not ignoring ROE by any means, and very aware of shareholders' concerns for that metric, but one that we think will see some compression as we move through this phase, but we think there's material growth in the phase.

Bradley Ness, Analyst

Okay. Thank you, gentlemen.

David Taylor, President and CEO

Thank you, Brad.

Operator, Operator

There are no further questions. I will now turn the conference back over to Mr. David Taylor for closing remarks.

David Taylor, President and CEO

Well, thank you. I'd like to thank everybody for joining us today and I look forward to speaking to you at the time of our third quarter results at the end of the summer. Thank you again.

Operator, Operator

Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you for participating and ask that you please disconnect your lines.