VersaBank (NASDAQ:VBNK) Q1 2023 Earnings Call Transcript

VersaBank (NASDAQ:VBNK) Q1 2023 Earnings Call Transcript March 8, 2023

Operator: Good morning, ladies and gentlemen. Welcome to VersaBank’s First Quarter Fiscal 2023 Financial Results Conference Call. This morning, VersaBank issued a news release reporting its financial results for the first quarter ended January 31, 2023. 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 this morning’s conference call. The webcast is listen-only. If you are listening on 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 provided 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 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 Mr. David Taylor, President and Chief Executive Officer of VersaBank. Please go ahead, Mr. Taylor.

David Taylor: Good morning, everybody, and thank you for joining us for today’s call. With me today is Shawn Clarke, our Chief Financial Officer. Before I begin, I’d like to remind you that our financial results are reported and will be discussed on this call and our reporting currency of Canadian dollars. Those interested, we provide U.S. translations for most of our financial numbers in our standard investor presentation, which will be updated and available on our website shortly. Now to the results. The first quarter was not only another record quarter for VersaBank, but more importantly, one that was demonstrative of the true efficiency and return on equity generating capability of our branchless business to business digital banking model.

And once again, this was complemented by the continued profitable contribution of our cybersecurity services business. Our digital banking operations contingency very strong year-over-year growth in our loan portfolio at 46%. Which drove our portfolio, to an all-time high of just under $3.25 billion. Growth was again driven primarily by Canadian point of sale loan and lease portfolio, which was up 68% from Q1 last year. The combination of loan growth and stable net interest margin drove record revenue and record interest income. On the cost side, as we anticipated the transitory costs related to growth in investments and our move to NASDAQ that temporarily elevated our noninterest expense and dampened our profitability in 2022 substantially normalized in the first quarter.

Putting our efficiency ratio back on track towards its full potential. We continue to expect further normalization as our noninterest expense and importantly, we haven’t only barely begun to realize the growth contributions of those investments we made last year. All this drove by far our best quarter ever in terms of net income and EPS. They for one outside quarter for net income in 2017 due to an accounting recognition when VersaBank amalgamated with PwC capital. Net income grew 69% year-over-year to $9.4 million, besting our previous record of 6.4 million by a full $3 million. And EPS grew 79% or $0.15 year over year to $0.34. Looking more closely at our performance, as I noted a moment ago, the first quarter financial results were marked once again by our best ever revenue, net interest income and net income and earnings per share.

Outside of these record results, there are three metrics that I’d like to highlight. The first is our net interest margin. It’s important to note that we have generated loan growth while maintaining our overall net interest margin and without taking on additional risk. This is something relatively unique compared to our peers. The second is our efficiency ratio. Now that we are through the bulk of our transitory costs for our strategic growth initiatives, that’s the truth, scalability and efficiency of our model is emerging. The third earnings per share growth, which outpaced net income growth as a result of our active share repurchase program. As we look ahead, in addition to the continued growth, we expect in our Canadian loan portfolio, we expect to generate significant long-term growth from our launch of the United States receivable purchase program.

This is our high value add financing offering for consumers and small business lenders. Based on our proprietary technology that provides them with a regular, reliable, inexpensive funding alternative to help them succeed in their businesses. As I discussed in our last quarterly call, this acquisition is transformational. The next step and VersaBank’s long-term growth strategy that will enable us to bring our track record of innovative digital banking solutions to address unmet needs to one of the world’s largest bank markets. We have launched this program on a limited basis in United States have the broad national rollout plan upon completion of the acquisition of the Minnesota based Stearns Bank Holdingford a fully operational OCC, Chartered National U.S. Bank.

Specifically, this acquisition will enable us to broadly rollout our receivable purchase program to the underserved U.S. market, which has been so successful in Canada, where we call it our point-of-sale financing business. In December, we submitted the requisite filings to the OCC and the reserves seeking approval of the acquisition and baseline continuing dialogue. We remain optimistic with respect to near term approval. In terms of an update on timing, which is ultimately the discretion of our regulators on both sides of the border. We anticipate receiving a decision the respect for its approval of the proposed application from the U.S. regulators during the second quarter of the calendar 2023. And as favorable, we will proceed to complete the acquisition as soon as possible subject to Canadian regulatory approval.

