Earnings Call Transcript - VBNK Q4 2024

Operator, Operator

Good morning, ladies and gentlemen. Welcome to VersaBank Fourth Quarter and Fiscal Year 2024 Financial Results Conference Call. This morning, VersaBank issued a news release reporting its financial results for the fourth quarter and year ended October 31, 2024. That news release, along 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. 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-in to 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 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. And I would like to turn the call over to David Taylor, President and Chief Executive Officer of VersaBank. Please go ahead, Mr. Taylor.

David Taylor, CEO

Good morning, everyone, and thank you for joining us for today's call. With me today is our Chief Financial Officer, John Asma. And incidentally, one of the beauties of being able to operate throughout all of North America is that I'm talking to you today from Fort Lauderdale. Turning to our financial results, as expected, due to preparation for and completion of the closing of our U.S. Bank acquisition on August 30, there was a significant amount of noise in the fourth quarter that impacted our earnings numbers. We have done our best to describe and quantify those to provide a clear picture of the continuing underlying strength of our business model. John will describe these in more detail in a few minutes, but at a high level, these fall into three buckets, which in aggregate total approximately CAD5.6 million for the quarter and CAD6.5 million for the year, and tax adjusted reduced EPS by an equivalent of CAD0.18 for the quarter and CAD0.20 for the year. These were one-time non-interest expenses, a change in the base of the acquired assets of VersaBank USA and the impact of holding higher and typical cash balances ahead of the acquisition and funding of the U.S. bank upon close of the acquisition. We are also, for the first time, providing fully segmented financial results that is broken out by Canadian banking operations, our U.S. banking operations, and DRT Cyber. We believe this provides a clearer view of the profitability, efficiency, and return on common equity of the existing Canadian banking business, while also allowing you to not only definitively track the growth of our receivable purchase program portfolio in the U.S., but also see the greater efficiency that we expect from that business as it wraps up. When we remove the noise associated with the acquisition, the underlying story for the fourth quarter is pretty straightforward and importantly paints a very positive picture heading into 2025 and the ramp up of our U.S. RPP business. Q4 saw yet another record high of total assets at CAD4.8 billion. Driven by 15% year-over-year growth in our Canadian RPP business, which expanded by 2% sequentially, even as discretionary spending in Canada generally remains soft. Growth continued to dampen by higher than typical putbacks of loans that have gone 90 days in arrears to our partners, due to higher defaults among the borrowers, as would be expected in these tougher economic times. As we've made whole on these loans through our cash holdbacks, this higher rate of putback to our partners has no impact on our provisioning for credit losses, which for Q4, as it always is, was minimal. Non-interest expenses were atypically high due to one-time costs associated mainly with the U.S. acquisition. We expect to return to normalized non-interest expenses in the first quarter of 2025 with the addition of the U.S. bank expenses, including the new leadership team. As it has been for nearly two years, net interest margin was dampened by the atypically inverted yield curve, which lowers our margin as we raise deposits in the short end of the curve and lend further out on the curve. We are now seeing yield curve flattening and are very encouraged by this trend. Net interest margin was also impacted by the one-times noted above. We feel good about the direction of our net interest margin in 2025, especially as we start to add U.S. RPP loans, where we expect to realize a meaningfully higher spread. For the year, we generated record net income excluding the one-time impacts of the U.S. acquisition, driven by the strong growth in our Canadian point-of-sale receivable purchase program. You can see that reflected in our efficiency ratio and our return on common equity. We expect to see new records for all of these metrics next year based on the continued growth of our RPP in Canada and the ramp-up of the RPP in the United States, as well as a couple of other meaningful opportunities that we'll discuss in a few minutes. I'd now like to turn the call over to John to review our financial results in detail. John?

