Versabank (VBNK) 2021 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to VersaBank's Third Quarter Fiscal 2021 Financial Results Conference Call. This morning, VersaBank issued a news release reporting its financial results for the third quarter and year-to-date ended July 31, 2021. 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. Please note that in addition to the telephone dial-in, VersaBank is webcasting its earnings conference call live over the Internet.

The webcast is listen only. (Operator Instructions) 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 by both 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 statements about future events made on this call are forward-looking in nature and based on certain assumptions and analysis by VersaBank's 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.

Thank you, Colin, and good morning, everyone. And thank you for joining us for today's call. With me are Shawn Clark, Chief Financial Officer and Treasurer; and Brent Hodge, General Counsel and Corporate Secretary.

The third quarter once again saw the continuation of the momentum of our digital banking business as we delivered strong year-over-year growth in all key metrics and excluding the temporary dampening effect of our USD 75 million subordinate note issuance, strong growth sequentially in most metrics as well.

As discussed on our last call on April 30, we completed a private placement with U.S. institutional investors of NVCC compliant fixed to floating rate subordinated notes payable in the principal amount of USD 75 million. This tax deductible nondilutive regulatory growth capital with favorable terms, allowing us to take advantage of both the extremely low interest rates as well as our favorable debts and issuer rating of A- and A, respectively, assigned by U.S. rating agency, Egan-Jones.

As the note offering was completed on the last day of the previous quarter, it did somewhat temporarily dampened certain performance metrics for the quarter as we were paying interest on those notes ahead of putting the capital to work and interest-generating loans. Q3 and the ensuing months were highlighted by a number of significant operational achievements that will contribute to the continued growth of the bank going forward.

Most notably, we took a major step forward with our VCAD digital deposit receipts, initiating closed ecosystem testing. We relaunched our indigenous and remote community lending program and our cybersecurity subsidiary, DRT Cyber, entered into 2 reseller agreements as we continue to build our solution offering. I will discuss each of these more in a few moments.

Total revenue increased 27% year-over-year to $15.7 million. Net income increased 24% year-over-year to $5.4 million. Cost of funds decreased 18 basis points or 11% year-over-year to 1.41%. Net interest margin increased 8 basis points or 3% year-over-year to 2.61%. And I will note here that adjusting for the impact of the note issuance, net interest margin would have been 2.94%, which is in line with our recent historical net interest margins.

We are especially proud to have achieved this performance amidst the short-term dampening effect of our decision to raise regulatory capital at the end of the second quarter to support the significant opportunities to drive the continued growth of our loan portfolio. As that capital is deployed into interest-generating loans over the coming quarters, we expect net interest margin to return to historical levels and drive continued growth and profitability based on our larger loan portfolio.

As a reminder, as Tier 2 regulatory capital, we can deploy that USD 75 million more than tenfold that it represents nearly $1 billion in future loan value. To provide some perspective on the quarterly impact, our average cash balance during the quarter was approximately 13% of total assets compared with our historical range of 6% to 7%. This was still slightly elevated due to our very cautious stance at the start of the pandemic, although significantly less so than the prior quarter as we have continued to deploy that cash into new loans. The greater impact to gain was the USD 75 million subordinate note offering on the last day of Q2.

Turning to the balance sheet. You can see the continued growth in our total assets, which reached just shy of $2.3 billion at the end of the quarter, up 18% from the end of Q3 last year and 7% from the end of the second quarter. Our cash balance, including liquid securities at the end of Q3 was $297 million, which was down significantly from $354 million at the end of Q3 last year when we're still maintaining high cash balances out of an abundance of caution in the early months of the pandemic. It is, however, up from $272 million at the end of Q2 of the year as our continued deployment of cash was more than offset by the net USD 73 million of the additional cash from the net proceeds of the subordinate note offering less the preferred share redemption.