In the interim, we continue to actively prepare for this significant opportunity to bring our differentiated and attractive financing solutions to U.S. partners. Topic of U.S. Receivable Purchase Program, or RPP. Our U.S. portfolio continues to expand with loans now nearly 44 million. As I discussed in our last call, we have limited aborning of loans head of the fulsome rollout upon completing the U.S. acquisition. And in fact, command to date has continued to outstrip our self-imposed short term capacity restrictions. Very comfortable with our progress and with a revised expectations for completion, we have made the decision to ramp up our U.S. RPP zones ahead of closing the acquisition — in this moment. I’d now like to turn the call over to Shawn to review our financial results.

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Shawn Clarke: Thanks, David. Before I begin, just a quick reminder that our full financial statements and MD&A for the first quarter are available on our website or the investor section, as well as on SEDAR and EDGAR. And as David mentioned, all the following numbers are reported in Canadian dollars as per our financial statements, unless otherwise noted. Starting with our balance sheet, total assets at the end of the first quarter of fiscal 2023 were just over 3.5 billion, up 46% from 2.4 billion at the end of Q1 last year, and up 8% from 3.3 billion at the end of fiscal 2022. Cash and securities at the end of Q1 were 251 million or 7% of total assets compared with 155 million or 6% of total assets at the end of Q1 last year at 203 million or 7% of total assets at the end of fiscal 2022.

Our total loan portfolio at the end of the first quarter expand to another record balance at 3.24 billion, an increase of 46% year-over-year, and 8% sequentially. I’ll break this out into its component parts in a moment. Book value per share increased 8% year-over-year and 3% sequentially to another record at $12.77. These increases reported function of higher retained earnings resulting from net income growth, partially offset by dividends paid and also benefited from the lower number of outstanding shares as a result of our active share buyback program. Our CET1 ratio was 11.2% down from 14.8% at the end of Q1 last year, and down from 12% at the end of fiscal 2022 or leverage ratio at the end of Q1 of this year was 9.21% down from 12.7% at the same point last year and 9.8% at the end of fiscal 2022.

Both of our CET1 and leverage ratios remain well above our internal targets. Turning to our income statement. Total consolidated revenue increased 42% year-over-year and 7% sequentially to a record 25.9 million with the increase driven primarily by higher net interest income derived from our digital banking operations resulting from the strong growth in our loan portfolio that I mentioned earlier, and the maintenance of our net interest margin. Consolidated net income for Q1 increased 69% year-over-year and 46% sequentially to a new record 9.4 million, excluding Q1, 2017, which is attributed primarily to a one-time recognition of deferred income tax assets pursuant to the amalgamation of VersaBank with PwC capital as David mentioned earlier.

In addition to the growth in net interest income as expected noninterest expense substantially reduced year-over-year and sequentially as a transitory costs related to our strategic investments in several strategic growth initiatives, including the U.S. Bank acquisition and the launch of the receivable purchase program in the U.S. rolls off. Consolidated earnings per share increased 79% year-over-year and 48% sequentially to $0.34, with the increase benefiting from strong earnings and the lower number of outstanding shares due to our active share repurchase program. During the first quarter, we were purchasing cancelled just over 822,000 shares bringing the total number of shares purchased under the NCIB as of the end of Q1 to just over 1 million.

Primary driver of growth in our loan portfolio was once again our point-of-sale financing business, which increased 68% year-over-year and surpassing the 2.4 billion mark just continue to be driven, this growth continued to be driven mainly by strong demand for home, home improvement, HVAC and our receivable financing. As we noted on our last call, although we expect very healthy growth from our point-of-sale business in 2023, we won’t see the same outsized growth as last year. Q1 of this year saw a sequential growth in the point of sale portfolio of 9% relative to Q4 of last year and we believe sequentially, quarterly growth in the same range throughout the remainder of the year is achievable is consumer spending in the sectors on which we focus remains active.

Our point-of-sale portfolio represents 75% of our total loan portfolio as of the end of Q1, which was unchanged from the end of fiscal 2022. Our commercial real estate portfolio was expanded 5% year-over-year and 6% sequentially to 807 million at the end of Q1. As discussed in our last several quarterly calls. We have taken a more cautionary stance with respect to our commercial lending portfolios to the expected volatility and valuations in this asset class in a rising interest rate environment as well as concerns led to higher construction costs resulting from supply chain disruptions in a very tight labor market. That said, we are seeing healthy demand for our construction term financing products in the form of very high-quality deal flow.