John Asma, CFO

Thanks, David. Before I begin, I will remind you that our full financial statements and MD&A for the fourth quarter and full-year are available on our website under the Investor Section, as well as on SEDAR and EDGAR. All of the following numbers are reported in Canadian dollars, as per our financial statements, unless noted. Starting with the balance sheet, total assets at the end of the fourth quarter of fiscal 2024 grew 15% year-over-year and 7% sequentially to a new high of CAD4.8 billion. Cash and securities were CAD525 million or 11% of total assets, up from 7% in Q4 last year and 9% in Q3 of this year. Book value per share increased to a record CAD15.35. Our CET1 ratio was 11.24% and our leverage ratio was 7.38% with both remaining above our internal targets. Turning to the income statement. As David described, there were a number of one-time items mostly related to the U.S. Bank acquisition that impacted the fourth quarter and the full-year results. A number of one-time non-interest expenses, the expense of a deferred tax asset due to a change in tax base of the acquired assets of VersaBank USA, maintaining higher than typical cash balances ahead of the closing of the acquisition, which was exacerbated by the impact of a temporary dampening of net interest margin that usually occurs when interest rates decline and CAD90 million in funding provided to VersaBank USA at closing of the SBH acquisition. Total consolidated revenue was CAD27.3 million, compared to CAD29.2 million last year. The year-over-year difference was driven primarily by lower non-interest income from the Bank's cybersecurity operations DRT Cyber, but was also impacted by higher cash assets associated with the funding of the U.S. Bank. Consolidated non-interest expense was CAD19.4 million, compared to CAD12.4 million last year and CAD13.5 million for Q3 of this year. The quarter included CAD3.3 million in one-time costs that were mostly associated with the U.S. Bank acquisition. The CAD3.3 million brought total acquisition related one-time costs for the year to CAD3.7 million. As a reminder, DRT expenses are included in our consolidated non-interest expenses and totaled CAD2.6 million and CAD9.4 million, up for the quarter and year, respectively. Finally, as David noted, we will see non-interest expenses return to a normalized level in Q1. Excluding one-time non-interest expenses and other one-time impacts, consolidated net income for the quarter was CAD10 million or CAD0.38 per share and consolidated net income for the year was CAD45 million or CAD1.69 per share. Looking at our digital banking operations, which with the close of the U.S. acquisition on October 30 now consists of our Canadian banking operations and our U.S. banking operations. As David mentioned, these are broken out in our press release and MD&A, but for the sake of brevity, I will discuss the combined results as the U.S. banking operations had limited positive contribution. Our loan portfolio grew to a new record of CAD4.24 million at the end of Q4, driven once again by our point-of-sale receivable purchase program, which increased 15% year-over-year or 2% sequentially to CAD3.3 billion. Our RPP portfolio represents 78% of our total loan portfolio at the end of Q4, down from 80% at the end of Q3. As David noted, RPP growth was dampened for both periods due to higher amount of putbacks. Our real estate portfolio contracted 12% year-over-year to CAD788 million as we continue to transition the portfolio towards CMHC insured loans. We are starting to see a ramp up of the program, which drove a 6% sequential increase in the real estate portfolio. We currently have commitments of close to CAD600 million with the loans outstanding of over CAD210 million, which continues to grow monthly, almost doubling since the end of Q3. As a reminder, our real estate portfolio is primarily business-to-business mortgages and construction loans for residential properties. We have little exposure to commercial use properties. Turning to the income statement for our digital banking operations. Net interest margins on loans, that is excluding cash and securities, was 2.34%, which was 35 basis points or 13% lower on a year-over-year basis and 7 basis points or 3% sequentially, mainly the result of an atypical inverted yield curve adversely affecting point-of-sale margins and the change in the real estate portfolio to CMHC insured loans. Net interest margin, including the impact of cash and securities and other assets was 2.12%, which was impacted by the higher cash balances, as well as the CAD90 million in capital provided to U.S. digital banking operations from the Canadian digital bank. Net income, excluding one-time impacts for the digital banking operations for the quarter was CAD10 million or CAD0.38 per share. Net income for the Canadian banking operations was CAD9.5 million or CAD0.36 a share. And net income for the U.S. banking operations, which for the quarter includes the contribution of only the acquired Stearns Holding for Bank operations, was CAD0.5 million or CAD0.02 per share. Turning to our credit losses. Our provision for credit losses or PCL in Q4 remained negligible at negative 0.01% on average assets, compared to negative 0.02% last year and with a 12-quarter average of 0%. I'd now like to turn the call back to David for some closing remarks.

