VersaBank Reports First Quarter 2017 Results(1)

All amounts are in Canadian dollars and are based on financial
statements prepared in compliance with International Accounting Standard
34 Interim Financial Reporting, unless otherwise noted. On January 31,
2017 VersaBank amalgamated with PWC Capital Inc. (“PWC”) pursuant to
section 228 of the Bank Act (Canada) (the “Amalgamation”), with the
amalgamated entity continuing under the name VersaBank. These financial
statements reflect the results of the amalgamated entity VersaBank (“VB”
or the “Bank”).
Our Q1 2017 Supplementary Financial Information
is available on our website at versabank.com/investor-relations.

VersaBank (VB on TSX) today reported net income of $11.9 million for the
first quarter ended January 31, 2017, up $9.6 million from a year ago.
Results reflect the recognition of $8.8 million in deferred income tax
assets (“DTA”) derived from the tax loss carry-forwards assumed pursuant
to the Amalgamation and strong earnings derived from Commercial Banking
and eCommerce.

Excluding the DTA gain noted above, income before taxes and
restructuring costs was $4.7 million up $1.5 million or 47% over the
last quarter. These strong results reflect loan growth (up 2% up from
last quarter) and a significant improvement in net interest margin
(“NIM”) (up 8% from last quarter).

“NIM is now one of the best in our industry at 2.54% and is particularly
impressive considering our provision for credit losses (“PCL”), of 2
bps, is one of the lowest in our industry. Our strategy to target niche
markets where the ‘risk/return’ trade-off is favourable is clearly
working,” said David Taylor, VB President and CEO.

Our capital position was very strong with a Common Equity Tier 1
(“CET1”) ratio of 10.28% and leverage ratio of 9.45%. The latter ratio
is more than double the average of the other publically held financial
institutions. Unlike the large banks that use their own models, many of
the smaller banks, including VB calculate their risk weighted assets
using the ‘Standardized Approach’. VB believes that the Standardized
Approach results in its low risk loan portfolio being risk weighted much
higher than the actual intrinsic risk of the portfolio warrants. This
serves to depress VB’s return on common equity (“ROCE”) and balance
sheet growth. Addressing this anomaly is a top priority for VB.

The Amalgamation resulted in VB acquiring net assets of $6.7 million
before transaction costs for net consideration of 1,028,494 common
shares bringing VB’s total issued and outstanding shares to 21,123,559.

Q1 2017 compared to Q1 2016(1)

 

  • Net income of $11.9 million (up 413% from $2.3 million)
  • NIM of 2.54% (up 17% from 2.18%)
  • Basic and diluted earnings per share (EPS) of $0.56 (up $0.47
    from $0.09)
  • Common share book value $8.20 (up 9% from $7.56)
  • ROCE of 27.22% (up 468% from 4.79%)
  • CET1 ratio of 10.28% (up from 10.11%)
  • Leverage ratio 9.45% (up from 9.23%)
  • Income before restructuring charges and income taxes of $4.7
    million (up 47% from $3.2 million)
Q1 2017 compared to Q4 2016(1)

 

  • Net income of $11.9 million (up 526% from $1.9 million)
  • NIM of 2.54% (up 8% from 2.36%)
  • Basic and diluted EPS of $0.56 (up $0.49 from $0.07)
  • Common share book value $8.20 (up 5% from $7.79)
  • ROCE of 27.22% (up 694% from 3.43%)
  • CET1 ratio of 10.28% (down from 10.52%)
  • Leverage ratio 9.45% (down from 9.82%)
  • Income before restructuring charges and income taxes of $4.7
    million (up 47% from $3.2 million)

(1) Certain highlights include non-GAAP measures. See definition under
‘Basis of Presentation’ in the attached Management’s Discussion and
Analysis.

Q1 2017 Business Operations

Commercial Banking – Loans are obtained by direct contact with
our clients by our lending staff located mainly in London, Ontario and
through mortgage brokers. Loans are well secured by real estate
primarily in Ontario and occasionally other areas of Canada. Assets at
January 31, 2017 totalled $765 million up 2.25% from the previous
quarter but down 4.17% from a year ago. NIM at January 31, 2017 was
approximately 3.15%.

eCommerce – Batches of small loan and lease receivables are
electronically purchased from our vendor partners who make point of sale
loans and leases in various markets throughout Canada. Assets at January
31, 2017 totalled $823 million up 1.23% from the previous quarter and up
17.30% from a year ago. NIM at January 31, 2017 was approximately 2.44%.
This is the fastest growing area of our business and we have just
enhanced it by developing the technology to enable us to buy individual
loan and lease receivables on a real time basis. This area of operations
also includes a small credit card receivable portfolio in the amount of
$23 million at January 31, 2017 that we are winding down.

Deposit Services – VB has developed 3 channels for gathering
deposits. It gathers deposits, without the need for branches, from a
large nationwide network of brokers, obtains deposits from its vendor
partners and it obtains deposits from insolvency professionals. The
latter channel resulted from VB’s software team developing a custom
banking program for insolvency professionals. This exciting new channel
continues to grow and serves to lower VB’s overall cost of funds and
further diversify its deposit base. VB’s cost of funds at January 31,
2017 was 1.70%, down 2% from last quarter and down 12% from a year ago.
VB’s low cost of funds enables it to earn industry leading NIM without
taking on the usual credit risk typically necessary to achieve higher
yields.

