Mr. David Taylor reports

VERSABANK REPORTS CONTINUED STRONG RESULTS FOR SECOND QUARTER 2023 HIGHLIGHTED BY 108% YEAR-OVER-YEAR GROWTH IN NET INCOME TO $10.3 MILLION

VersaBank has released its results for the second quarter of fiscal 2023, ended April 30, 2023.

Highlights for the second quarter of fiscal 2023

Consolidated:

• Consolidated revenue increased 43 per cent year-over-year and 3 per cent sequentially to a record $26.7-million, driven by higher interest income resulting primarily from continuing strong loan growth, as well as an increased contribution from DRT Cyber Inc. (DRTC).
• Consolidated net income increased 108 per cent year-over-year and 9 per cent sequentially to a record $10.3-million as a function of higher revenue, which was driven primarily by strong loan growth, as well as an increased contribution from DRTC, offset partially by higher non-interest expense.
• Consolidated earnings per share (EPS) increased 124 per cent year-over-year and 12 per cent sequentially to 38 cents as a function of higher net income, as well as the positive impact of the purchase and cancellation of VersaBank's common shares through its normal course issuer bid (NCIB).
• The bank purchased and cancelled 419,500 common shares under its NCIB, bringing the total number of common shares purchased through the NCIB as at April 30, 2023, to 1,437,096.
• The bank continues to advance the process seeking approval of its proposed acquisition of OCC (Office of the Comptroller of the Currency)-chartered United States bank, Stearns Bank Holdingford, and expects a decision with respect to approval of its application from U.S. regulators by the end of summer 2023. If favourable, the bank will proceed toward completion of the acquisition as soon as possible, subject to Canadian regulatory (OSFI (Office of the Superintendent of Financial Institutions)) approval.

Digital banking operations:

• Loans increased 40 per cent year-over-year and 6 per cent sequentially to a record $3.42-billion, driven primarily by growth in the bank's point-of-sale (POS) financing portfolio, which increased 58 per cent year-over-year and 5 per cent sequentially, as well as growth in the bank's commercial real estate (CRE) portfolio (predominantly related to residential-use properties), which increased 4 per cent year-over-year and 7 per cent sequentially.
• Revenue increased 43 per cent year-over-year and 2 per cent sequentially to a record $24.7-million, driven primarily by loan growth, as well as redeployment of available cash into higher-yielding, low-risk securities, offset partially by higher interest expense attributable to higher deposit balances.
• Net interest margin on loans decreased 12 bps (basis points), or 4 per cent, year-over-year and decreased four bps, or 1 per cent, sequentially to 2.99 per cent, due to higher cost of funds attributable primarily to a shift in the bank's funding mix, offset partially by higher yields earned on the bank's lending assets.
• Net interest margin increased one bps year-over-year, or less than 1 per cent, and decreased five bps, or 2 per cent, sequentially to 2.78 per cent. The year-over-year trend was as a function primarily of higher yields earned on the bank's lending and treasury assets resulting primarily from a higher interest rate environment, offset partially by higher cost of funds. The sequential trend was a function primarily of higher cost of funds attributable primarily to a shift in the bank's funding mix, offset partially by higher yields earned on the bank's lending and treasury assets.
• Provision for credit losses as a percentage of average loans was 0.03 per cent, compared with a 12-quarter average of negative 0.01 per cent, which remains among the lowest of the publicly traded Canadian Schedule I (federally licensed) banks.
• Efficiency ratio (excluding DRTC) improved year-over-year to 43 per cent (down from 58 per cent) due to revenue growth (43 per cent) continuing to significantly outpace non-interest expense growth (8 per cent) over the same period. On a sequential basis, efficiency ratio increased slightly (up from 42 per cent).

DRTC (cybersecurity services, and banking and financial technology development):

• Revenue for the cybersecurity services component of DRTC (Digital Boundary Group, or DBG) increased 5 per cent year-over-year to $2.6-million as a function of higher service engagement in the current quarter, while gross profit increased 35 per cent to $1.9-million as a function primarily of improved operational efficiency. Sequentially, revenue and gross profit for Digital Boundary Group increased 11 per cent and 17 per cent, respectively, as a function of higher service engagements in the current quarter. DBG's gross profit amounts are included in DRTC's consolidated revenue, which is reflected in non-interest income in VersaBank's consolidated statements of income and comprehensive income. DBG remained profitable on a stand-alone basis within DRTC.

