Earnings Call Transcript - VBNK Q2 2025

Operator, Operator

Good morning, ladies and gentlemen. Welcome to VersaBank's Second Quarter Fiscal 2025 Financial Results Conference Call. This morning, VersaBank issued a news release reporting its financial results for the second quarter ended April 30, 2025. That news release, along with the bank's financial statements, MD&A and supplemental financial information are available on the bank's website in the Investor Relations section as well as on SEDAR+ and EDGAR. Please note that in addition to the telephone dial-in, VersaBank is webcasting this morning's conference call. For those participating in today's call by telephone, the accompanying slide presentation is available on the bank's website. Also, today's call will be archived for replay both by telephone and via the Internet beginning approximately 1 hour following completion of the call. Details on how to access the replays are available in this morning's news release. I would like to remind our listeners that the statements about future events made on this call are forward-looking in nature and are based on certain assumptions and analysis made by VersaBank management. Actual results could differ materially from our expectations due to various material risks and uncertainties associated with VersaBank's businesses. Please refer to VersaBank's forward-looking statement advisory in today's presentation. I would now like to turn the call over to David Taylor, President and Chief Executive Officer of VersaBank. Please go ahead, Mr. Taylor.

David Roy Taylor, President and CEO

Good morning, everyone, and thank you for joining us for today's call. With me is our Chief Financial Officer, John Asma. The second quarter of fiscal 2025 unfolded as planned with a number of positive highlights that will continue to drive momentum in our business. We saw the first drawdowns of our U.S. RPP portfolio, which by the end of the quarter had surpassed USD 70 million. We saw growth in our Canadian residential construction loan portfolio. We saw a meaningful expansion of our net interest margin due to several factors that are trending positively. John will go into these in more detail, and we do expect these trends to continue to support NIM around these levels for the remainder of the year. This drove record assets, record credit assets, record revenue alongside sequential improvements in banking efficiency and return on common equity based on our core earnings. And subsequent to quarter end, we initiated a structural realignment of our business to that of the standard U.S. bank framework, which, if approved by regulatory authorities and shareholders, we expect will realize additional shareholder value, reduce costs and further mitigate risk. Looking at the financial highlights in more detail. As I noted, record credit assets and very healthy expansion of our net interest margin drove record revenue. Credit assets on both sides of the border are expanding more or less in line with expectations this year. Net interest margin also expanded as we saw several favorable trends continue, driving a 23 basis point increase in NIM on credit assets sequentially. I will note here, there were two items that did slightly dampen our income. The first is some preliminary costs associated with our proposed structural realignment. The second is the impact of foreign exchange translation of U.S. subsidiary assets, which was a typically large unrealized noncash loss due to the precipitous drop of the U.S. dollar versus the Canadian dollar in Q2. Excluding these items, earnings per share was $0.28. I would take the opportunity to remind you that this is an early point in our U.S. Receivable Purchase Program. Although profitable, the results of our U.S. operations continue to reflect the cost structure that will support our ramp to vastly larger revenues. As I noted last quarter, we tend to look at our Canadian banking operations as a proxy for where we think the efficiency and return on common equity of our U.S. banking operations can go. And we are pleased to see both improve sequentially, excluding the two aforementioned items to 44% and 12.53%, respectively. And I will remind you that our Canadian banking operations bear the vast majority of our corporate overhead costs, including our public company costs. So as an indicator of true potential efficiency and return on equity of our U.S. business is actually significantly understated. And finally, as I did last quarter, I'll remind you that our EPS for the quarter reflects a significantly higher number of shares outstanding in Q2 as a result of our December capital raise, most of which we are still putting to work. We deploy this capital at around 12x or more and around a 2.5% spread. So it is very accretive. Now I'd like to turn the call over to John to review the financial results in detail. John?