Capital – As at January 31, 2017, VB’s CET1 ratio was 10.28%,
down 24 bps from last quarter and up 17bps from a year ago. VB like most
small banks uses the ‘Standardized Approach’ to calculate its risk
weighted assets and because VB focuses on lower than average risk
commercial and consumer loans (as is demonstrated by its history of
extremely low PCL) it believes the Standardized Approach does not
properly reflect the intrinsic risk of its loan portfolio. As a
consequence VB’s leverage ratio is more than twice the average leverage
ratio of the big banks, which use the ‘Internal Ratings Based Approach’
to calculate their risk weighted assets. Addressing this anomaly is a
top priority for VB.

Credit Quality – Total PCL of $303,000 at January 31, 2017 was
down $119,000 or 28% from last quarter, largely reflecting lower
provisions relating to our credit card portfolio that we are winding
down. Total PCL ratio of 0.02% was down 1 bps as compared to last
quarter and reflects the very low intrinsic risk in our loan portfolio.

Total gross impaired loans were again nil as they have been for the past
4 years. VB’s business model is to incur less lending risk than the
other financial institutions (“FI”), but achieve greater NIM, by lending
to niche markets that are not well served by the larger FIs.
Accordingly, this strategy is producing the best NIM in our industry
with the least gross impaired loans.

FINANCIAL HIGHLIGHTS

                     
(unaudited)       for the three months ended
      January 31   October 31   January 31
($CDN thousands except per share amounts)     2017       2016       2016  
Results of operations
Net interest income $ 11,145 $ 10,066 $ 9,142
Non-interest income 287 320 325
Total revenue 11,432 10,386 9,467
Provision for credit losses 303 422 212
Non-interest expenses 6,458 6,779 6,051
Income before restructuring charges and income taxes* 4,671 3,185 3,204
Restructuring charges 470 549
Net income 11,864 1,896 2,311
Income per common share:
Basic $ 0.56 $ 0.07 $ 0.09
    Diluted       $ 0.56     $ 0.07     $ 0.09  
Yield* 4.24 % 4.09 % 4.11 %
Cost of funds* 1.70 % 1.73 % 1.93 %
Net interest margin* 2.54 % 2.36 % 2.18 %
Return on average common equity* 27.22 % 3.43 % 4.79 %
Book value per common share* $ 8.20 $ 7.79 $ 7.56
Gross impaired loans to total loans 0.00 % 0.00 % 0.00 %
  Provision for credit losses as a % of average loans     0.02 %     0.03 %     0.01 %
            as at
Balance Sheet Summary
Cash and securities $ 135,949 $ 103,922 $ 170,422
Total loans 1,590,470 1,563,612 1,501,889
Average loans 1,577,041 1,531,309 1,474,775
Total assets 1,773,004 1,704,400 1,702,015
Average assets 1,738,702 1,694,847 1,663,911
Deposits 1,430,359 1,369,647 1,396,502
Subordinated notes payable 14,095 14,067 13,984
Shareholders’ equity 202,583 185,884 176,374
Capital ratios*
Risk-weighted assets $ 1,403,760 $ 1,425,171 $ 1,372,173
Total capital 183,514 189,122 180,726
Common Equity Tier 1 (CET1) ratio 10.28 % 10.52 % 10.11 %
Tier 1 capital ratio 12.37 % 12.58 % 12.25 %
Total capital ratio 13.07 % 13.27 % 13.17 %
  Leverage ratio       9.45 %     9.82 %     9.23 %

* This is a non-GAAP measure. See definition under ‘Basis of
Presentation’ in the attached Management’s Discussion and Analysis.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL
CONDITION

This management’s discussion and analysis (MD&A) of operations and
financial condition for the first quarter of fiscal 2017, dated March
16, 2017, should be read in conjunction with the unaudited interim
consolidated financial statements for the period ended January 31, 2017,
included herein which have been prepared in accordance with
International Financial Reporting Standards (IFRS). This MD&A should
also be read in conjunction with the Bank’s MD&A and the audited
consolidated financial statements for the year ended October 31, 2016,
which are available on SEDAR at www.sedar.com.
Except as discussed below, all other factors discussed and referred to
in the MD&A for the year ended October 31, 2016, remain substantially
unchanged.

Basis of Presentation

Non-GAAP and Additional GAAP Measures

Yield

Yield is calculated as interest income (as presented in the Consolidated
Statements of Income) divided by average total assets. Yield does not
have a standardized meaning prescribed by IFRS and, therefore, may not
be comparable to similar measures presented by other financial
institutions.

Cost of funds

Cost of funds is calculated as interest expense (as presented in the
Consolidated Statements of Income) divided by average total assets. Cost
of funds does not have a standardized meaning prescribed by IFRS and,
therefore, may not be comparable to similar measures presented by other
financial institutions.

Income before restructuring charges and income taxes

Income before restructuring charges and income taxes is equal to total
revenue less the provision for credit losses and less non-interest
expenses, as presented in the Consolidated Statements of Income.

Net Interest Income and Net Interest Margin or Spread

Most banks analyze profitability by net interest income (as presented in
the Consolidated Statements of Income) and net interest margin or
spread. Net interest margin or spread is defined as net interest income
as a percentage of average total assets. Net interest margin or spread
does not have a standardized meaning prescribed by IFRS and, therefore,
may not be comparable to similar measures presented by other financial
institutions.

Basel III Common Equity Tier 1, Tier 1, Total Capital Adequacy and
Leverage Ratios

Basel III Common Equity Tier 1, Tier 1, total capital adequacy and
leverage ratios are determined in accordance with guidelines issued by
the Office of the Superintendent of Financial Institutions Canada (OSFI).