Management commentary

"Our second quarter financial results were once again evidence that VersaBank is at an inflection point in terms of realizing the significant operating leverage inherent in our branchless, digital banking model," said David Taylor, president and chief executive officer, VersaBank. "Forty-per-cent year-over-year loan growth to a record $3.42-billion loan portfolio drove a 108-per-cent year-over-year increase in net income and a 124-per-cent increase in earnings per share, as we continue to take advantage of our share buyback program.

"We anticipate continued strong growth in our loan portfolio in the second half of 2023, driven by continued growth in our Canadian point of sale portfolio, which typically benefits from higher consumer spending in the spring and summer months. We also expect to benefit from continued growth from the ramp up of the limited launch of our U.S. receivable purchase program, which we plan to broadly launch upon approval of our pending U.S. bank acquisition. At the same time, we are being opportunistic in our commercial real estate portfolio, 90 per cent of which is related to residential-use properties, an asset class that continues to present an attractive return on equity and low risk profile in Canada.

"Our pending acquisition of a national, OCC-chartered U.S. bank presents the opportunity to supercharge our already strong growth prospects domestically through the opportunity to address an underserved market need with an innovative, proven financing solution. We continue to be encouraged by our discussions with prospective partners as we advance toward regulatory approval of our acquisition, which we now expect to receive by the end of the summer of this year. If favourable, we will proceed toward Canadian regulatory approval and closing of the acquisition as quickly as possible thereafter.

"Continued strong growth in our loan portfolio combined with the significant operating leverage in our model is expected to drive meaningful improvement in our efficiency ratio, continued strong growth in net income, significant expansion of return on common equity and continued creation of value for our shareholders."

Financial review

Consolidated

Net income -- net income for the second quarter of fiscal 2023 was $10.3-million, or 38 cents per common share (basic and diluted), compared with $9.4-million, or 34 cents per common share (basic and diluted), last quarter, and $4.9-million, or 17 cents per common share (basic and diluted), for the same period of fiscal 2022. The sequential and year-over-year increases were a function of higher revenue, attributable primarily to lending asset growth, redeployment of available cash into higher-yielding, low-risk securities and higher revenue contributions from DRTC, offset partially by higher non-interest expense.

Digital banking operations

Net interest margin -- net interest margin (or spread) for the quarter was 2.78 per cent compared with 2.83 per cent last quarter and 2.77 per cent for the same period of fiscal 2022. The sequential trend was a function primarily of higher cost of funds attributable to a shift in the bank's funding mix, offset partially by higher yields earned on the bank's lending and treasury assets. The year-over-year trend was as a function primarily of higher yields earned on the bank's lending and treasury assets attributable to a higher interest rate environment, offset partially by higher cost of funds.

Net interest margin on loans -- net interest margin on loans for the quarter was 2.99 per cent compared with 3.03 per cent last quarter, and 3.11 per cent for the same period of fiscal 2022. Year-to-date net interest margin on loans was 3.02 per cent compared with 3.14 per cent for the same period a year ago. The sequential and year-over-year trends were a function primarily of higher cost of funds attributable to a shift in the bank's funding mix, offset partially by higher yields earned on the bank's lending assets due to a higher interest rate environment.

Net interest income -- net interest income for the quarter increased to a record $24.6-million from $24.3-million last quarter and $17.2-million for the same period of fiscal 2022. The sequential and year-over-year trends were a function primarily of higher interest income earned on higher loan balances attributable to strong growth in both the bank's POS financing and CRE mortgage portfolios, higher yields earned on floating-rate lending assets, and the redeployment of available cash into higher-yielding, low-risk securities, offset partially by higher interest expense attributable to higher deposit balances.

Non-interest expenses -- non-interest expenses for the quarter were $12.7-million compared with $12.3-million last quarter and $11.8-million for the same period of fiscal 2022. The sequential and year-over-year trends were a function primarily of higher salary and benefits amounts attributable to higher staffing levels to support expanded business activity across the bank, higher general, annual compensation adjustments and higher professional fees, attributable to the continuing regulatory approval process associated with VersaBank's acquisition of a U.S. bank. Investments associated with the acquisition of the U.S. bank are expected to continue over the course of fiscal 2023 in amounts similar to the current period and will be related primarily to the bank ensuring that it is in compliance with all necessary U.S. banking regulatory requirements. The year-over-year increase in non-interest expenses was partially offset by lower insurance premiums relative to the premiums paid during the comparative period attributable to VersaBank's listing on the Nasdaq in September, 2021, and lower capital tax expense attributable to a shift in the provincial allocation of the bank's loan and deposit originations.