We expect this to continue throughout to 2023. We remain very comfortable the risk profile of our commercial real estate portfolios based on our criteria working only with well-established well capitalized development partners to demonstrate excellent track records and of course, restricting transaction to modest loan to value ratios. Turning to the income statement for our digital banking operations net interest margin on loans that is excluding cash security and other assets decreased 20 basis points or 6% year-over-year, but was unchanged sequentially at 3.03%. Year-over-year decrease was due mainly to a shift in the bank’s funding mix combined with rising interest rates or the respective periods offset partially by generally higher yields or normal lending portfolio.

And this is margin overall which includes the impact of cash securities and other assets. Increased 6%, or two big, sorry, increased 6 basis points or 2% year-over-year, and 2 basis points are slightly less than 1% sequentially to 2.83% this is attributed to higher yields earned on lending and treasury assets offset partially by higher cost of funds. Now interest expenses for Q1 are 12.3 million compared with 10.6 million for the same period of 2022. However, down meaningfully from the elevated levels of 13.8 million for Q4 2022. The year-over-year increases due mainly to higher salary and benefits costs resulting from an increase in staffing levels to support expanded revenue generating business activity across the entire bank. Higher costs related to employee retention to very tight labor market and higher cost way to investments in the bank’s business development initiatives.

Offset partially by lower insurance premiums attributed adverse events listed on the NASDAQ September 2021, as well as lower capital tax expense. The sequential decrease is due to the expected significant reduction in transitory costs related to strategic growth investments, and our listing on NASDAQ that David and I both mentioned earlier, as well as lower capital tax expense. Cost of funds for Q1 was 2.95% of 166 basis points year-over-year and up 50 basis points sequentially, but both increases due mainly to the larger proportion of Wealth Management Deposits relative to our lower cost and solvency professional deposits versus the comparative periods, as well as the general increase in marketing interest rates. Increasing our cost of funds remain significantly less than the Bank of Canada’s increasing the benchmark rate of 425 basis points to the beginning of fiscal 2021.

Insolvency professional deposits once again can track it slightly in Q1 on both the year-over-year and sequential basis to historically low bankruptcy activity Canada’s experienced primarily as a result of government support for both individuals and small businesses extended during the pandemic. Wealth management or what we refer to as personal deposits expanded 87% year-over-year 14% sequentially. They will talk a little bit more about our expectations around funding mix in just a moment. Our provision for credit losses or PCLs in Q1 once again evidence that prudent risk mitigation strategies inherent in our lending models and outstanding credit quality of our loan portfolio, especially evident given the product expansion and PCL ratio there appears are reporting.

Provision for credit losses for Q1 was 385,000, compared with a provision for credit loss of 2,000 in Q1 of last year, and a provision for credit losses of 205,000 for the fourth quarter of 2022. Sequential and year-over-year changes were a function primarily of changes in the forward-looking information used by the bank and its credit risk models, as well as higher lending asset balances. PCL is as a percentage of average loans for Q4 was 5 basis points and our average for the past 12 quarters was zero. Our PCL ratio who continues to remain one of the lowest in the Canadian banking industry. Turning now to DRTC. I would like to remind you that DBG’s gross profit amounts are included in DRTCs consolidated revenue, which in turn is reflected in non-interest income in VersaBank’s consolidated statements of income and comprehensive income.

DBG’s revenue for Q1 decreased 3% year-over-year and 19% sequentially 2.3 million as a function of lower service work volume in the current quarter. Historically, Q1 is softer for DBG attributed the impact of the slower holiday period which typically results in lower revenue generating activity. Gross profit, however, increased 70% year-over-year and decreased 6% sequentially to 1.6 million, with a year-over-year increase driven primarily by higher pricing on engagements, and improved operational efficiency. DBG remain profit on a standalone basis this quarter. DRTC consolidated revenue for the quarter that is including revenue generated through the provision of various technologies support and consultation services provide VersaBank digital banking operations increased 3% sequentially 29% year-over-year to 1.8 million.