Book Value Per Common Share

Book value per common share is defined as Shareholders’ Equity less
amounts relating to preferred shares recorded in equity, divided by the
number of common shares outstanding.

Return on Average Common Equity

Return on average common equity is defined as annualized net income less
amounts relating to preferred share dividends, divided by average common
shareholders’ equity which is average shareholders’ equity less amounts
relating to preferred shares recorded in equity.

Overview

VersaBank (the “Bank”) is a technologically proficient Canadian Schedule
I chartered bank which operates using an electronic branchless model. It
sources its deposits through a well-established and widely diversified
network of deposit brokers and purchases loan and lease receivables. The
Bank also makes residential development and commercial loans and
mortgages which are sourced through direct contact with clients by its
lending staff. The Bank’s Common Shares, Series 1 Preferred Shares, and
Series 3 Preferred Shares trade on the Toronto Stock Exchange.

On September 12, 2016 and November 15, 2016, PWC and VersaBank jointly
announced that they had entered into an agreement to merge by
amalgamation under the Bank Act (Canada) (the “Amalgamation”). This
transaction was completed on January 31, 2017, pursuant to section 228
of the Bank Act (Canada), with the amalgamated entity continuing under
the name VersaBank. Pursuant to the Amalgamation: (i) each issued and
outstanding common share of PWC (other than PWC common shares with
respect to which dissent rights were exercised) was converted into
common shares of the Bank on the basis of 54.508758 PWC common shares
for 1 Bank common share, resulting in a total of 13,643,713 Bank common
shares being issued, (ii) 12,615,219 outstanding common shares of
VersaBank held by PWC prior to the Amalgamation were cancelled, and
(iii) each issued and outstanding security of VersaBank held prior to
the Amalgamation continues on under the same arrangement subsequent to
the Amalgamation. As a result of the above, at January 31, 2017 the
issued and outstanding common shares of the Bank increased by 1,028,494
shares to 21,123,559 common shares.

In addition, each outstanding option to acquire PWC Common Shares was
converted into an option to purchase Bank common shares resulting in
7,059 additional options being issued.

The fair values of the assets and liabilities acquired by the Bank on
Amalgamation are as follows:

       
  January 31
($CDN thousands)       2017  
 
Incremental assets recognized:
Cash $ 1,569
Deferred income tax asset 11,939
Other assets 2,025
Other net liabilities assumed (8,793 )
Transaction costs, net of income taxes of $500 (1,352 )
       
Total impact of amalgamation   $ 5,388  
 

See Note 18 to the unaudited interim consolidated financial statements
for additional information pertaining to the Amalgamation. Further
information regarding the Amalgamation of the Bank and PWC can be found
in the Bank and PWC’s Management Information Circulars and the Joint
Disclosure Booklet dated November 22, 2016, along with various
Amalgamation press releases issued throughout the course of 2016 and
2017. These documents and other additional information about the Bank
are available on SEDAR at www.sedar.com
or via the Bank’s website at http://www.versabank.com/investor-relations/merger-of-pwc-and-versabank/.

Net income for the current quarter was $11.9 million or $0.56 per common
share (basic and diluted), compared to $1.9 million or $0.07 per common
share (basic and diluted) for the previous quarter and $2.3 million or
$0.09 per common share (basic and diluted) a year ago. The increase in
net income compared to the previous quarter and the same period a year
ago is due to growth in net interest income and the recognition of $8.8
million in deferred income tax assets derived from the income tax loss
carry-forwards assumed from PWC pursuant to the Amalgamation. Net income
of the Bank for the current quarter includes restructuring charges of
$470,000 compared to $549,000 for the previous quarter and $nil a year
ago. Income before restructuring charges and income taxes for the
current quarter was $4.7 million compared to $3.2 million for the same
period a year ago, an increase of 47%.

Total assets at January 31, 2017 were $1.77 billion compared to $1.70
billion at the end of the previous quarter and $1.70 billion a year ago.
Lending assets totalled $1.59 billion compared to $1.56 billion at the
end of the previous quarter and $1.50 billion a year ago. Credit quality
remains strong with no gross impaired loans at January 31, 2017,
unchanged from October 31, 2016 and a year ago.

Total Revenue

Total revenue consists of net interest income and non-interest income.
Non-interest income consists primarily of fees from credit card
operations.

For the three months ended January 31, 2017, total revenue increased to
$11.4 million from $10.4 million for the previous quarter and from $9.5
million for the same period a year ago, an increase of 21%. The increase
in total revenue was due to growth in net interest income over these
same periods.

Net Interest Income

Net interest income for the three months ended January 31, 2017
increased to $11.1 million from $10.1 million for the previous quarter
and from $9.1 million for the same period a year ago, an increase of
22%. The increase in net interest income was primarily due to lending
assets growing 6% year over year to $1.59 billion at January 31, 2017
from $1.50 billion as well as the Bank’s yield on assets increasing 3%
year over year to 4.24% from 4.11% and from the Bank’s cost of funds
decreasing 12% year over year to 1.70% from 1.93%.

Net Interest Margin

Net interest margin or spread for the three months ended January 31,
2016 increased to 2.54% from 2.36% for the previous quarter and 2.18%
for the same period a year ago. Net interest margin increased primarily
as a result of a decrease in the Bank’s cost of funds as noted above.