Adjusting for the note offering, our cash balance would have been approximately CAD 254 million, which includes the impact of the redemption of the Series 3 preferred shares on April 30. Finally, on the balance sheet book, value per share increased 7% year-over-year and 2% sequentially to $11.29.

Our CET1 capital ratio has continued to decline and was 11.94% for Q3, down from 12.52% for Q2 and 11.11% for Q3 last year. This is the result of leveraging our CET1 capital to grow our loan portfolio and drive return on equity. Our leverage ratio also declined 200 basis points year-over-year to 9.99%, again due to funding our loan portfolio. Both CET1 ratio and our leverage ratio are still well above our target ratios. The credit quality of our loan portfolio remains strong with no impaired loans, no loans and arrears.

Provisions for credit losses for Q3 increased to $96,000, mainly due to the larger loan portfolio. As a result, the bank's PCL ratio for Q3 increased to 0.02% from a negative 0.07% in Q2 when we recorded recovery of PCLs. I note that for the last 12 quarters, we have averaged a PCL ratio of 0.

Amidst the continuing evolution of the pandemic as well as some elevated geopolitical concerns, we continue to operate at a heightened level of diligence to ensure that our origination and underwriting practices remain highly disciplined and focused.

Q3 was another excellent quarter on the deposit side of our business and in fact, would have been another record low for cost of funds, absent the impact of the note offering. Including the note offering, our cost of funds was 1.41%, down 18 basis points compared to Q3 of last year. When excluding the note offering, cost of funds was actually down 3 basis points from Q2 to 1.25%. The decrease in cost of funding was again driven by the continued expansion of our insolvency professional deposits on which we currently pay 0% interest. Those increased to $598 million as of the end of Q3, up 7% from the end of Q2 as we continue to onboard deposits from new partners added over the last year.

And I will again note this quarter that our business continues to grow in what is relatively flat market for the types of personal and small business bankruptcies for which our partners rely on us.

Our success in continuing to lower our cost of funding is especially encouraging as we progress towards the commercial launch of our revolutionary digital deposit receipt VCAD, a highly secured digital deposit based on the bank's proprietary reversible technology and represented one-for-one by actual Canadian dollar deposits with our bank.

As I mentioned earlier, we have initiated closed ecosystem testing of VCAD to validate the security, processes, procedures and protocols. Essentially, we are conducting real-time transactions minting, transferring and burning VCAD's based on real Canadian dollar deposits on the public stellar blockchain and soon Algorand also.

As I discussed in our last call, VCAD is a natural evolution of our secure digital deposit-taking business, which is how we have been raising deposits since we first started nearly 30 years ago. When commercially launched, we expect VCAD to be high demand based on its ability to be used as a digital currency, which also has the backing of an investment-grade rated Schedule 1 bank. It, therefore, represents a significant potential additional source of very low-cost deposits, providing the opportunity to diversify our funding sources and even further reduce or already ultra low cost of funds.

Our total loan portfolio increased 7% sequentially to another record mark of $1.95 billion at the end of the third quarter. That's an increase of 18% for 2021 year-to-date. The bulk up sequential growth was driven by real estate mortgages and the commercial lending portion of our business and point-of-sale loan and lease business, which were each up 7% sequentially. And I'm very pleased to report that subsequent to the end of Q3, our loan portfolio surpassed the $2 billion mark.

We continue to explore new lending opportunities that further leverage our digital platform. We are relaunching a lending business in which we had great success in the past. In our earlier years, we operated a very active and successful lending business to indigenous and remote communities with the recent emergence of an encouraging environment including the federal government's commitment to closing infrastructure gaps for indigenous communities.

We are thrilled to relaunch this program, and we do so with the addition of 2 outstanding indigenous leaders: Roland Bailey, who was appointed Executive Director of our Indigenous Infrastructure Program and Robert-Falcon Ouellette who was appointed Executive Director Indigenous Housing Initiatives.

We are excited to contribute to the growth and prosperity of these communities, which are so vital to our nation.