Provision for/recovery of credit losses -- provision for credit losses for the quarter was $237,000 compared with a provision for credit losses of $385,000 last quarter, and a provision for credit losses of $78,000 for the same period of fiscal 2022. The sequential trend was a function primarily of changes in the forward-looking information used by the bank in its credit risk models, offset partially by higher lending asset balances and changes in the bank's lending asset mix. The year-over-year trend was a function primarily of changes in the forward-looking information used by the bank in its credit risk models, higher lending asset balances and changes in the bank's lending asset mix. Provision for credit losses as a percentage of average loans was 0.03 per cent, compared with a 12-quarter average of negative 0.01 per cent.

Capital -- at April 30, 2023, VersaBank's total regulatory capital was $455-million compared with $447-million last quarter and $432-million a year ago. The bank's total capital ratio at April 30, 2023, was 15.37 per cent, compared 15.34 per cent last quarter and 18.68 per cent a year ago. The sequential and year-over-year capital ratio trends were a function primarily of retained earnings growth, the impact of the purchase and cancellation of common shares through the bank's NCIB, and changes to the bank's risk-weighted asset balances and composition over the same periods.

Credit quality -- the bank's allowance for expected credit losses (ECL) at April 30, 2023, was $2.5-million compared with $2.3-million last quarter and $1.5-million a year ago. The sequential and year-over-year changes were a function primarily of the factors set out in the provision for/recovery of credit losses section above. VersaBank's provision for credit losses ratio continues to be one of the lowest in the Canadian banking industry, reflecting the very low risk profile of the bank's lending portfolio, enabling it to generate superior net interest margins by offering innovative, high-value deposit and lending solutions that address unmet needs in the banking industry through a highly efficient partner model. Given that the vast majority of the bank's CRE portfolio is composed of loans and mortgages for residential use properties, it has very limited exposure to the commercial real estate market.

Lending operations: POS financing -- POS financing portfolio balances for the quarter increased 5 per cent sequentially and 58 per cent year-over-year to $2.5-billion, as a function primarily of continued strong demand for home improvement/HVAC and transportation receivable financing. Although consumer spending and business investment in Canada are expected to slow during the second half of 2023 (due primarily to the impact of higher interest rates combined with elevated inflation), the economic slowdown is expected to be short lived, with modest layoffs and stable unemployment levels. As was the case during the first half of fiscal 2023, management expects any impact of a slower economy on the POS financing portfolio in the second half of fiscal 2023 to be substantially outweighed by the bank's continued success in adding new origination partners and expanding business with existing partners. Combined with what is seasonally stronger growth historically in the POS portfolio in the second half of the fiscal year, management expects growth in the POS portfolio for the second half of 2023 to be, at a minimum, consistent with that of the first half.

U.S. receivable purchase program (RPP) -- despite higher interest rates, elevated inflation and high gas prices in the U.S., the labour market remains tight, which management expects will continue to support consumer spending, and in turn will support stable demand for durable goods and agricultural products, which is expected to continue to stimulate transportation and manufacturing equipment purchases. Additionally, despite a cooling of the residential home market in the U.S., overall construction activity is expected to continue to expand modestly over the course of 2023, which is anticipated to support demand for construction equipment in the near term which management believes will continue to support growth in the bank's RPP portfolio over the course of fiscal 2023.

Lending operations: commercial lending -- the commercial lending portfolio for the quarter increased 7 per cent sequentially and 4 per cent year-over-year to $866-million. Management anticipates continued moderate growth in the commercial mortgage sector related to financing for residential housing properties, which is expected to result in healthy demand for the bank's residential construction and term financing products, for which the bank is currently experiencing and expects to continue to experience high-quality deal flow, throughout at least fiscal 2023. Notwithstanding the effective risk mitigation strategies that are employed in managing the bank's CRE portfolios, including working with well-established, well-capitalized partners and maintaining modest loan-to-value ratios on individual transactions, management continues to take a cautionary stance with respect to its broader CRE portfolios due to the anticipation of volatility in CRE asset valuations in the current and anticipated interest rate environment, and the potential impact of same on borrowers' ability to service debt, as well as due to concerns related to inflation and higher input costs, which continue to have the potential to drive higher construction costs. Additionally, management anticipates more meaningful participation in the OFSI B-20-compliant conventional, uninsured mortgage financing space. Management anticipates business generated from this initiative will have a positive balance sheet impact through fiscal 2024.