Provision For Credit Losses

The Bank maintains high credit quality and strong underwriting standards
and as a result traditionally requires minimal provisions for credit
losses. The provision for credit losses for the current quarter was
$303,000 compared to $422,000 for the previous quarter and $212,000 for
the same period a year ago. The decrease in the provision for credit
losses quarter over quarter was primarily a function of a decrease in
credit card balances over that same period which resulted in a
corresponding decrease in the collective allowance. The increase in the
provision for credit losses year over year was due to an increase in the
collective allowance as a result of overall lending asset growth.

Non-Interest Expenses

Non-interest expenses of the Bank, excluding restructuring costs,
totalled $6.5 million for the current quarter compared to $6.8 million
for the previous quarter and $6.1 million for the same period a year
ago. The decrease in non-interest expenses from the previous quarter was
due primarily to a reduction in employee compensation as a result of a
reduction in staff. The increase in non-interest expenses from a year
ago was due primarily to an increase in regulatory related costs.

Restructuring Charges

During the three months ended January 31, 2017, the Bank incurred
restructuring charges totalling $470,000, as well as $549,000 in the
previous quarter and $nil in the same period a year ago. These
restructuring charges relate to costs associated with the Bank’s
corporate rebranding as well as the strategic review that was conducted
by PWC and the Bank which resulted in the Amalgamation of PWC and the
Bank.

Income Taxes

The statutory federal and provincial income tax rate of the Bank is
approximately 27%, similar to that of the previous periods. The
statutory rate is impacted by certain items not being taxable or
deductible for income tax purposes.

For the three months ended January 31, 2017, the provision (recovery)
for income taxes was ($7,663,000) compared to $740,000 for the previous
quarter and $893,000 for the same period a year ago. As noted in the
“Overview” section above, the decrease in the provision for income taxes
from the previous quarter and from a year ago was due primarily to the
impact of recognizing $8.8 million in deferred income tax assets derived
from the aggregate tax loss carry-forwards of PWC assumed by the Bank
pursuant to the Amalgamation. See Note 11 to the unaudited interim
consolidated financial statements for additional information on the
Amalgamation.

Comprehensive Income

Comprehensive income is comprised of net income for the period and other
comprehensive income which consists of unrealized gains and losses on
available-for-sale securities. Comprehensive income of the Bank for the
three months ended January 31, 2017 was $11.9 million compared to $1.9
million for the previous quarter and $2.3 million a year ago, with the
current quarter’s comprehensive income reflecting the impact of the
recognition of the deferred income tax asset, referenced in the previous
section and increased earnings from operations. Due to the current
composition of the Bank’s treasury portfolio, which consists primarily
of liquid securities, unrealized gains or losses in the portfolio are
not significant and as a result comprehensive income does not differ
significantly from net income.

Consolidated Balance Sheet

Total assets at January 31, 2017 were $1.77 billion compared to $1.70
billion at the end of the previous quarter and $1.70 billion a year ago.
The increase in total assets from a year ago was due to lending assets
growing 6% year over year to $1.59 billion from $1.50 billion. Growth in
lending assets was primarily a result of an increase in loan and lease
receivables sourced through the Bank’s bulk purchase program.

Cash and Securities

Cash and cash equivalents consist of deposits with Canadian financial
institutions and government treasury bills with less than ninety days to
maturity from the date of acquisition. Securities in the treasury
portfolio typically consist of Government of Canada, Canadian provincial
and municipal bonds and debt of other financial institutions. Amounts
invested in each of these securities are determined based on the Bank’s
liquidity requirements, investment yield and capital management
considerations. Cash and securities, which are held primarily for
liquidity purposes, totalled $136 million or 7.7% of total assets
compared to $104 million or 6.1% of total assets at the end of the
previous quarter and $170 million or 10.0% of total assets a year ago.
The level of cash and securities as a percentage of total assets
increased quarter over quarter as the Bank raised additional deposits
and increased liquidity in preparation for a high volume of loan
fundings anticipated to occur early in the second quarter.

Loans

At January 31, 2017, loans totalled $1.59 billion compared to $1.56
billion at the end of the previous quarter and $1.50 billion a year ago.
The increase in loans from the previous quarter and a year ago was due
primarily to growth in loan and lease receivables purchased through the
Bank’s bulk purchase program, with the quarter over quarter increase in
loans being augmented by growth in commercial lending assets.

Loan and lease receivables purchased through the Bank’s bulk purchase
program continued to show strong growth increasing to $797 million at
January 31, 2017 from $784 million at the end of the previous quarter,
and from $671 million last year, a net increase of $126 million or 19%.
The bulk purchase program, which consists of the purchase of individual
loan and lease receivables, continues to be a key growth driver of the
Bank’s lending portfolio. The cash holdback structure applied to the
purchased receivables results in these assets attracting a lower
collective allowance.

Construction mortgages also showed modest growth quarter over quarter
and year over year while government loans continued to decline over
these same periods. The latter trend is reflective of the Bank’s
decision to reallocate resources and lending capacity to the bulk
purchase program.

Total new lending for the quarter was $254 million compared to $262
million for the previous quarter and $231 million a year ago. Loan
repayments for the quarter totalled $224 million compared to $198
million for the previous quarter and $177 million a year ago. At January
31, 2017, loan commitments representing loans in the Bank’s pipeline
totalled $210 million compared to $266 million at the end of the
previous quarter and $253 million a year ago.

Residential mortgage exposures

In accordance with the Office of the Superintendent of Financial
Institutions (OSFI) Guideline B-20 – Residential Mortgage
Underwriting Practices and Procedures
, additional information is
provided regarding the Bank’s residential mortgage exposure. For the
purposes of the Guideline, a residential mortgage is defined as a loan
to an individual that is secured by residential property (one to four
unit dwellings) and includes home equity lines of credit (HELOC’s). This
differs from the classification of residential mortgages used by the
Bank which also includes multi-family mortgages.