We are especially thrilled to begin offering home financing solutions based on our new instant mortgage software application, which will focus on meeting the specific needs of Indigenous Canadians in both urban centers and northern communities.

As our core digital banking operations continue to grow in both scale and profitability, in parallel, we are making steady progress in advancing this strategy of our cybersecurity subsidiary, DRT Cyber, to offer a comprehensive suite of solutions to government and businesses based on 4 pillars: assessment, detection, protection and privacy.

On the privacy side, in Q2, we launched RAVEN, the first and only fully automated integrated solution that provides complete compliance with all major global anti-spam legislation. And yesterday, we announced a reseller agreement with U.K.-based Syrenis, under which DRT will sell under subscription-based flagship product, Cassie. Cassie is the world's leading consent and preference management solution, providing a central single source of truth for all data subjects across myriad of systems found in multinational corporations. It helps plants comply with increasingly stringent and complex global privacy laws while also managing consented data to ensure their clients can confidently and legally use the data in marketing activities. Importantly, Cassie integrates seamlessly with our RAVEN solution and we see a lot of potential for revenue synergies here.

On the assessment side and detection side, during Q3, we entered into a reseller and development agreement with EzoTech, under which DRT added the rule's first AI-powered autonomous cybersecurity penetration testing platform to its offering. The addition of EzoTech's complementary solution to Digital Boundary Group's leading on-demand manual penetration testing solution, significantly strengthened DRT's value proposition as with each passing week, the identification of cybersecurity vulnerabilities moves to the top of the priority list for more and more IT departments globally.

As part of the agreement, DRT will also leverage EzoTech's AI technology to develop and launch what it expects will be the world's first AI-powered automated continuous cybersecurity posture reporting platform for organizations of all types and sizes further building on DBG's solid foundation.

With the addition of 2 resellers agreements for best-in-class products, DRT Cyber is building momentum, providing additional upside beyond the strength of our core digital banking operations. Importantly, we are executing on our growth plan, and that will drive value over the longer term.

All in all, Q3 was another strong quarter for VersaBank, setting us up for a strong finish for 2021. Our core digital banking model addresses unmet needs through innovative solutions based on our proprietary software platform through a highly efficient partner-based model. It continues to deliver strong performance with significant new near-term opportunities on the deposit and lending sides of our business that are expected to support continued growth.

At the same time, our cybersecurity subsidiary, DRT Cyber, is executing on plan to capitalize on the massive opportunity as a leader in this rapidly growing sector.

And with that, I'd like to open the call to questions.

Colin?

(Operator Instructions) Your first question comes from Greg MacDonald from LodeRock.

Listen, I've got 2 questions, 1 broad, 1 a little more specific. The first is just overall outlook for loan growth with the resurgence in the Delta variant. I mean it's tough to tell, I know, given the fact that we're coming out of summer, but we've seen some renewed caution on the part of some people that they're concerned about what the Delta could mean for economic disruptions in the fall.

Is there anything coming out of the summer in terms of loan growth volumes that you might point to, to say that things have changed a little bit? Or is it just with the credit loss provision, that's almost entirely or entirely based on the growth in your loan book? Anything to give us a sense of what the outlook for loan growth is going to be in the fall and whether anything has changed in the last quarter?

Well, you're right. The PCL provision was just driven out of the increased size of the loan book, and it's driven by models. We are on a trajectory of about 7% per quarter in loan growth in both the real estate and the point of sale. I don't see anything to impede that. Mind you that we're taking into consideration the possible impact of the Delta variant. It might be another variant though that could slow things down.

But right now, we're pretty comfortable with the trajectory that we're on, looking for a strong year-end finish and into 2022. It looks even better in that we've been signing up some new partners in the point-of-sale program that are sending more business our way. So continuation of the growth that you have seen with perhaps even an acceleration in 2022 with the new partners.

Okay. And extending those questions to the U.S. market, any more insight there?

