Versabank (VBNK) 2020 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the VersaBank Second Quarter Results Conference Call.

I would now like to turn the call over to VersaBank for a brief introduction.

Good morning.

This morning, VersaBank issued a news release reporting its financial results for the second quarter ended April 30, 2020.

That news release, along with the bank's financial statements are available on the bank's website in the Investor Relations section.

Please note that this quarter, VersaBank has begun webcasting its earnings conference call over the Internet.

The webcast is listen only.

If you are listening to the webcast, but wish to ask a question in the Q&A section following Mr. Taylor's presentation, we ask you to please dial into 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 as well.

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 now like to remind you, our listeners, that statements about future events made on this call are forward-looking in nature, and are based on certain assumptions and analysis made 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, which is on Slide 2.

I would now like to turn the call over to David Taylor, President and Chief Executive Officer of VersaBank.

Please go ahead, Mr. Taylor.

Good morning, and thank you for joining us today.

With me via teleconference is Shawn Clarke, Chief Financial Officer; Aly Lalani, Chief Risk Officer; and Brent Hodge, General Counsel, as we continue to practice social distancing as we have done for more than 2 months now.

For those that are interested, I'm broadcasting from our Innovation Centre at London Airport, which, other than birds flying, is somewhat deserted today.

In fact, VersaBank, with our branchless technology-based model and our small efficient employee base is ideally suited to effectively manage through the current environment.

As we have since the beginning of the pandemic, we continue to work to ensure the safety and wellness of our employees and substantially all of our bank staff are working remotely with virtually no operational issues, supported by our recently implemented two-factor authentication Virtual Private Network, providing the highest level of security.

We are also continuing to strengthen and enhance our already robust risk-management processes with specific focus on the prudent mitigation of potential elevated credit, liquidity risk exposures.

Our ongoing approach to risk mitigation had the bank very well positioned entering into this unprecedented economic environment, an unprecedented time.

We built VersaBank for stability and success in all economic environments, while no one expected the current situation, we were certainly prepared for it.

Although it has been 90 days since our last call, the world and the macroeconomic situation outlook have changed considerably.

Against this backdrop, there are several matters specifically related to VersaBank that I want to highlight at the outset, as I think it's absolutely vital for VersaBank shareholders and prospective investors to understand.

First, with respect to point-of-sale financing portfolio.

I want to be clear, that we have extremely low exposure here.

At first blush, one might think the portfolio is highly exposed to credit risk, however, consistent with our risk adverse approach to our entire banking operations, these loans and leases are structured such that each loan we hold back funds from our partners, such that these holdbacks are still more than 3x in excess of their intrinsic risk.

In addition, as I'll discuss in a moment, the bank has temporarily increased its cash balance and surplus regulatory capital for the near term.

Turning to our results.

The financial performance during Q2 continues to be the highlight, VersaBank and its efficient, low-risk model as a standout in the Canadian banking and financial institutional landscape.

And I want to note at the outset that the bank's strong performance in Q2 was tempered by the cautious stance we took in the back half of the quarter as the pandemic and the impact on the broader economy began to take hold.

I'm going to specifically call out revenue this quarter as it provides additional perspective on the performance before the higher provisions for credit losses, which we increased in Q2, I would say an abundance of caution.

I'll discuss this more in a moment.

Revenue increased by 14% year-on-year to a record $14.9 million due to strong year-over-year growth and overall loan portfolio and yield held steady.

Net interest margin for Q2 expanded 13 basis points year-on-year to one of the highest in our history, 3.08%, up from 2.95%, which continues to be the highest amongst our peer group.

Again, I will note that net interest margin in Q2 this year was dampened by our conservatism, most notably, our decision to increase our cash balance in the back half of the quarter.

For perspective, at normal cash levels in our historical range of 6% to 7%, net interest margin would have been in the area of 3.5%.

The strong year-over-year improvement, even with the higher cash balances was driven primarily by low-cost of funds, which declined to 1.75%.

Net income increased 5% year-over-year to $5.1 million or $0.22 per share from $4.9 million or $0.21 per share.

And core cash earnings, or CCE, also increased 5% to $7.1 million or $0.34 per share.

Recall that by not paying cash taxes, VersaBank is building regulatory capital, about 27% faster than most banks that are paying cash taxes.