Under OSFI’s definition, the Bank’s exposure to residential mortgages at
January 31, 2017 totalled $627,000 compared to $637,000 at the end of
the previous quarter and $668,000 a year ago. The Bank did not have any
HELOC’s outstanding at January 31, 2017, at the end of the previous
quarter or a year ago.

Credit Quality

Gross impaired loans at January 31, 2017, were $nil, unchanged from the
end of the previous quarter and a year ago. At January 31, 2017, the
collective allowance totalled $3.0 million compared to $3.0 million at
the end of previous quarter and $3.2 million a year ago. The collective
allowance decreased from a year ago as a result of changes in the mix of
the loan portfolio, particularly growth in loan and lease receivables
sourced through the bulk finance program which attract a lower
collective allowance due to the cash holdbacks which are retained
against the purchased receivables combined with a decrease in credit
card balances over that same timeframe which attract a higher collective
allowance.

Based on the Bank’s review and analysis of its lending and treasury
assets, combined with the secured nature of the existing loan portfolio,
the Bank is of the view that any credit losses which exist but cannot be
specifically identified at this time are adequately provided for.
Additionally, the Bank’s exposure to Western Canada and to the oil and
gas industry remains limited and the Bank is not concentrated in the
housing markets in Toronto and Western Canada.

The geographic concentration of the Bank’s lending portfolio at January
31, 2017 has not changed significantly from that at the end of the
previous quarter and from a year ago where a majority of the lending
portfolio is in the province of Ontario.

Other Assets

Included in other assets are prepaid expenses, funds held for
securitization liabilities, capital assets and the deferred income tax
asset. Other assets totalled $46.6 million at January 31, 2017, compared
to $36.9 million at the end of the previous quarter and $29.7 million a
year ago with the change from last quarter and a year ago due primarily
to an increase in the Bank’s deferred income tax asset derived from the
tax loss carry-forwards assumed by the Bank pursuant to the
Amalgamation, offset by the decrease in funds held for securitization
liabilities.

The deferred income tax asset of the Bank was $26.7 million at January
31, 2017, compared to $6.4 million at the end of the previous quarter
and $8.1 million a year ago. The increase is the result of the Bank
acquiring a deferred income tax asset pursuant to the Amalgamation with
PWC at a cost of $11.9 million, and the Bank subsequently recognizing an
additional $8.8 million in deferred income tax assets on its revaluation
to its accounting value. The deferred income tax asset acquired relates
mostly to tax loss carry-forwards of PWC assumed by the Bank pursuant to
the Amalgamation. The Bank’s income tax loss carry-forwards are
scheduled to begin to expire in 2025 if unutilized.

Deposits and Other Liabilities

Deposits are used as a primary source of financing growth in assets and
are raised primarily through a well-established and well-diversified
deposit broker network which the Bank continues to grow and expand
across Canada. Deposits at January 31, 2017, totalled $1.43 billion
compared to $1.37 billion at the end of the previous quarter and $1.40
billion a year ago and consist primarily of guaranteed investment
certificates. The increase in deposits from a year ago was due to the
raising of new deposits to fund lending asset growth.

Of the total amount of deposits outstanding, $18.1 million or
approximately 1.27% of total deposits at the end of the current quarter
were demand savings accounts compared to $17.5 million or 1.27% of total
deposits at the end of the previous quarter and $17.1 million or
approximately 1.23% of total deposits a year ago.

An additional source of funds for the Bank, which not only contributes
to diversifying the Bank’s funding mix, but also to reducing its cost of
new deposits, is a specialized chequing facility platform for trustees
in the Canadian bankruptcy industry. The Bank has developed banking
software to enable this market to efficiently administer its chequing
accounts and has provided this software to trustees operating across
Canada. At January 31, 2017, balances for these low cost chequing
accounts totalled $197.2 million compared to $189.1 million at the end
of the previous quarter and $119.8 million a year ago.

Other liabilities typically consist of accounts payable and accruals and
holdbacks payable related to the bulk purchase program. At January 31,
2017, other liabilities totalled $92.6 million compared to $91.2 million
at the end of the previous quarter and $71.5 million a year ago with the
increase due primarily to growth in holdbacks associated with loan and
lease receivables purchased through the bulk purchase program. These
holdbacks payable totalled $81.4 million at January 31, 2017 compared to
$82.6 million at the end of previous quarter and $66.4 million a year
ago.

Securitization Liabilities

Securitization liabilities relate to amounts payable to counterparties
for cash received upon initiation of securitization transactions. At
January 31, 2017, securitization liabilities totalled $33.4 million
compared to $43.6 million at the end of the previous quarter and $43.7
million a year ago. The quarter over quarter and year over year
reduction in securitization liabilities was due to the maturity of $10.3
million in Canada Mortgage Bonds. The amounts payable to counterparties
bear interest at rates ranging from 3.55% – 3.95% and mature in 2020.
Residential mortgages and other assets are pledged as collateral for
securitized liabilities.

Subordinated Notes Payable

Subordinated notes payable, net of issue costs, totalled $14.1 million
at January 31, 2017 compared to $14.1 million at the end of the previous
quarter and $14.0 million a year ago. The face value of the outstanding
subordinated notes totalled $14.5 million. These subordinated notes were
issued by the Bank to an unrelated party, are currently callable, bear
interest at rates ranging from 8.00% to 11.00% and mature between 2019
and 2021.