Yes. We're working on some U.S. dollar receivables presently. Taking a little longer than I would have liked. There's of course, U.S. laws -- security laws to take into consideration. But we're excited about the opportunity in the United States. It's a huge market, and it appears that our particular method of financing receivables is without peers. So we may be able to bring a real valuable new program for U.S. point-of-sale finance companies. So I'd look in the fourth quarter for us to have done our first deal.

Okay. Great. And then the second, a little bit more specific, I'm curious about the relaunch of the indigenous and remote community lending business. And I know we've all got an idea that from the political environment, more money is going to be spent.

Sometimes, there's a delay between political announcements and when you actually see execution. Can you talk a little bit about -- provide more details on what you're seeing there, specifically with respect to timing and any outlook on size to what it might mean, but it is a pretty exciting opportunity.

Yes. In the past, it was a wonderful business for us. We provided financing for schools, hospitals, pipelines, hydro lines all kinds of facilities. In fact, some of the major northern communities, we held 100% of their debt. So the Illinois, for example, at 1 time we provided the entire financing for that city. We think there's a huge gap in the infrastructure requirements. And we -- with our interim construction financing expertise sort of ideally suited to provide the interim construction loans to put these facilities in place.

Generally speaking, we don't do the takeout. So I think there's a big demand and we had success in working with the government with respect to supporting the projects. But as you say, things do move a little slowly in the government were a lot lower than these are going to in our world. But there's a huge demand. And it's right in the sweet spot of our construction lending team. So we have a lot of good contacts in that area, and I hope we can make some headway soon because obviously the people in those communities desperately need the facilities that we used to finance.

So should we be thinking in some time in the next year? Or is it beyond the year that we're looking at?

Yes, I would say in the next year for sure in '20 -- I'd be very disciplined if we don't have a lot of projects going in 2022. The service that we provide is we meet with the community leaders and determine what they really need, and we put together syndicated people that can construct the project. We do the financing and put it all together.

So we help out with the partner might allude people in that there's a lot of moving parts to build something in the Canadian Arctic. But we're very successful with that in the past. And our real estate financing team is -- from their perspective, they can finance a high-rise, a hospital, they can finance a school just as easily. And of course, as I said, there's a huge demand for that.

And it seems given the appointments that you've made that you think housing is a disproportionate opportunity this time around. Is that safe to say? Or am I misreading that?

Yes. Housing is a huge opportunity in that a lot of our Indigenous Canadians are living on reserves where it's -- well, it's difficult. It's impossible to get individual traditional mortgage financing. But our instant mortgage app seems ideally suited to sort of bridge that impediment. So we're excited about doing that.

And in the major centers in Canada, sort of due to the strict normal lending requirements that the banks have, it's inadvertently sort of precluded a lot of people from being able to get the financing for their home. There may be seasonal workers that may have moved. But for some reason, they don't fit the traditional mortgage requirements, but our instant mortgage app has the flexibility to be able to provide the financing for a home, which quite often is much cheaper than the rent they have been paying presently. So it's a win-win. We end up with good quality financing for homes to get people in houses that they own. And the monthly payment is probably a lot less than we have been paying for rent.

(Operator Instructions) Your next question comes from Trevor Reynolds from Acumen Capital.

Just wondering when you expect to get back to traditional cash levels in the lending portfolio?

It'll be early in 2022. We -- there's 2 factors, of course, I mentioned in the presentation. One is just the USD 75 million that was proceeds of subordinate debt offering in Canadian dollars, that's about CAD 93 million that went in as cash. So that bumped the cash balances.

And secondly, in kind of recent times, we came a bit -- not a bit but some are concerned about geopolitical risk. And so we kept our cash balances a little higher than we would have otherwise. So those 2 factors, hopefully in 2022, will not be present. We'll start utilizing the U.S. dollars that we took in the note on the U.S. receivables. And hopefully, geopolitical risk will diminish somewhat, although who knows. But that from a banker's perspective, potentially could affect liquidity for banks. So I always tend to err on the side of caution and hold on lobster cash.