As I noted a moment ago, as expected, out of an abundance of caution, the bank increased its provision for credit losses this quarter by an additional $490,000, which dampened both net income and CCE.

As I will discuss in a moment, despite the increase, VersaBank still leads the industry with respect and in fact, has no doubt significantly widened the gap over the large Schedule I banks based on Q2 results we are seeing.

In terms of key balance sheet metrics and capital ratios, our financial position at the end of Q2 continues to reflect the financial strength and stability of the bank.

At VersaBank, risk management is in our DNA.

It is fundamentally built into our model and is an overriding consideration in every decision we make.

Accordingly, as we saw the COVID-19 pandemic begin to impact the broader economy and financial market and before knowing how the Bank of Canada would proceed.

Again, out of abundance of caution, especially with the hindsight of 2007, we made the prudent decision to temporarily increase our cash balances for the near-term to add an additional layer of liquidity during these unprecedented times.

Our cash balance at the end of the second quarter, 2020, was $340 million or about 17% of average assets, up from the bank's historical range of 6% to 7% of average assets.

We have since increased this such that our cash balance currently sits at approximately $420 million, and at the end of the second quarter, 2020, the bank had more than $80 million in surplus and regulatory capital over Basel III minimums.

It looks now, though, we may have been somewhat overly cautious through this period.

However, this small short-term impact is easily justified by the need for prudence.

And importantly, we have -- now have the capacity to advantageously deploy capital to a number of potential opportunities, we see VersaBank emerging out of the current environment.

As I mentioned, in the current uncertain economic environment, we have taken an even more cautious stance than typical for our risk-averse bank.

In fact, we've often heard that we don't take on enough risk.

But even pre the COVID-19 pandemic, we have been already reducing our project financing loans as that market seemed to be topping out, and we made the conscious decision to increase our cash reserve.

Diving a little deeper into the bank's increased credit provisions.

At the end of the second quarter, those watching the broader industry will have seen and will continue to see over the next few days, enormous increases in loss provisions by our peer group and especially the large banks however, because of our low-risk model, our provisions at the end of Q2 are just 15 basis points of average loans.

And as a reminder, our access to very low cost funding, including insolvency deposits, at their current rate of 0 enables us to generate the highest net interest margin in our peer group while mitigating risk through a lower risk lending.

You can see in this graph that VersaBank's provisions has a proportion of average loans at the end of Q2, even at the highest level in our history, are still less than half that of the big banks' average even before there are significant increases in Q2.

With the history of no loan losses, we believe we have been very conservative with our provisions.

And I want to specifically note here that we have not taken any loss provisions for our point-of-sale financing portfolio, which we previously referred to as e-commerce.

As a reminder, our point-of-sale business provides access to capital and proprietary technology for financing companies who support big ticket consumer purchases, such as hot tubs, cosmic, surgery, motorcycles, et cetera.

As I mentioned earlier, we structured these loans such that we hold back a portion of the payment for these loans in cash that essentially provides insurance should the consumer default on the loans.

In addition, in our construction lending portfolio, which is mainly composed of loans to build apartment blocks, the majority of these projects are nearing completion, which significantly limits risk as I mentioned earlier, our strong performance in Q2 was in part driven by our continued reduction of our cost of funds, which declined to 1.75%.

To a large degree, the result of the higher proportion of 0 interest insolvency professional deposits and nearly 0 interest points of sale holdbacks.

We are also benefiting from the lower cost (inaudible) environment.

Importantly, in the context of the current and expected economic business environment, we expect to see our cost of funds to further decline over the quarters to come.

As the proportion of deposits from the solvency professionals increases due to, unfortunately, higher bankruptcies.

On the lending side of our business, our total portfolio expanded to $1.9 billion in assets, up from $1.7 billion at the end of Q2 last year.

That $1.9 billion breaks down to just shy of $1 billion for our point-of-sale loans and leases, around $620 million for our commercial banking portfolio, which itself is composed of about $257 million in commercial mortgages and $363 million in project financing on other loans, and finally, the $340 million in cash.

As a side note, we are now using the name point-of-sale here as we think it is more reflective of the portfolio itself.

And also to augment our concerted effort to simplify our story for the investment community because we think it's a good story.

As I noted earlier, the point-of-sale portfolio is very well insulated from credit risk.