John W. Asma, CFO

Thanks, David. Before I begin, I will remind you that our financial statements and MD&A for the second quarter 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 otherwise noted. Starting with the balance sheet. Total assets at the end of the second quarter of fiscal 2025 grew 15% year-over-year and 2% sequentially to a new high of over $5 billion. Cash and securities were $445 million or 9% of total assets, down from 11% at the end of Q1 as we steadily deploy the capital we raised in December of last year. Book value per share increased to a record $16.25. Our CET1 ratio increased to 14.28% and our leverage ratio was 9.61%, both remaining above our internal targets. Total consolidated revenue was a record at $30.1 million, up 6% year-over-year and 8% sequentially. The increase was driven primarily by our continued growth in credit assets with the sequential growth being additionally driven by solid expansion of our net interest margin. Consolidated net interest expense was $17.5 million compared to $12.2 million in Q2 of last year and $15.7 million for Q1 of this year. As David discussed, Q2 NIEs included $900,000 related to the preliminary costs associated with the bank's proposed structural realignment as well as an atypically high unrealized foreign exchange translation loss. Excluding these costs, NIEs were in line with our expectations. Otherwise, the year-over-year increase in net interest expenses was primarily due to the addition of VersaBank USA. As a reminder, DRT Cyber expenses were included in our consolidated net interest expenses and totaled $2.7 million for the quarter. Reported net income was $8.5 million and consolidated earnings were $0.26 per share. Excluding the preliminary costs associated with the proposed structural realignment and the impact of the foreign exchange translations, consolidated net income was $9.2 million and consolidated earnings per share was $0.28. Looking at the income statement on a segmented basis, the vast majority of revenue continues to be driven by our Canadian digital operations as well as our U.S. RPP program ramped up with continued incremental growth. Revenue for the Canadian banking operations was $25.6 million, up 8% sequentially from Q1. As the corporate expenses flow through the Canadian Digital Banking segment, net income and net earnings per share were negatively impacted by costs associated with the structural realignment and the impact of foreign exchange translation. Excluding these impacts, net income for the Canadian banking operation was $9.9 million, which comes to $0.30 per share. Revenue from the U.S. banking operations was $2.5 million, a 22% sequential increase. And net income for U.S. banking operations was $133,000, a 29% increase sequentially. Within DRT Cyber, the cybersecurity component generated revenue of $1.8 million, down from $2.3 million in Q2 of last year. Net loss was $652,000, impacted by higher operating expenses. Within DRTC, Digital Meteor revenue was $569,000 with a net loss of $152,000. Our credit assets grew to a record $4.52 billion at the end of Q2, driven once again by our Receivable Purchase Program, which increased 14% year-over-year and 4% sequentially to $3.5 billion. Our RPP portfolio represented 79% of our total asset portfolio at the end of Q2, consistent with the end of Q1. Our multifamily residential loans and other portfolio grew 8% year-over-year and 3% sequentially to $958 million as we steadily drew down on CMHC-insured loan commitments. As a reminder, our multifamily residential loans and other portfolio is primarily business-to-business mortgages and construction loans for residential properties. We have very little exposure to commercially used properties. Turning to the income statement of digital banking operations. Net interest margin on credit assets, that is excluding cash and securities, was 2.59%. That was 7 basis points or 3% higher on a year-over-year basis and 16 basis points or 10% higher sequentially. As David discussed, our net interest margin on credit assets is benefiting from several positive trends. The yield curve is no longer inverted, further replacement of maturing higher interest rate term deposits with lower interest rate term deposits, continued expansion of our low-cost insolvency professional deposits and higher margin generated by our U.S. RPP. Net interest margin overall, including the impact of cash, securities and other assets was 2.29%, an increase of 21 basis points sequentially, which still remained among the highest of the publicly traded financial licensed banks in Canada. Our provision for credit losses or PCL in Q2 increased slightly this quarter to 0.08% of average credit assets compared to 0% last year and is higher than our 12-quarter average of 0.02%. The increase this quarter was due to changes in forward-looking information used in our credit risk models, mainly due to increased uncertainty and a more challenging outlook for the economy. I'd now like to turn the call back to David for some closing remarks.