Fair. Yes. I know I understand the note offering, obviously will increase things there. And then just on -- can you speak to -- well, actually, that's the first on the insolvency side of things. Can you touch on where that business sits? I know there's still some restrictions with the government subsidies being provided. Just maybe touch on where that business sits.

Well, absolutely, the support that our government has been providing to people and small businesses has reduced insolvencies to almost a record low in Canada. So theoretically, you would think that our insolvency balances wouldn't be growing. But indeed, they are. And that's because the partners that we deal with are continuing to send deposits our way from other banks.

So even though we're sort of an all-time low for insolvencies in Canada, we're still growing 7% quarter-by-quarter pretty rapidly as our existing partners continue to move deposits from other banks over to us. So I hate to say it, but in 2022, when the support payments probably come to an end, there will probably be a resurgence of insolvencies and then I'd expect the balances to grow even more rapidly, which is good from a banking perspective in that these are 0 cost deposits, which help our net interest margin and our funding sources. But I feel for the people and the small businesses that will be struggling to make ends meet.

Got it. And with the reseller agreement that you announced yesterday and previously, just maybe can you speak to the order of magnitude of what you expect provides for the private vision?

It's pretty hard to put a number on it. They're just new agreements and we think the market is huge. It's a worldwide market. And we think that the various people who attack corporations aren't going away and we think we brought in state-of-the-art products. So it's hard to put a number. It could be a huge numbers of revenues from these 2 sources. But it's very early days.

That's fair. Is there opportunities for more of these reseller agreements?

Right now, we don't see any -- we're not engaged with anybody and bringing anybody else on board. We're getting pretty close to a full suite of cybersecurity products. So no, it's -- now we've got to market these products and get our share of the market. Like I said, I think we have the state-of-the-art DBG does a fantastic job of serving their clients. They have about 350 or so the who's who in North America that they provide probably the best penetration testing of any firm in the world. And these other add-ons, these complementary add-ons should round out the product offering for other corporations.

In particular, the RAVEN that we created in-house, RAVEN anti-spam software, we use it in our bank. And what that does is prevent us from inadvertently sending an e-mail out to somebody who has requested to go on the unsubscribed list. And as you know, there's some significant fines for corporations, governments that make a mistake on that front. So RAVEN, I think, is -- everybody should have RAVEN protecting them from doing that. Eventually, corporations or governments make mistakes and the fines are substantial.

Got it. And then last one just on the VCAD and the testing and where kind of -- where you sit in terms of public rollout on this products.

Well, VCAD, as I said in the presentation, is now live on the seller blockchain and probably soon to be on Algorand blockchain. I have VCAD in my wallet right now, 50,000 VCADs. And maybe after this call, I'll buy a bicycle from Shawn, our CFO. Maybe it would be an expensive bicycle, and I'll trade some VCADs to his wallet, and we'll trade it back. So it actually is fully functional.

We're keeping it within our walled garden staff members e-wallets and we'll be burning it, i.e., withdrawing VCAD, we will be issuing more VCAD, i.e., minting it and doing all the internal tests and writing up the policies and procedures. We've asked a third party to review the software to provide a first phase of an audit on it. So all in, it's possible within the next 30 days VCAD could go live to the general public.

(Operator Instructions) Your next question comes from Brad Ness from Choral Capital.

Regarding VCAD, can you just discuss the distribution that you expect and how that process is going also?

Well, initially, Brad, it's going to go through our partner Stablecorp. And Stablecorp hasn't mind swapping their QCADs into our VCADs when we're live with the public. It will go through Stablecorp's partner cryptocurrency exchanges and then out through the cryptocurrency ecosystem. There are other cryptocurrency exchanges that we're talking to support the VCAD also. The market strategy (inaudible) like this.