While this portfolio has experienced excellent momentum over the past 5 years or so, not surprisingly, we do expect to see some contraction in the coming quarters as loan origination has come to a near standstill during the pandemic lockdown.

While we can't predict when consumers will start buying again, we are optimistic that the rebound will reflect pent-up demand, especially given that the bulk of job losses, thus far, appear to have impacted lower wage earners.

In our commercial banking portfolio, as I have discussed for a number of quarters now, we have been letting our construction loan portfolio run off somewhat as we became more cautious in what was becoming an overheated real estate climate.

That said, we are now pivoting back to opportunities in the public sector, where we believe there will be a strong demand as governments undertake stimulus projects and grapple with loss of tax revenues.

We have started actively pursuing these opportunities and, in fact, have a long track record of success and performance in the fare of lending.

Not surprisingly because of their government ties, these are low risk-weighted loans that due to our low-cost of funding model, we can turn to and still generate strong net interest margins.

In addition, with the best leverage ratio amongst Canadian schedule banks, we have a lending capacity of more than $2 billion to put to work in these types of loans.

With the objective to lend to end fiscal 2020 with an overall loan portfolio approximately equal to our potentially larger than that at the end of 2019.

Before I open the call to questions, I want to spend a few minutes on our overall risk mitigation strategy because it's core part of what we consider to be our value proposition as a publicly traded bank.

We look at risk in mainly 3 different ways: credit risk, liquidity risk and operational risk.

I talked earlier about our credit risk mitigation, and we feel good about where we are right now.

Again, credit provisions we have taken this quarter although substantially up, are still by far the lowest in our industry.

On operational risk, if the pandemic has proven anything to us it's that our highly efficient, branchless technology-based model, which requires very small head count is more than up for such a formidable challenge.

Finally, liquidity risk.

We're always conservative here and are being even more prudent in the current environment.

We continue to have access to a vast supply of low-cost funds and our liquidity curve ratio currently stands at 20%.

Before I wrap things up, just a quick note on our DRT Cyber.

Beyond the economic consequences of this global pandemic had a broader and deeper impact on the way they work and interact socially.

It has precipitated a step function change across the spectrum of online activities and behaviors that were already gradually evolving.

Clearly, security is the very center of all this.

And the last several months have highlighted it as fundamental importance.

There's significant room for improvement and the many opportunities it presents.

Importantly for VersaBank, we believe this is a very positive implications for DRT Cyber subsidiary overall and specifically for VersaVault as well as some of the additional offerings we are working on and getting close to launching.

To conclude, we entered Q2 of 2020 with significant momentum in our business.

Although COVID-19 pandemic and the bank's additional caution in this environment will dampen growth in the second half of the year, we remain well positioned to capitalize on opportunities presented by the new economic climate.

And expect to return to our trajectory of earnings growth.

We believe the current environment presents more opportunity than it does challenges or risk.

Accordingly, our growth strategy remains very much intact and has continued to lower our cost of funds to support [industry's] leading margin and continues to pursue long-term growth with near-term transition back to our previous success in the public sector project financing as we look forward to the resumption of point-of-sale loan and lease origination.

We also look forward to the launch of Direct-Connect application for home and condo builders and sale stations, which entered beta testing this past quarter.

While the pandemic has, not surprisingly, paused this process, this is a long-term opportunity for the bank that builds on the success of the point-of-sale business, allowing us to enter the residential mortgage sector in a profitable way with a high value-add offering for the industry, another unmet need that we are addressing.

Importantly, we have significantly -- significant capacity more than $2 billion at the ready to capitalize on our near-term and long-term opportunity.

Finally, we will continue to explore acquisition opportunities to generate step function growth in our loan portfolio.

And with the challenges created by the current environment, for many of our peers, we certainly think there is more opportunity and more value than there was just a few months ago.

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

Operator?

(Operator Instructions) And our first question is from Stephen Boland.

Can you hear me okay?

I can hear you fine, Steve.

Okay, great.

Dave, could you go back to the point-of-sale loan or what used to be the e-commerce.

I guess I'm surprised that, that portfolio is still performing really well.

And just in terms of what -- maybe 2 parts.

The first is what impact because of these consumer purchases, what's your outlook for the next couple of quarters?

And then maybe you mentioned that the loans have like a surplus portion.

I presume that, that really -- that surplus really depends on the maturity of the loan.