DRTC recorded a net loss of just over $0.5 million compared to net income of 150,000 in Q1 last year, and net loss of just under $0.5 million in Q4 last year. The year-over-year trend was a function primarily higher interest expense is attributed to higher salary and benefits expense due to higher staffing levels to support expanded business activity and higher costs associated with employee retention invested current challenging labor market. And now let’s turn the call back to David for some closing remarks. David?

David Taylor : Thanks Shawn. As many of you know, I’m an avid pilot and we aviators have a term that describes the absolute best conditions for flying at being capital K, which means ceiling and visibility, okay. As I look out to the foreseeable future for VersaBank, we have capital K. Sidenote, I’m sitting here at London Airport looking out my window and today it is indeed capital K. Our comps for Canadian digital banking operations will benefit throughout 2023 from the outsized loan portfolio growth of 2022. And we continue to see sequential quarterly growth in the neighborhood of 8%. We expect net interest margin on loans to remain robust. We expect meaningful add for our loan portfolio through our U.S. receivable purchase program.

With each passing month, with more discussions with our existing and potential customers for our RPP offering in United States. We are more confident in the uniqueness and attractiveness of our offering. Case in point last week, we attended KBW, Fintech conference in New York City, providing us with an opportunity to discuss our solution with a number of potential partners, and the response was overwhelmingly positive. Although the approval process for our U.S. Bank opposition is taking longer than expected, it has not in any way changed our belief on the size of the opportunity. In the interim, we made the decision to expand our limited pre acquisition rollout to better capitalize on the near-term demand I described earlier. And as we await the opportunity for broad rollout, notably, we expect to generate a larger spread compared to Canada when we rolled it out broadly.

Last quarter, I discussed how I specifically designed VersaBank to perform well in good times, and even better in more challenging times. A core component of this model in addition to risk mitigation, being at the core of everything we do. It’s our high value insolvency professional deposit business. As a reminder, we have almost singularly addressed the unserved market opportunity to provide integrated technology to easily enable Bankruptcy Trustees to park deposits with us. We have the vast majority of the market for personal and small business bankruptcies in Canada. Insolvencies plummeted during the pandemic due to government financial support reduced consumer spending, and a halt to collection activity. Hitting a low of over 7,500 per month for the period April 2020 to February 2022.

This compares to an average over the two years preceding the pandemic of over 11,300 per month. As expected, we are now seeing those numbers begin to climb. Now up to 9,000 for January 2023, an obvious leading indicator with respect to our insolvency deposit growth. And we are now very recently seeing this flow through in terms of account openings and quite dramatically. At the same time, we are continuing to add new trustees and partners, further expanding our already impressive market share. This obviously bodes well for the low cost deposits moving forward. To conclude, as discussed at the outset of this call, we view our results for the first quarter. As clearly evidence of the operating leverage inherent in our branchless business to business digital bank you model the resulting return on equity generating capability.

We continue to grow our loan portfolio in Canada and add the significant additional long-term growth we extract in United States. We expect to continue to see the torque in our operating leverage. Notably, our U.S. receivable purchase program will be serviced by the same technology centers in London, Ontario and Saskatoon, Saskatchewan service, our Canadian point of sale portfolio, and essentially the same number of personnel that’s operating leverage. With that, I’d like to open the call to questions. Michelle.

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Q&A Session

Operator: Your first question will come from David Feaster at Raymond James.

David Feaster : I’m just wanted to start on appreciate all the color on the loan growth front. I just was hoping to get maybe some more detail on the U.S. expansion. Glad to hear you’re kind of going to be accelerating that. I’m just curious how, you’ve had good reception thus far. But how is demand in the states, the pipeline of new partnerships and just kind of the roadmap for the U.S. expansion? And maybe where do you think that portfolio gets to by the end of the year? I don’t know if you had any targets for that?

David Taylor: Well, David, that sort of thing in the comments, we had purposefully limited our lending activity in the United States pending receipt of the approval to acquire the Stearns Holding for bank. We just wanted to test the market and get the legal documentation in place and our internal systems in place. And that we did. And we were expecting that we would be able to operate the bank around now. So we just sort of slowed it down. But it looks like it’ll be a little longer before we’re able to operate the U.S. Bank. So we’ve made the decision to lend directly from our Canadian bank for the time being, so as not to lose the momentum that we’ve been gathering by talking to various potential partners. So to answer your question, there’s a huge number of points of well don’t call them point of sale financing states, but let’s call them receivable purchase program partners and United States that are really keenly interested in itching up to our program.