David Taylor, CEO

Thank you, John. 2025 is shaping up to be another year of growth for our loan portfolio and profitability, which will enhance our efficiency ratio and return on common equity as we leverage our business model. Our Canadian digital banking operations have a solid foundation, and we take pride in leading publicly traded banks in net interest margin, especially since we don't account for loan losses. We anticipate steady growth in Canada, with our receivable purchase program expanding alongside 2024, and potential upside if interest rates continue to decline as expected. Additionally, we expect our growing CMHC insured loan business to contribute positively to our opportunistic real estate portfolio. These zero risk-weighted loans require no capital and yield a favorable spread. We also foresee the continuation of several positive trends supporting net interest margin. As mentioned earlier, the yield curve appears to be flattening, which will be beneficial for the spread of our RPP loans. Moreover, our low-cost insolvency professional deposit business in Canada is likely to have a positive impact as bankruptcies trend upward. We are aggressively pursuing opportunities in the U.S. RPP market, transitioning our first U.S. partners from our pilot program to the First Bank USA balance sheet. Importantly, we expect to add our first partner post-acquisition soon, with more to follow. Finalizing contracts and onboarding new partners takes time, but we anticipate a faster pace of additions moving forward. Our pipeline is robust, and discussions with potential partners indicate that our RPP is perceived as a unique and attractive solution for financing significant purchases and services at the point of sale. To support the expected ramp-up in 2025, we announced the transition of the team responsible for our Canadian RPP to focus on U.S. opportunities. Nick Kristo will serve as Chief Credit Officer for the U.S., and Mike Dixon will be the SVP of RPP in the U.S. They have been vital to our RPP growth in Canada for the past 14 years, achieving a compounded annual growth rate of 27% over the last five years, totaling more than CAD9 billion in financings for point-of-sale lenders, with no losses. They join an experienced team that will be crucial as we scale up the U.S. RPP program in the significant U.S. point-of-sale market. Overall, we expect the efficiency of our U.S. RPP business to surpass what we currently achieve in Canada, owing to reduced personnel needs on both the deposit and lending fronts. We have robust capabilities in Canada and are pleased to announce David Thoms as SVP of point-of-sale financing at VersaBank Canada and Saad Inam as Chief Credit Officer at VersaBank Canada. We will expand our U.S. RPP business as rapidly as our balance sheet allows. Given the expected high demand, we will initially syndicate our RPP loans to U.S. banks. This model allows us to earn our typical RPP spread on the loan's portion, with our partner receiving a similar spread on their part, plus a fee estimated at around 1% from our partner banks. Cash holdbacks will remain on our balance sheet, and the risk profile remains unchanged, bringing in some diversification regarding our partners. Consider this as VersaBank effectively white labeling RPP to enhance profitability. Moreover, we anticipate the RPP spread to potentially be up to 1% higher in the U.S. compared to Canada. Before we proceed to questions, I'd like to mention that our cybersecurity firm, DRT Cyber, has developed what we believe is the world's first and most secure digital vault, VersaVault, and what we think are the first digital deposit receipts issued by banks. These technologies have significant value, enabling U.S. banks to offer cutting-edge access to the emerging landscape of digital commerce. We are optimistic about the favorable stance of President-elect Donald Trump and his proposed administration concerning digital currencies and what it will imply for our Made in America solution. Our digital deposit receipts operate on Algorand, Ethereum, and Stellar Blockchain and are SOC 2 Type 1 compliant using VersaVault. Now, I would like to open the floor for questions.

Operator, Operator

Thank you, Mr. Taylor. Your first question will be from Tim Switzer at KBW. Please go ahead.

Tim Switzer, Analyst

Hey, good morning, guys. Thank you for taking my questions.

David Taylor, CEO

Good morning, Tim.

Tim Switzer, Analyst

Did you provide an update on how the conversations with new partners in the U.S. are going? And how many partners should we expect to be, kind of, fully launched over the next few quarters?

David Taylor, CEO

Well, we have very productive discussions with one U.S. Bank as a partner. And we've tested the data flow. It works exceptionally well. So we'd expect very soon to have our first RPP new point-of-sale partner. And we'll also have a partner bank sharing in those loans. So, I said imminently, and we're just in the paperwork stage where the lawyers are working as quickly as they can to finalize that. With respect to additional partners, there's been about 30 or so that we've been talking to, and I think the constraint has just been how fast we're going to be able to do the paperwork to sign them up.

Tim Switzer, Analyst

Okay, great. And, you know, related to that, how should we think about the origination trajectory in the U.S. and the balance sheet growth over the course of the year? Is it a gradual acceleration, kind of, evenly each quarter or is there a point in the year where you think it really starts to significantly pick up?

David Taylor, CEO

Well, it's sort of quantum jumps in growth depending on how fast we're signing up partners. Right now we're looking to have on balance sheet about CAD250 million by the end of the year and that would be sharing at least 50% with other banks. So in total, as the administration about CAD500 million and it may grow a lot faster depending on how quickly we can get the paperwork done.