So as the loan matures, you put the surplus up and eventually, the loan turns into like a -- you have a positive surplus.

Well, I guess it would be a surplus.

But I guess what I'm trying to say is that the maturity of the loan matter in terms of size of the surpluses, is there a point where that surplus runs out?

Good question, Steve, as always.

Yes.

We've renamed publicly that portfolio point-of-sale, because that's what it is.

There are loans that are made at the point of sale.

For the most part, they are consumer loans, as I mentioned, with the various categories, motorcycle, hot tubs and such.

And there's a portion that are also to small businesses.

And yes, indeed, that portfolio would have been hit fairly hard by the pandemic.

And what I call the intrinsic risk and the propensity for default, say, it would have gone up from an average of about $8 million or so in the $1 billion portfolio to closer to $30 million or so in the portfolio.

So it's like a huge increase in propensity to default.

However, we hold back at the time of purchase with these loans in total, about $100 million.

So when I said we have about the 3x intrinsic risk in the portfolio.

I mean we've held back so much additional cash collateral that it's able to absorb the, no doubt, increase in defaults that will take place in the portfolio.

3x is a lot.

So -- No, with respect to the maturity on the portfolio they are a short duration -- yes, there are short duration, in fact, most of our portfolio short duration are, it's about 1.5 years assets, 1.5 years liabilities.

So that is a significant risk mitigator and that they pay off rather rapidly when you're calculating your ECL.

But we take the cash collateral upfront when we buy the loan.

So if anything, as the loans start to pay down, the cash collateral becomes pose higher and higher.

And then we have a mechanism in some cases where we released some of the cash back to the vendor of the loan.

Okay.

And maybe you could just like the -- not so much on the credit side, but the origination side, there must be a slowdown since there is a portion, while they're consumer loans, but portions of those have been impacted, right, certain cycles more than others?

Absolutely.

I mean a huge slowdown.

It's just down to a trickle.

The lockdown has pretty well stopped point-of-sale financing and purchases.

Now mind you, we're somewhat optimistic.

There'll be -- as I was saying, there'll be a bit of pent-up demand coming in, it will come back.

I don't expect too quickly.

But towards the end of the year, fiscal year, we'd probably see a fair percentage come back.

But yes, right now, it's down to -- it's just a dwindle of deals for a few.

Okay.

And I guess that would be since -- well i guess it would be mostly April, May, and then we'll see what happens.

So we should expect a large decline in revenue like going forward?

From that portfolio, yes, going forward.

We have, on the other side of the lending Ross Duggan's commercial banking side.

So we're saying we've pivoted into public sector project financing, and that's where now you're familiar.

That's where we started, actually, mainly in small communities throughout the north.

And we're back at it again, and we're hoping that we'll be able to make up some of the lack of lending in the point-of-sale business with some public sector drawdowns.

Mind you, that will probably take a few months, too.

Is there something changed in that?

Is it the yields, if I remember, the yields don't really fit in that business and it was really competitive.

Is it due just to the overall government stimulus, something that's happened there that's made the business more attractive?

Yes, exactly.

We expect that governments, small and large, will take on projects.

I think they should.

That's a good way to put people back to work.

And we stand ready, of course, as we have in the past, to provide the financing.

The thing that's changed is that our cost of funds has got -- getting lower and lower because of the operational accounts that we're issuing.

So the proportion of deposits that we receive, say, from the insolvency professionals will likely grow higher and higher.

It's a good counterbalance to the lack of revenue in the other portfolios.

And that what is terrible for others in the lending side brings to us have a bonus and that it supplies us with a lot more, and presently, it's 0 cost deposits.

So while our cost of funds is descending, it means that we can finance public sector projects and still earn quite a large margin.

And as you know, some of them are -- most of them are 20% risk weighted.

So theoretically, we get 5x the return on risk-weighted capital with a loan like that.

So yes, it's opening up.

The 2 drivers I expect there'll be a big demand for project financing, public sector, and our cost of funds is getting to record lows.

(Operator Instructions) We have question from Ryan Smith.

First, another fantastic job, and I really like the fact that you did exactly what you said you're going to do on the last call, and you've performed extremely well.

So congratulations to your team.

Yes, now one of the things that's curious to me is that -- your investment in the VersaVault.

You said you've commercialized it, but have you had any beta trials?