We know this about [80] billion or so in inferior stable coins now. Inferior in that they're not issued by an investment grade bank and they don't represent deposits in that bank. They're thought to be secured with deposits and perhaps other banks or assets somewhere. And this is, in fact, represents a real deposit with a real bank that is highly regulated, being a Schedule 1 bank at investment grade. So we think it's a superior stable coin. And we think some of that 80 billion will flow our way. Why wouldn't if you're keen on a stable coin and you're willing to accept a risk that it's backed up by an asset somewhere else, perhaps out of the country, not a regulated entity. Surely, you'll want a salable coin that a bank like we are issuing.

Sure. So would you say these crypto exchanges are maybe eager to have a new stable coin like you on their platform? Or has there been a little bit of a pushback?

No pushback. Eager is probably the word. It's just corny thing to say, you build it and they will come. It's from -- I know I'm, of course, biased, but I mean it's a huge jump forward in the stable coin type product. If you really do want a stable coin to transact business, I mean what's better than a bank note. This is a modern day bank note like banks used to issue many years ago in paper format.

It's from a merchant's perspective, if you want your Canadian dollars back or U.S. dollars or Euro or sterling, you can just present it for a withdrawal, they call burning, and you got your money back. We hope they don't. We hope they see it as a currency that they can keep in their e-wallets. And if interest rates climb somewhat in the world, we'll push a little interest to buy their patients and who can do that other than the bank. So I think it's a huge leap ahead of what the market had to deal with until we come up with this one.

Sure. And remind me, is this something you can collect a burning and minting fee from?

Well, it's possible, but we don't really have that in mind. We're treating it as we do all our deposits. We're -- from our perspective, it's an economical diversified funding source that we can use to fund our loans or mainly our point-of-sale finance loans. So we're not looking it as a fee generator.

Even the fees that are associated with trading on Algorand and Stellar are just fractions of $0.01 as opposed to say what's on Ethereum. Even that's a huge advantage. And the transaction time is nanosecond. So I moved VCADs around in split seconds with tiny fractions of cost, but that's another advantage, I think, that people will appreciate is the speed of the transaction and the almost frictionless with respect to fees.

Right. Got you. Okay. Last question here. On DBG, 2 questions. One, can you just remind me of kind of the stability of this revenue flow? Are these 350 clients on longer-term contracts? Or are these just more transactional is kind of the first question. And two, could you size this opportunity, now it's 8% of revenue. Could this income from this source be 20% of revenue a few years from now?

Yes. The 350 from DBG's clients are repeat customers, but they're not on a contract basis for the most part. So they're invited to do the penetration testing regularly, particularly more often when some terrible breach takes place. So the 350 are regular clients, customers that DBG has been dealing with some cases, 20 years. But it's not on a sort of a contract basis. The other new products we brought up are contract basis though. And that's -- what we're trying to do is diversify into steady cash flow from providing ongoing cyber surveillance for firms. So if you think of it this way, we're trying to provide smoke detectors.

So if somebody is even tapping at the door or exploring breaking in, the fire alarms go off and the IT people get a heads up that there's a probe, whereas DBG is providing on-site on occasions, penetration testing to eliminate flaws that a firm might have. And as you can imagine, considering the nefarious people are quite innovative. They're always trying to find a new way in. So there's never any short of business for DBG who is up. We're in the white hats. On the other side is this is innovative, finding ways to protect the attempts of those getting in. So it could easily be 20% or much more. It's a huge market. And it doesn't seem like any end in sight for the bad actors who are creating this market.

There are no further questions at this time. I'll turn it back to Mr. Taylor for closing remarks.

Well, I'd like to thank everybody for joining us today. And I look forward to entertain your questions at the next one of these at the year-end. And in the meantime, if something comes up, I'm just an e-mail away. Happy to talk to you on the phone or respond by e-mail. Well, thank you, and over and out.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.