Shareholders’ Equity

At January 31, 2017, shareholders’ equity was $202.6 million compared to
$185.9 million at the end of the previous quarter and $176.4 million a
year ago. The quarter over quarter and year over year increase in
shareholders’ equity was primarily due to earnings generated over these
same periods as well as the impact of the recognition of net assets in
the amount of $6.7 million, less $1.4 million in transaction costs, and
recognition of an additional $8.8 million in deferred income tax assets
attributable to the aggregate tax loss carry-forwards of PWC assumed
pursuant to the Amalgamation.

Common shares outstanding at January 31, 2017 totalled 21,123,559
compared to 20,095,065 in the previous quarter and compared to
19,437,171 a year ago with the increase due to the issue of 657,894
common shares under private placement on March 9, 2016 as well as the
issue of 13,643,713 common shares, offset by the cancellation of
12,615,219 common shares pursuant to the Amalgamation.

The Bank’s book value per common share (non-GAAP measure) at January 31,
2017 was $8.20 compared to $7.79 at the end of the previous quarter and
$7.56 a year ago.

See Note 10 and Note 18 to the unaudited interim consolidated financial
statements for additional information relating to share capital.

Updated Share Information

As at March 16, 2017, there were no changes since January 31, 2017 in
the number of outstanding common shares, Series 1 and Series 3 preferred
shares and common share options.

Off-Balance Sheet Arrangements

As at January 31, 2017, the Bank does not have any significant
off-balance sheet arrangements other than loan commitments and letters
of credit resulting from normal course business activities. See Note 13
to the unaudited interim consolidated financial statements for more
information.

Related Party Transactions

During the three months ended January 31, 2017, the Bank incurred
management and other fees totalling $225,000 (January 31, 2016 –
$150,000) to PWC.

The Bank’s Board of Directors and senior executive officers represent
key management personnel. See Note 14 to the unaudited interim
consolidated financial statements for additional information on related
party transactions and balances.

Risk Management

The risk management policies and procedures of the Bank are provided in
its annual MD&A for the year ended October 31, 2016.

Capital Management and Capital Resources

The Basel Committee on Banking Supervision has rules supporting
stringent global standards on capital adequacy and liquidity (Basel
III). Significant rules under Basel III that are most relevant to the
Bank include:

  • Increased focus on tangible common equity.
  • All forms of non-common equity such as the Bank’s conventional
    subordinated notes must be non-viability contingent capital (NVCC)
    compliant. NVCC compliant means the subordinated notes must include a
    clause that would require conversion to common equity in the event
    that OSFI deems the institution to be insolvent or a government is
    ready to inject a “bail out” payment.
  • Changes in the risk-weighting of certain assets.
  • Additional capital buffers.
  • Requirements for levels of liquidity and new liquidity measurements.

The Bank reports its regulatory capital ratios using the Standardized
approach for calculating risk-weighted assets, as defined under Basel
III, which may require the Bank to carry more capital for certain credit
exposures compared to requirements under the Advanced Internal Ratings
Based (AIRB) methodology. As a result, regulatory capital ratios of
banks that utilize the Standardized approach are not directly comparable
with the large Canadian banks which use the AIRB methodology.

OSFI requires that all Canadian banks must comply with the Basel III
standards on an “all-in” basis for purposes of determining its
risk-based capital ratios. Required minimum regulatory capital ratios
are a 7.0% Common Equity Tier 1 (CET1) capital ratio and an 8.5% Tier 1
capital ratio and 10.5% total capital ratio, all of which include a 2.5%
capital conservation buffer. The Basel III rules provide for
“transitional” adjustments whereby certain aspects of the new rules will
be phased in between 2013 and 2019. The only available transition
allowed by OSFI for capital ratios is related to the 10 year phase out
of non-qualifying capital instruments.

Under the Basel III standards, total regulatory capital of the Bank was
$183.5 million at January 31, 2017 compared to $189.1 million at the end
of the previous quarter and $180.7 million a year ago. The increase in
total regulatory capital from a year ago was due primarily to earnings
generated over the same period and a private placement of common shares
by the Bank for proceeds of $5.0 million in March 2016. The reduction in
regulatory capital from the previous quarter reflects the impact of the
transactions costs related to the Amalgamation and adjustments to
certain assets acquired pursuant to the Amalgamation that for purposes
of regulatory capital are not accretive.

At January 31, 2017, the Bank exceeded the current minimum Basel III
regulatory capital requirements referred to above with a CET1 ratio of
10.28% compared to 10.52% at the end of the previous quarter and 10.11%
a year ago. At January 31, 2017, the Bank’s Tier 1 capital ratio was
12.37% compared to 12.58% at the end of the previous quarter and 12.25%
a year ago. In addition, the Bank’s total capital ratio was 13.07% at
January 31, 2017, compared to 13.27% at the end of the previous quarter
and 13.17% a year ago. The year over year trends exhibited by the Bank’s
capital ratios are a function of the same variables outlined in the
previous section.

At January 31, 2017, the Bank’s leverage ratio was 9.45% compared to
9.82% at the end of the previous quarter and 9.23% a year ago.

See Note 15 to the interim consolidated financial statements for more
information regarding capital management.

Interest Rate Risk Management

The Bank is subject to interest rate risk which is the risk that a
movement in interest rates could negatively impact net interest margin,
net interest income and the economic value of assets, liabilities and
shareholders’ equity. The following table provides the duration
difference between the Bank’s assets and liabilities and the potential
after-tax impact of a 100 basis point shift in interest rates on the
Bank’s earnings during a 12 month period and the potential after-tax
impact of a 100 basis point shift in interest rates on the Bank’s
shareholders’ equity over a 60 month period if no remedial actions are
taken.