Is there -- do you have a pipeline of potential sales since that seems to be a focus is to try to build out the business technology by selling the technology to others rather than enhancing your own bank's capacity to do banking.

Yes.

Basel testing took place a few years ago, it's up and running, and we leased it, the VersaVault technology, out to a financial company in Europe, called Chairmans Financial.

And they have acquired a number of customers.

So it is working.

It is functioning and it is providing revenue to our subsidiary, DRT Cyber.

Not a lot of revenue.

There's been a fair amount of caution in the -- it's mainly used by their cryptocurrency exchanges.

So it's a fair amount of caution in that area.

But most recently, I noted that one of the large U.S. banks has opened up accounts for crypto -- the largest cryptocurrency exchanges in the world.

And as a similar safekeeping as our Vault.

We don't think it's as good.

So we see a market opening up.

There are -- there is use as a bank for a digital vault to keep high-value assets safe and secure.

And our Vault will do that, although we haven't seen a lot of demand for it in Canada.

In the United States, there seems to be a lot more demand.

So we're exploring the U.S. market with VersaVault.

And as I was saying earlier, we've done a number of other software projects in DRT Cyber that we'll be launching.

There are projects that we do for our bank, and we think they have applicability all across the world, that's what I'm thinking of, as a cloud-based application, that our bank certainly will be using.

And hopefully, others will, too.

Okay.

Yes.

I have another question if possible.

Yes, in terms of, I guess, the potential acquisition, are you -- would you be looking at a technology platform like the VersaVault?

Or would you be looking at some ways to increase the scale of the banking business?

And it's a banking business, it's somehow a bank that's inefficiently using technology?

Is that -- yes, so is it a portfolio?

What exactly do you see yourself scaling, so?

Well, first and foremost, we would be delighted to acquire other banks, maybe smaller banks that are -- that haven't quite got to the efficiency levels that our technology allows us to get to.

So we believe there's a few out there.

That are below their efficient sizes and don't have our access to achieve funding on our technology advantage.

So that would be ideal and that we have a lot of capacity.

And we'd like to bring it to bear and grow our portfolio more rapidly than it looks like we're going to be able to grow it organically for the next while.

So first and foremost, other financial institutions operating in Canada that may think it's better to sell themselves than to keep on with a suboptimal operation.

And in the technology side, there are a few technology firms that seem like they would be nice tuck-ins to the DRT Cyber suite of cybersecurity products.

We are looking at some, but nothing right yet.

Okay.

So it's more of the former then.

Okay.

Yes.

Yes, it's former.

That's -- if you have a look at our ratios, we've got a lot of surplus capital and...

No -- otherwise, I'd be asking about buybacks, but I have -- you've proven yourself to be such great operators, but I really want you guys to deploy capital even if the market doesn't recognize it now?

Well, if the regulator hadn't made the nationwide decree, no buybacks, I'd certainly be buying back shares.

Even just a small amount, we have so much capital and at $5.50 a share.

My goodness, how can you go wrong, right?

Exactly.

So it's extremely mispriced.

The -- it must be -- I guess frustrating.

And -- but I assume there's some sort of -- well, I've noticed the insiders have stopped buying.

So I assume there's some sort of acquisition issue going on.

That's why, but you obviously can't comment on that.

No, we can't.

Yes.

So I guess, I'm in an indolent position as being in the dark but able to buy.

But yes, it's quite amazing what you've done with this technology in the bank and the other banks, as you say, are reporting enormous loan losses.

So anyways, keep up the great work.

Well, thank you, I. mean, just on there, looking at our big bank partners.

Well, they were directly exposed to the consumer and small business market.

And we are -- we have the holdbacks to protect us.

So that's what you'd expect.

They have great years.

And every so often, something like this comes along and they take larger provisions.

That's just their model.

Ours is different because we're so small.

So we manage ourselves, so we won't be subject to large losses and provisions.

There are no further questions registered at that time, I would like to turn the meeting over back to you, Mr. Taylor.

Well, thank you, everybody, for dialing in and listening.

And as we were saying earlier, this information will be available on our website, if you want some further detail.

And please feel free to send me an e-mail if you have another question that you think of later.

And I look forward to catching up with you at the end of August.

Thank you.

Thank you.

The conference has now ended.

Please disconnect your lines at this time.

And we thank you for your participation.