David Roy Taylor, President and CEO

Thanks, John. Looking ahead to the second half of the year, we expect positive trends of Q2 to continue into the third and fourth quarters, which we expect will drive steady sequential growth in core earnings, meaning excluding the investment in the structural realignment. Credit assets should continue to steadily grow, driven by momentum in our U.S. Receivable Purchase Program, which we continue to expect to reach at least USD 290 million by the end of the year. The U.S. has a vastly underserved market for big ticket point-of-sale financing, and we have a unique solution that offers a number of clear advantages over existing alternatives. We see some potential for incremental growth in Canada amidst what remains a challenging environment for consumer spending, and we expect to see an increasing contribution from our growing CMHC-insured Multifamily Residential Loan business in this opportunistic part of our Canadian business and remain on target to achieve $1 billion in commitments by the end of the year. We will increasingly benefit from the operating leverage in our business model as those assets scale, especially as we deploy the capital from our equity offering last December, contributing to further improvements in efficiency and return on common equity on core earnings. We expect to see the continuation of this favorable trend in support of our net interest margins that are in line with our expanding Q2 levels, further replacement of maturing higher cost term deposit receipts with those at the current rates, the normalized yield curve, which benefits from our RPP spreads, the higher spread we generate on RPP assets in the U.S. and the higher deposits in our low-cost Insolvency Deposit business. Q2's insolvency balances were up another 5% sequentially and 22% year-over-year, and we continue to expect those deposits to grow to about $1 billion. Finally, as discussed in our last call, we are aggressively pursuing the renewed opportunity for our proprietary digital deposit receipts. As we expected with the U.S. administration's significantly more favorable view towards digital assets, including digital currencies and stablecoins, we are starting to see the industry itself ramping up their plans. Most notably, the Wall Street Journal reported JPMorgan Chase, Citi, Wells Fargo, Bank of America, and others are all exploring the use of this technology to modernize payments. Our digital deposit receipts are a market-ready solution created by a bank or banks that seamlessly integrate with existing bank software systems while addressing the major concerns of regulators. They take the concept of stablecoin to an entirely new level. In fact, next week, I'll be speaking at the Florida Bankers Association Annual Meeting, the title of my presentation: Introducing the Ultimate Stablecoin, the only USD digital deposit receipt. I will discuss why we believe our first-of-a-kind stablecoin minted by a national bank, SOC2-approved based on the highest military-grade security can, and we believe will, play a role in changing the banking industry. Before we open the call to questions, a few words on the proposed structural realignment we announced last week. The details are a little convoluted and well laid out in our news release, so I won't get into those here. The purpose of this initiative is to realign our corporate structure to that of the most international banks under which there is a corporate parent entity that holds the various operating subsidiaries. This is the structure with which U.S. and international investors are most familiar. Under the proposed plan, the new parent would be domiciled in the United States and fall under the purview of the U.S. regulators as would our U.S. operations. Our Canadian operations would remain domiciled in Canada and remain under the purview of the Canadian regulators. The benefits of this proposed realignment are clear. We would simplify our regulatory oversight. We would further mitigate risk, something we continuously seek to do. We would generate meaningful cost savings. Our stock should become eligible for certain indices, including the Russell 2000. And looking longer-term, it would provide a structure that would be favorable to further international expansion. We would expect all this to generate additional shareholder value over and above the value we expect to drive through growth of the business itself. The realignment is subject to a number of approvals, the OCC, the Fed in the U.S., the Minister of Finance in Canada, the NASDAQ and the Toronto Stock Exchange, of course, and our shareholders. There is a significant cost of this undertaking, which we view as an investment with a substantial expected return. We estimate that to be around CAD 8 million to be roughly divided between the third and fourth quarters this year with a small amount incurred in Q2, as noted earlier. That expected $8 million investment equates to about 1.5% of our current market cap. We are confident that the combined benefits will drive incremental shareholder value far in excess of this investment. With that, I'd like to open up the call to questions.

Operator, Operator

Operator Instructions. With that, our first question comes from the line of Joe Yanchunis with Raymond James.

Joseph Peter Yanchunis, Analyst

So in your prepared remarks, I believe you said that you expect insolvency deposits will reach $1 billion. What's the timing for that target? And in conjunction with this tailwind and the several others that you listed, do you have a sense for the magnitude of NIM expansion in the out quarters?

David Roy Taylor, President and CEO

Can you repeat the second half of that? It broke up a little bit.

Joseph Peter Yanchunis, Analyst

Yes. What is the timing for reaching the $1 billion target and what is the near-term outlook for NIM expansion?

David Roy Taylor, President and CEO

I'm anticipating that by the end of the calendar year, we should reach $1 billion. Currently, we're experiencing a 22% year-over-year growth. Unfortunately, Canada is facing almost record low consumer sentiment and insolvency rates. While this is a challenging time for many Canadians, it presents a good opportunity for the insolvency business, which should provide us with attractively priced deposits. If the current growth rate continues, we should hit the $1 billion mark by year-end. Regarding NIM expansion, I'm pleased to see a sequential increase of 29 basis points in credit assets. However, there is a slight dampening effect occurring in Canada right now, despite approximately $700 million in GICs maturing in the coming months at about 1% less than previous rates, with replacement GICs also about 1% lower. This situation is generally favorable for us, but the yield curve remains relatively flat and may have a minor inversion at the shorter end, which dampens expectations. Thus far, it hasn't rebounded as it typically would. Additionally, the marginal Government of Canada bonds relating to our GICs have been unusually high, currently around 80 basis points compared to the usual 50. As things stand, I expect NIM to hold steady and potentially begin to rise again once some of this market noise dissipates.

