VersaBank Q4 FY2024 earnings call

Key managerial messages: - The U.S. bank acquisition caused noise in Q4 earnings, with one-time non-interest expenses, changes in the tax base of acquired assets, and higher cash balances. - Total assets reached CAD4.8 billion in Q4, driven by a 15% year-over-year growth in the Canadian RPP business despite soft discretionary spending in Canada. - Non-interest expenses were atypically high due to U.S. acquisition-related one-time costs, expected to normalize in Q1 2025. - Net interest margin was affected by an inverted yield curve and acquisition-related factors, but expected to improve in 2025 with the ramp-up of U.S. RPP loans. - Record net income excluding U.S. acquisition impacts was driven by strong growth in the Canadian point-of-sale receivable purchase program. - The real estate portfolio contracted year-over-year but started ramping up CMHC insured loans with commitments near CAD600 million.

The segment performance includes: Canadian Banking operations saw loan portfolio growth to CAD3.3 billion via the point-of-sale receivable purchase program, with a 15% year-over-year increase and 2% sequential growth; RPP represents 78% of the total loan portfolio at the end of Q4. U.S. Banking operations had limited positive contribution in Q4, with loan portfolio growth impacted by acquisition-related factors. DRT Cyber expenses totaled CAD2.6 million in the quarter and CAD9.4 million for the year, included in consolidated non-interest expenses.

Management guidance includes: - Expect non-interest expenses to return to normalized levels in Q1 2025. - Anticipate new records in efficiency ratio and return on common equity in 2025 due to continued growth of the RPP in Canada and the U.S., as well as other opportunities. - The U.S. RPP business is expected to benefit from greater efficiencies, with plans to initially syndicate loans. - Encouraged by the favorable stance on digital currencies under the proposed Trump administration for DRT Cyber's digital deposit receipts.

Risks discussed include: - Uncertainties related to the regulatory environment for DRT Cyber's digital products. - Potential material differences between forward-looking statements and actual results due to various risks and uncertainties. - Impact of economic conditions on loan putbacks and the balance sheets of partners.

Q: Could you provide an update on how the conversations with new partners in the U.S. are going and how many partners we should expect to be fully launched over the next few quarters?

A: We have very productive discussions with one U.S. bank as a partner. We've tested the data flow and it works exceptionally well. We'd expect very soon to have our first RPP new point-of-sale partner and also a partner bank sharing in those loans. With respect to additional partners, there's been about 30 or so that we've been talking to, and the constraint has just been how fast we're going to be able to do the paperwork to sign them up.

Q: What is the expense outlook for next year? Once we exclude some of the one-time items 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?

A: 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 about the heavy hitters are already on board.

Q: Given the growth governors on the U.S. expansion, where are you in the build out in that process and the platform and whether you've started to test that yet?

A: We built it. It's called AMS 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, 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.

Q: Where are you focused in the U.S. currently? Like where do you see the most opportunity here?

A: It's mainly the larger stuff, although our software is capable of dealing with tiny loans too. But the sweet spot is the larger ticket items such as home improvement, new HVAC systems, that sort of thing. That’s -- I think United States would be quite similar to what we experience in Canada about 50% of our point-of-sale portfolio is home improvement.

Q: Do you see more opportunity in the spread difference in the States, and any interest in bringing back CADV in that opportunity?

A: 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. It’s -- I find the regulatory environment wasn't mature enough to receive that product, but it appears with the Trump appointing or pending appointees and it looks like a favorable environment for digital commerce that this product that we have that's been tested and actually fully functional would be sort of wonderful for the smaller FIs in the United States to use. And we're at your cheese stands 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 some -- 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, the 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.

Q: You touched about increased putbacks to your partners in Canada, and how has this impacted the partners in Canada and the health of their balance sheet and their ability to absorb those losses so far?

A: Well, to touch wood, Dave they've all been able to do that. We tend to pick the strongest point-of-sale partners we can and they've been dealing with it. It's sort of the inevitable downturn some people in Canada are calling it a recession and considering our trustee deposits have increased by 20% year-over-year, that's a big number for -- that's a 20% increase in bankruptcies. We probably are in a bit of a recession. But our partners have stood up and to be fine. They're all sort of eagerly awaiting perhaps a jumbo decrease in the overnight rates for the Bank of Canada that might be announced on Wednesday. So generally speaking, our model has held up wonderfully and it's just slow growth with a record high putback this year. And our partners seem to be in good shape and if the Bank in Canada drops the rates as people are hoping and predicting, then that might return us to that upward sloping yield curve again where we were scoring about 300 basis points in that interest margin. So sort of stay tuned. I hope Wednesday is good news for the Canadian economy.

Q: You guys saw a return on growth in your CRE portfolio. Can you talk about how you feel about the portfolio where it is now and provide additional color on the CMHC portfolio?

A: 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’s 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 the government insured and get a really good rate of return.

Q: Could you talk about the pipeline of business activity for DRTC?

A: 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 the 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. And we 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 1,000s 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 [trans like] (ph) 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 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. And I think time is right, I was quoting George Orwell long back saying, no wine before it's time. And 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. And 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.