Tim Switzer, Analyst

Okay. And if I can get one more, please. What is the expense outlook for next year? Once we exclude some of the one-time rates you guys reported, are most of the costs associated with running the U.S. business now in the run rate, or is there kind of another lift to the expense base of some of these customers?

David Taylor, CEO

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

Tim Switzer, Analyst

Perfect. Okay, that's all for me. Thank you, David.

David Taylor, CEO

Thanks, Tim.

Operator, Operator

Next question will be from David Feaster at Raymond James. Please go ahead, David.

David Feaster, Analyst

Hi. Good morning, everybody.

David Taylor, CEO

Good morning, David. I'm enjoying this sunny day today, thankfully.

David Feaster, Analyst

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

David Taylor, CEO

Well, we built it. It's called AMS 3.0, that's short for Asset Management System 3.0. Canada, we use AMS 2.0. It's in the cloud facility in Des Moines, Iowa, at the Azure Facility, and it's fully functional. It's also on the syndication side, and it's also able to parse each individual loan to the component parts, so that we'd retain it on our balance sheet and our partners would retain it. So that's all set to go. We're just waiting for the finalized documentation for the first brand new point-of-sale partner. Hopefully, that's very soon. And then the data starts to flow, representing the loans being parsed for us and for our first community bank partner.

David Feaster, Analyst

Okay, and then you touched on some of the differences too between kind of the small ticket opportunity and the larger ticket opportunity? I'm curious maybe, where are you focused in the U.S. currently? Like where do you see the most opportunity here? Is it in the smaller ticket or maybe some of the larger stuff?

David Taylor, CEO

Our software can handle small loans, but we really focus on larger items like home improvement projects and new HVAC systems. I believe the situation in the United States is similar to what we see in Canada, where about 50% of our point-of-sale portfolio is dedicated to home improvement.

David Feaster, Analyst

Okay. For my last question, you mentioned a 100 basis point better spread in the United States. Do you see more opportunities? Is that coming from the funding side or the loan yield side? Also, regarding the funding side, you mentioned the election and potential tailwinds from digital currencies. I'm interested to know if there's any consideration of bringing back CADV in relation to that opportunity?

David Taylor, CEO

Well, good point. We've seen on the test market we did in the United States, we got better yields, and we got lower cost of funds to give rise to that approximately 1% additional spread. So it was both on the yield and on the funding side. With respect to DRTC's technology that we announced about four years ago, we’re quite proud of it. We have what we call VUSD and VCAD, our digital deposit receipts on Algorand, Stellar, and Ethereum. We had it SOC 2 reviewed and obtained SOC 2 Taiwan rating. So that technology is all set to go. But as Paul Masson, as George Orwell said, no wine before its time. I find the regulatory environment wasn't mature enough to receive that product, but it appears with the Trump appointing or pending appointees, it looks like a favorable environment for digital commerce that this product that we have that’s been tested and is actually fully functional would be wonderful for the smaller financial institutions in the United States to use. And we're ready to provide that service for them. With respect to our own bank, we have such wonderful access to cheap deposits through the large brokerage firms. There isn't a lot of need for us to adopt that. We have our work cut out for us to expand the RPP program, but DRT Cyber could provide that service to other small banks, community banks that don’t have this water flux as we do to very cheap funding. So it’d be a product for DRTC and sometime in the future it may be something that our U.S. bank adopts too, but there isn't any burning need for our bank to adopt it.

David Feaster, Analyst

Okay, and then maybe if I could squeeze one more in, you touched about increased putbacks to your partners in Canada, and we're really validating your business model and that's great, you've had no credit issues, but I'm curious, maybe how has this impacted the partners in Canada and the health of their balance sheet and their ability to absorb those losses so far?

David Taylor, CEO

Well, to be positive, Dave, our partners have managed to handle the situation effectively. We focus on collaborating with the strongest point-of-sale partners available, and they have been navigating these challenges. Some people in Canada are referring to it as a recession, and given that our trustee deposits have risen by 20% year-over-year, which corresponds to a 20% increase in bankruptcies, it appears we might be experiencing a recession. However, our partners have remained resilient and are looking forward to a potential decrease in the overnight rates from the Bank of Canada that could be announced on Wednesday. Overall, our model has performed exceptionally well, although growth has been slow, and we are facing record high putbacks this year. Our partners appear to be in good health, and if the Bank of Canada reduces rates as many are anticipating, that could help restore an upward sloping yield curve similar to the one where we were achieving around 300 basis points in interest margin. So, stay tuned, and I hope Wednesday brings good news for the Canadian economy.