Joseph Peter Yanchunis, Analyst

Got it. I appreciate that. And then kind of moving over to expenses. So excluding the realignment costs, how should we think about noninterest expenses kind of trending from here? And then what are the expected annual savings from redomiciling in the U.S.?

David Roy Taylor, President and CEO

Well, excluding the onetime expenditures with respect to reorganizing, there's probably a little bit more in NIE in the states. We've got maybe one more hire to do. And out of that, it should stabilize. So maybe a slight increase in the U.S. bank's expenses going forward and then stable. And with respect to the savings, you could probably pencil in around $2 million, $3 million a year once we've got the reorganization done.

Joseph Peter Yanchunis, Analyst

Excellent. I appreciate that. And just the last one for me. With respect to capital, and perhaps I missed this in the materials, but it didn't look like you utilized your recent share repurchase authorization. How should we think about your appetite for repurchases in the out quarters?

David Roy Taylor, President and CEO

Well, routine to buy our stock back less than book value, and it looks like it's less than book value, maybe to say it has been the last. So we are keen to buy it back at that price. Personally, I don't expect it to stay down there that long. But if it is, we've got loads of capital, and probably the best place to deploy our capital is buying back our stock less than book.

Operator, Operator

And your next question comes from the line of Tim Switzer with KBW.

Timothy Jeffrey Switzer, Analyst

Can you update us on the expectations you have to sell DRT Cyber and the timeline there?

David Roy Taylor, President and CEO

Well, we're in the sort of the final stages of engaging a firm to look after that sale. And I would expect by the end of this fiscal year, we'll have a deal done. It's, I think, a very popular business, unfortunately, but a terrible comment on humanity that cybersecurity attacks just seem to be relentless, and DRT Cyber is seen to be a world leader, particularly in their penetration testing. So we're actively in the sale process now. And as I say, we expect fairly soon to engage a firm to look after that for us.

Timothy Jeffrey Switzer, Analyst

Okay. Great. That's good to hear. And can you provide an update on how the conversations with new partners in the U.S. are going? Maybe how many new programs you expect to be fully launched by the end of the year?

David Roy Taylor, President and CEO

Well, the conversation is going quite well. And of course, it's a very attractive product. But the onboarding process is a little longer than I would like. We've got three signed up now. And by the end of the year, say we have another three signed up. I'm hoping for a lot more than that, but it has taken a while to onboard. The legal work is different in the States versus what we have in Canada, not that much different, but there are nuances to it. So three now, maybe another three. And if the guys pleasantly surprised me, maybe another three on top of that.

Timothy Jeffrey Switzer, Analyst

Okay. That sounds good. And the last question I have is, can you just provide some commentary on the credit trends you're seeing in the CRE book where we've seen some reserve release over the last few quarters, but have also had some charge-offs? Just would love to hear what you guys are seeing there?

David Roy Taylor, President and CEO

The charge-offs are essentially an academic concern since they come from the U.S. portfolio we acquired with the bank purchase. They do not pertain to the Canadian real estate sector, where we have no charge-offs at all. We bought the portfolio along with the associated expected loss provision. The Canadian real estate market is currently experiencing some turmoil, making lending in that area quite cautious. I've been in this field for 48 years, so we need to proceed carefully during this time. This is why we are concentrating on government-insured CMHC mortgages and plan to maintain that focus. We primarily lend to long-term clients in the London, Ontario region. Even our real estate developer clients are mostly holding onto cash, waiting for the economy to stabilize. No problem, Tim. I might see you in New York next week.

Andrew Scutt, Analyst

So my first one here is a little bit of a two-parter. You guys had nice growth in the RPP portfolio. So kind of breaking it out by geography; with the softness in the Canadian economy, can you just kind of talk about what verticals you did see strength in? And then maybe within the active U.S. portfolio, is there anything you've kind of learned that surprised you thus far?