And, in fact, the saying of the last visit we had in New York City encouraged him KBW, I met many potential new partners who were very keenly interested in signing up. That’s why I made the decision to fund it from Canada for the time being, I didn’t want to disappoint them. And I like to keep the momentum going. We don’t have any year end targets. By quarter by quarter, you’ll start seeing it grow. And I expect, we’ll have the approvals. And then we’ll be able to really ramp up with the U.S. Bank.

David Feaster : And maybe touching on the CRE book, you talked about some of the cautiousness that you might have had past few quarters. I’m just curious, maybe what changed? Is it availability of credit, in the market, where are you seeing demand that provides good risk adjusted returns for you? And I mean, have you tightened underwriting standards in that segment at all?

David Taylor: Well, we operate with sort of a mantra, and it goes like this. Bad loans are made in good times. So quarter-over-quarter, you see me saying we’re being quite cautious, because we believed in quite rightly so that there was somewhat of a real estate bubbling cannon, probably all of North America, prices were way too high. And so we were very cautious in our lending during that period of time. Now we’ve seen the prices reset, and getting down to what we might call a recent reasonable pricing switch gives us a bit of comfort. And secondly, as usual, as soon as they are our tactic our competitors are usually licking their wounds around about this time from finding themselves over lent on various properties. So that’s the reason why the resurgence now in our optimism and the CRI portfolio, like a competition and pricing coming to reasonable levels.

And of course, we have the who’s who in the industry as clients. So it’s a typical for us, I’ve done this every coming out every recession in my 45 years being a banker.

David Feaster : And then maybe last one for me. I mean, you’ve been extremely active repurchasing stock we’re still trading well below tangible, you’ve got plenty of capital. I’m just curious your appetite for repurchasing stock here and how you think about capital when you’ve got such strong organic growth at the same time. Just curious, your thoughts on capital return capital priorities and yes, supporting the organic growth?

David Taylor: Well, we just love buying backer stock at these precious. I mean, it’s about, it’s the best invest and Warren Buffett said, his very best investment at zero risk, we buy it back, we get the return. I kind of doubt we’re going to have that opportunity much longer. I think the market probably wondered if we had something to do with the crypto industry and I got sort of treated the same way as others have. There’s no reason why our stock should drop below book. They’re kind of earnings. So this quarter, we sort of, I think, shaken that misconception off obviously our model is very powerful. It works extremely well and the earnings we’ve just produced her leave most of the industry in the dust. So I’d love to buy back keep buying back the stock, but I can’t see the stock stand on this level for much longer with these kind of numbers coming out.

David Feaster : Well, congrats on a great quarter. I appreciate all the questions.

David Taylor: Thanks David. Look forward to seeing you sometime in Florida. I’m still in the frozen north here but I hope to turn the airplane sell 180 degrees and head back.

David Feaster : It’s sunny and beautiful. So come on down.

David Taylor: My wife tells me that too.

Operator: Your next question will come from Mike Rizvanovic at KBW Research.

Mike Rizvanovic: I wanted to just ask a couple of quick questions on the numbers here. So first on the POS hold back, I think you’re down about 5.5%, you were, I think, well north of 10, or a little bit north of 10 in the depths of the pandemic. Do you have a blindness sight as to how low that number might go? And or any maybe ranges? Is it range bound? Can you get much lower from here? How do you sort of look at that number going forward?

David Taylor: Well, the number depends on the quality of the receivables that we’re purchasing. So it’s 100% dependent on the quality. So we don’t have any particular overall target it just by chance sort of settled in 10% for a while. The portfolio has or migrated over to lower risk assets. That might be something to do with the impending perhaps recession. We’re seeing less riskier assets than we did in the past, i.e., now, it’s moving towards home improvement type loans, which generally are a lot less riskier than, say, hot tubs and motorcycles and RVs, and that sort of thing. So we’re seeing a migration towards the lower risk asset classes, as consumers, maybe spend less in the what you call luxury items, items, they don’t really need to they really need a new motorcycle when a recession might be coming, maybe not.

But maybe we really need to look at our house and make sure it’s insulated property. And we’ve got a really energy efficient furnace. Now, that price furnace now that price energy costs are higher. So that’s the reason it’s just simply a lower risk portfolio than it was when times are buoyant.