Deposit funding -- cost of funds for the second quarter was 3.27 per cent, an increase of 32 bps sequentially and 189 bps year-over-year, attributable to a shift in the bank's funding mix and a higher interest rate environment. Management expects that commercial deposit volumes raised through VersaBank's trustee integrated banking (TIB) program will return to growth late in the second half of fiscal 2023 as a function of an increase in the volume of consumer and commercial bankruptcy and proposal restructuring proceedings over the same time frame, attributable primarily to a more challenging current and forecasted economic environment as evidenced by increasing Canadian consumer bankruptcy filing volumes. Further, VersaBank continues to pursue a number of initiatives to grow and expand its well-established, diverse deposit broker network through which it sources personal deposits, consisting primarily of guaranteed investment certificates. The bank's current deposit channels remain an efficient, reliable and diversified source of funding, providing ample access to reasonably priced deposits in volumes that comfortably support the bank's liquidity requirements. Substantially all of the bank's deposit volumes raised through these channels are eligible for CDIC (Canada Deposit Insurance Corp.) insurance.

DRTC (cybersecurity services and banking and financial technology development)

DRTC revenue (including that from services provided to the digital banking operations) increased 17 per cent sequentially to $2.1-million and 50 per cent year-over-year, as a function primarily of higher service engagements in the current quarter and higher gross profit from DBG. DRTC recorded net income of $433,000 compared with a net loss of $516,000 in the sequential quarter, and net loss of $472,000 a year ago. The sequential and year-over-year trends were a function primarily of a $530,000 deferred tax asset associated with DRTC's non-capital loss carry forward, which is anticipated to be applied to future taxable earnings.

DBG revenue increased 11 per cent sequentially as a function of higher service engagements in the current quarter, while gross profit increased 17 per cent sequentially as a function primarily of improved operational efficiency achieved by DBG over the course of the year. DRTC's DBG services revenue and gross profit increased 5 per cent and 35 per cent year-over-year to $2.6-million and $1.9-million, respectively, as a function of higher service engagements in the current quarter. DBG's gross profit amounts are included in DRTC's consolidated revenue which is reflected in non-interest income in VersaBank's consolidated statements of income and comprehensive income.

About VersaBank

VersaBank is a Canadian Schedule I chartered (federally licensed) bank with a difference. VersaBank became the world's first fully digital financial institution when it adopted its highly efficient business-to-business model in 1993 using its proprietary state-of-the-art financial technology to profitably address underserved segments of the Canadian banking market in the pursuit of superior net interest margins while mitigating risk. VersaBank obtains all of its deposits and provides the majority of its loans and leases electronically, with innovative deposit and lending solutions for financial intermediaries that allow them to excel in their core businesses. In addition, leveraging its internally developed IT (information technology) security software and capabilities, VersaBank established wholly owned subsidiary DRT Cyber Inc., based in Washington, D.C., to pursue significant large-market opportunities in cybersecurity and develop innovative solutions to address the rapidly growing volume of cyberthreats challenging financial institutions, multinational corporations and government entities on a daily basis.

Conference call

VersaBank will be hosting a conference call and webcast today, Wednesday, June 7, 2023, at 9 a.m. (ET) to discuss its second quarter results, featuring a presentation by Mr. Taylor, president and CEO, and other VersaBank executives, followed by a question-and-answer period.

Dial in details

Toll-free dial-in:  1-888-664-6392 (Canada/U.S.)

Local dial-in:  416-764-8659

Please call between 8:45 a.m. and 8:55 a.m. (ET).

To join the conference call by telephone without operator assistance, you may register and enter your phone number in advance, on-line, to receive an instant automated call back.

Webcast access: For those preferring to listen to the conference call via the Internet, a webcast of Mr. Taylor's presentation will be available on the bank's website.

Instant replay

Toll-free dial-in:  1-888-390-0541 (Canada/U.S.)

Local dial-in:  416-764-8677

Passcode:  008318 followed by the pound key

Expiry date:  July 7, 2023, at 11:59 p.m. (ET)

The archived webcast presentation will also be available via the Internet for 90 days following the live event on the bank's website.

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