                     
        January 31, 2017   October 31, 2016
       

Increase 100
bps

 

Decrease 100
bps

 

Increase 100
bps

 

Decrease 100
bps

         
Impact on projected net interest
income during a 12 month period $ 2,936 $ (2,848 ) $ 2,387 $ (2,243 )
Impact on reported equity
during a 60 month period $ 5 $ 34 $ (1,631 ) $ 1,667
                     
Duration difference between assets and
liabilities (months)       1.0         0.6      
 

The Bank’s sensitivity to changes in interest rates and its duration
difference between assets and liabilities at January 31, 2017 has not
changed significantly since the end of the previous quarter. As
indicated by the above, the impact on net interest income during a 12
month period of a 100 basis point increase would be approximately $2.9
million and the impact on net interest income of a 100 basis point
decrease would be approximately ($2.8 million). Similarly at January 31,
2017, the impact on equity during a 60 month period of a 100 basis point
increase would be approximately $5,000 and the impact on equity of a 100
basis point decrease would be approximately $34,000. At January 31, 2017
the duration difference between assets and liabilities is approximately
1 month compared to approximately 1 month at October 31, 2016 and shows
that the Bank’s assets and liabilities would reprice at approximately
the same time in the event of a change in interest rates.

Liquidity

The unaudited Consolidated Statement of Cash Flows for the three months
ended January 31, 2017 shows cash provided by operations of $43.9
million compared to $22.6 million for the same period last year. The
operating cash flow is primarily affected by the change in the balance
of its deposits (an increase in deposits has a positive impact on cash
flow and a decrease in deposits has a negative impact on cash flow) as
compared to the change in the balance of its loans (an increase in loans
has a negative impact on cash flow and a decrease in loans has a
positive impact on cash flow). Based on factors such as liquidity
requirements and opportunities for investment in loans and securities,
the Bank may manage the amount of deposits it receives and loans it
funds in ways that result in the balances of these items giving rise to
either negative or positive cash flow from operations. The Bank will
continue to fund its operations and meet contractual obligations as they
become due from cash on hand and from managing the amount of deposits it
receives as compared to the amount of loans it funds.

Contractual Obligations

Contractual obligations as disclosed in the Bank’s MD&A and audited
consolidated financial statements for the year ended October 31, 2016,
have not changed significantly as at January 31, 2017.

Capital Assets

The operations are not dependent upon significant amounts of capital
assets to generate revenue. Currently, the Bank does not have any
commitments for capital expenditures or for significant additions to its
level of capital assets.

Summary of Quarterly Results

                                 
($CDN thousands except per share amounts)     2017     2016     2015  
Q1 Q4   Q3   Q2   Q1 Q4   Q3   Q2
 
Results of operations:
Total interest income $ 18,586 $ 17,462 $ 17,628 $ 17,346 $ 17,226 $ 16,685 $ 16,513 $ 15,630
Yield on assets (%) 4.24 % 4.09 % 4.13 % 4.14 % 4.11 % 4.15 % 4.24 % 4.21 %
Interest expense 7,441 7,396 7,792 7,986 8,084 7,724 7,786 7,375
Cost of funds (%) 1.70 % 1.73 % 1.82 % 1.91 % 1.93 % 1.92 % 2.00 % 1.99 %
Net interest income 11,145 10,066 9,836 9,360 9,142 8,961 8,727 8,255
Net interest margin (%) 2.54 % 2.36 % 2.31 % 2.23 % 2.18 % 2.23 % 2.24 % 2.22 %
Non-interest income 287 320 343 285 325 384 368 304
Total revenue 11,432 10,386 10,179 9,645 9,467 9,345 9,095 8,559
Provision for credit losses 303 422 24 213 212 319 297 427
Non-interest expenses 6,458 6,779 6,654 6,472 6,051 6,562 6,421 6,264
Restructuring charges 470 549 98 445
Income before income taxes 4,201 2,636 3,403 2,515 3,204 2,464 2,377 1,868
Income tax provision (recovery) (7,663 ) 740 947 708 893 (306 ) 670 (194 )
Net income $ 11,864 $ 1,896 $ 2,456 $ 1,807 $ 2,311 $ 2,770 $ 1,707 $ 2,062
 
Income per common share
Basic $ 0.56 $ 0.07 $ 0.09 $ 0.06 $ 0.09 $ 0.11 $ 0.05 $ 0.09
Diluted   $ 0.56     $ 0.07     $ 0.09     $ 0.06     $ 0.09     $ 0.11     $ 0.05     $ 0.09  
 

The financial results for each of the last eight quarters are summarized
above. Total interest income and net interest income continued to
increase through the first quarter of 2017 as a result of growth in
lending assets, specifically loan and lease receivables purchased
through the Bank’s bulk purchase program and from a decrease in the
Bank’s cost of funds.

Non-interest income has been comparable over the quarters and consists
primarily of fees from credit card operations.

Restructuring charges incurred to date in 2017 relate to costs
associated with the Bank’s corporate rebranding and the Amalgamation.

The provision for income taxes in each of the quarters reflects the
effective statutory income tax rate of 27% applied to earnings in the
Bank. The provision for income taxes in the current quarter, as well as
the second and fourth quarters of 2015 includes positive income tax
adjustments relating to a change in the estimate of previously
unrecognized deferred income tax assets of the Bank.