David Feaster, Analyst

That's great, color. Thanks, everybody.

David Taylor, CEO

Thank you.

Operator, Operator

Next question will be from Andrew Scutt at Roth Capital Partners. Please go ahead, Andrew.

Andrew Scutt, Analyst

Hey, good morning, guys, and thanks for taking my questions. First one for me, you guys saw a return on growth in your CRE portfolio. I know you guys have been recently, kind of, right-sizing that portfolio, maybe changing up the mix? Can you kind of talk about how you feel about the portfolio where it is now and then maybe provide some additional color on the CMHC portfolio?

David Taylor, CEO

Absolutely. So this portfolio is almost all composed of loans on residential properties and there's two types. One, we call conventional loans. So these are the normal loans that banks have made over the years that are risk-weighted fairly highly. Those can be multi-family, normally construction, apartment block construction, and some low-rise. And because of the high-risk weighting and there's a little additional risk involved. We're running a loan to value ratio around 60% on these. We pivoted over to CMHC insured construction mortgages. These are wonderful in that they're 0% risk-weighted, so don't absorb any CET1 capital and match really nicely against our floating rate trustee deposits. On average, we pay about, say, prime minus 285 on those, and we earn maybe prime minus 20 on the CMHC. So we're making about a 265 basis point spread on a zero risk-weighted asset, no capital required. That's the portfolio that John talked about that we have a CAD600 million right now in committed facilities to draw down in 2025, almost double that we had last quarter. We're looking at probably that figure increasing by the end of 2025, say to CAD1.5 billion or maybe even CAD2 billion. So it's a really wonderful opportunity for us to help with the construction in Canada, but not take hardly any risk because they're government insured and we get a really good rate of return.

Andrew Scutt, Analyst

Great. Well, thank you for the additional color. And then second one for me, you've kind of expanded on this earlier, but you know as you look out in 2025, can you kind of just talk through the pipeline of business activity for DRTC?

David Taylor, CEO

Well, DRTC's cybersecurity business has been growing quite by the sign-up of new customers quite dramatically. We've had some really big well-known names and the revenue hasn't flowed into the statements yet, but not all of it is starting to come in. So this increased demand for DRTC cybersecurity product amongst the big players, the brand name retailers and other financial institutions. But the product that we have in DRTC that we just sort of kept under wraps for a while, pending a more favorable regulatory environment, is the ability to issue digital deposit receipts. So this is state-of-the-art. And I was just at a conference where a very smart individual pointed out there's a huge difference between a stablecoin that's backed up by an asset or a deposit held by somebody else and an actual digital deposit receipt, which represents the deposit held by a real bank. We've developed this technology about four years ago and approved it all out and tested it and had it audited. We just kept it on the shelf until the right time. But it looks like it is the right time. So we could host this for thousands of community banks in the United States and bring them to this new state-of-the-art way to raise deposits, let their customers have the deposits in e-wallets and such, and conduct business in almost negligible fees and it's almost instantaneous. It's a state-of-the-art payment vehicle, state-of-the-art deposits. For example, say you bought Bitcoin at CAD1,000 and you see that CAD100,000 and you'd like to swap it into a bank deposit. Well, that can be done seamlessly in your e-wallet with our VUSD product or VCAD courtesy of our technology and our VersaVault. I think the time is right. I was quoting George Orwell long back saying, no wine before its time. That's why we just did promote it or just kept it on the shelf, because the regulatory environment had to mature and regulators had to get the rules in place. I think regulators would like banks to issue these types of products rather than the unregulated entities that have in some cases got into trouble in the past. So it's a service for DRTC to provide, and I'm pretty excited about it. I think it's something that a lot of community banks will want to take us up on.

Andrew Scutt, Analyst

Alright, yes, that sounds like a wonderful opportunity. Congrats on the growth and thanks for taking my questions.

David Taylor, CEO

Well, thank you, Andrew. Look forward to talking to you later on.

Operator, Operator

Alrighty. Well, I'd just like to thank everybody for joining the call and look forward to talking to you at the end of the next quarter. Stay safe and so long. I'll have to put some suntan lotion on here. Being a cloud-based bank and a U.S. operation now, I've got the luxury of operating anywhere in North America. And today it's a very sunny day in Lauderdale. Thank you. Bye. Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we ask that you please disconnect your lines.