David Roy Taylor, President and CEO

Well, it surprised me that the Canadian portfolio grew despite all the negative indicators like consumer sentiment hitting an all-time low and insolvencies reaching an all-time high. I was not expecting to see any growth in Canada. The main area of growth seems to be in home improvement. Canadians are purchasing new furnaces and energy-efficient hot water heaters, which ultimately help them save on monthly expenses. So, strangely enough, that's where we're seeing growth in Canada, and I think it will likely continue through the end of the year. You might see about a 10% increase year-over-year in the RPP in Canada. On the other hand, we’re experiencing a 22% growth year-over-year in insolvency deposits, which are helping to drive our margin expansion. In the United States, the lesson is that the alternative source of financing is securitization, and credit spreads in that area have been pretty narrow. Although nearly everyone we talk to in the States wants to join our program as a steady and reliable source of capital for their loans, the market is currently offering money at low rates. This means we may not be the top priority compared to what we would be if credit spreads were wider. Additionally, American point-of-sale customers tend to be much larger than Canadian ones. However, due to their size, Canadian customers don’t have access to securitization programs, while American ones do, influencing their interest in our program based on the credit spreads.

Andrew Scutt, Analyst

Really appreciate the detail there. And the second one for me, if I may. You guys added an additional deposit broker in the quarter, noted this could potentially be a tailwind to NIM. So can you kind of talk us through how that could be a benefit to you guys and if you're interested to further expand your network?

David Roy Taylor, President and CEO

We were fortunate to have Bank of Montreal add us to their board, especially since I started my career there. They provide a significant channel for distributing our deposits, which contributes positively to our net interest margin expansion and enhances the diversity of our deposit base. We appreciate their support. There may be one more large bank in Canada that could bring us on board, which would also benefit our deposit diversity and NIM expansion. Essentially, the more channels we have for distributing deposits, the less we pay for them, preventing us from relying too heavily on one specific channel. This distribution across Canada is advantageous. Additionally, there is another bank that was part of the early development of our model, and we should look to sign them up as well, which would allow us to cover the entire country effectively. Are you in the baking hot St. Petersburg right now?

Jeff Wagman, Analyst

No, no. I'm actually getting warmer in Toronto.

David Roy Taylor, President and CEO

No kidding. Sorry, I thought you were down to the headquarters.

Jeff Wagman, Analyst

No. I hope to be in London sometime through the summer. But anyway, just a general question, given the political climate and the expansion and wisely, I think, the concentration of business to the United States. Are you experiencing or hearing of any possible pushback given the political environment regarding foreigners in the U.S.?

David Roy Taylor, President and CEO

No, not yet, but we've heard sort of statements earlier on about Canadian banks in general, and it hasn't affected us negatively. In fact, on the balance, the current U.S. administration's propensity for digital commerce has helped us a lot. As you know, we have the world's first digital deposit receipt. We pioneered it in Canada under the Canadian regulatory environment. And now it seems that it's absolutely perfect for what the U.S. administration is talking about. So other than a little bit of rhetoric about Canadian banks, the overwhelmingly positive thing is the endorsement of digital commerce and our digital deposit receipt, of course, is at least two years ahead of the game. We not only pioneered it in the regulatory environment, but we also obtained a SOC type 2 audit on it, which is you can only get by having it actually be functional. So everybody else that's dreaming of doing this, they've got a few years to go. And we've got the thing ready to roll in the United States. So anything on the balance, it's positive to be in the United States.

Jeff Wagman, Analyst

All right. There are discussions regarding tax increases on foreign investments in the United States and the potential rise in withholding taxes on dividends. However, I have not received any information about business operations yet.

David Roy Taylor, President and CEO

Yes. And a good portion of our shareholders are U.S. other than our major holding company, it's 80% U.S. shareholders.

Jeff Wagman, Analyst

But it won't impact your business as an operational thing, will it?

David Roy Taylor, President and CEO

Also, obviously, with us adopting the same holding company structure that the other international U.S. banks have, that minimizes the risk that there might be some sort of aversion to Canadian banks in the United States. We'll have a holding company structure identical to that of, say, JPMorgan. So that minimizes all that stuff.

Jeff Wagman, Analyst

Okay. I'll give you a shout. And hopefully, when you guys are in London, I'll make a plan to come down and see you.

David Roy Taylor, President and CEO

Yes. I'm currently in London at the VersaBank's Innovations Center of Excellence. Unfortunately, I can't fly in to visit with you this time. I want to mention...

Operator, Operator

And we have no further questions at this time. I would like to turn it back to David Taylor for closing remarks.

David Roy Taylor, President and CEO

Well, I'd like to thank everyone for joining us today, and I look forward to speaking to you at the time of our third-quarter results.

Operator, Operator

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you all for joining. You may now disconnect.