Significant Accounting Policies and Use of Estimates and Judgments

Significant accounting policies are detailed in Note 3 of the Bank’s
2016 Audited Consolidated Financial Statements. There have been no
material changes in accounting policies since October 31, 2016.

In preparing the consolidated financial statements, management has
exercised judgment and developed estimates in applying accounting
policies and generating reported amounts of assets and liabilities at
the date of the financial statements and income and expenses during the
reporting periods. Areas where significant judgment was applied were in
the assessments of impairment of financial instruments and recognition
of deferred income tax assets.

Estimates were developed in the calculation of the allowance for credit
losses and the measurement of deferred income taxes.

It is reasonably possible, on the basis of existing knowledge, that
actual results may vary from that expected in the generation of these
estimates. This could result in material adjustments to the carrying
amounts of assets and/or liabilities affected in the future.

Estimates and their underlying assumptions are reviewed on an ongoing
basis. Revisions to accounting estimates are applied prospectively once
they are recognized.

The policies discussed below are considered particularly significant as
they require management to make estimates or judgements, some of which
may relate to matters that are inherently uncertain.

Loans

Loans are initially measured at fair value plus incremental direct
transaction costs. Loans are subsequently measured at amortized cost,
net of allowance for credit losses, using the effective interest method.
On a monthly basis, the Bank assesses whether or not there is any
objective evidence to suggest that the carrying value of the loans may
be impaired. Impairment assessments are facilitated through the
identification of loss events and assessments of their impact on the
estimated future cash flows of the loans.

A loan is classified as impaired when, in management’s opinion, there
has been deterioration in credit quality to the extent that there is no
longer reasonable assurance as to the timely collection of the full
amount of principal and interest. Loans, except credit cards, where
interest or principal is contractually past due 90 days are
automatically recognized as impaired, unless management determines that
the loan is fully secured, in the process of collection and the
collection efforts are reasonably expected to result in either repayment
of the loan or restoring it to current status. All loans, except credit
cards, are classified as impaired when interest or principal is past due
180 days, except for loans guaranteed or insured by the Canadian
government, provinces, territories, or a Canadian government agency,
which are classified as impaired when interest or principal is
contractually 365 days in arrears. Credit card receivables are written
off when payments are 180 days past due, or upon receipt of a bankruptcy
notification.

As loans are classified as loans and receivables and measured at
amortized cost, an impairment loss is measured as the difference between
the carrying amount and the present value of future cash flows
discounted using the effective interest rate computed at initial
recognition, if future cash flows can be reasonably estimated. When the
amounts and timing of cash flows cannot be reasonably estimated, the
carrying amount of the loan is reduced to its estimated net realizable
value based on either:

(i) the fair value of any security underlying the loan, net of expected
costs of realization, or,

(ii) observable market prices for the loan.

Impairment losses are recognized in income or loss. If, in a subsequent
period, the impairment loss decreases and the decrease can be related
objectively to an event occurring after the impairment was first
recognized, then a recovery of a portion or all of the previously
recognized impairment loss is adjusted through income or loss to reflect
the net recoverable amount of the impaired loan.

Real estate held for resale is recorded at the lower of cost and fair
value, less costs to sell.

Allowance for Credit Losses

The Bank maintains an allowance for credit losses which, in management’s
opinion, is adequate to absorb all credit related losses in its loan
portfolio. The allowance for credit losses consists of both individual
and collective allowances and is reviewed on a monthly basis. The
allowance is included in loans on the Consolidated Balance Sheets.

The Bank considers evidence of impairment for loans at both an
individual asset and collective level. All individually significant
loans are assessed for impairment first. All individually significant
loans found not to be specifically impaired and all loans which are not
individually significant are then collectively assessed for impairment.

The collective allowance is determined by separating loans into
categories that are considered to have common risk elements and
reviewing factors such as current portfolio credit quality trends,
exposure at default, probability of default and loss given default rates
and business and economic conditions. The collective allowance may also
be adjusted by management using its judgment taking into account other
observable and unobservable factors.

Corporate Income Taxes

Current income taxes are calculated based on taxable income at the
reporting period end. Taxable income differs from accounting income
because of differences in the inclusion and deductibility of certain
components of income which are established by Canadian taxation
authorities. Current income taxes are measured at the amount expected to
be recovered or paid using statutory tax rates at the reporting period
end.

The Bank follows the asset and liability method of accounting for
deferred income taxes. Deferred income tax assets and liabilities arise
from temporary differences between financial statement carrying values
and the respective tax base of those assets and liabilities. Deferred
income tax assets and liabilities are measured using enacted or
substantively enacted tax rates expected to apply to taxable income in
the years when temporary differences are expected to be recovered or
settled.

Deferred income tax assets are recognized in the consolidated financial
statements to the extent that it is probable that the Bank will have
sufficient taxable income to enable the benefit of the deferred income
tax asset to be realized. Unrecognized deferred income tax assets are
reassessed for recoverability at each reporting period end.

The realization of the deferred income tax asset is dependent upon the
Bank being able to generate taxable income during the carry-forward
period sufficient to offset the income tax losses and deductible
temporary timing differences. While management is of the opinion that it
is probable that the Bank will be able to realize the deferred income
tax asset, there is no guarantee the Bank will be able to generate
sufficient taxable income during the carry-forward period. The
realization of the deferred income tax asset is dependent upon the Bank
being able to generate taxable income in future years sufficient to
offset the income tax losses.

Future Change in Accounting Policies

Financial instruments (IFRS 9)

In July, 2014, the International Accounting Standards Board (IASB)
issued the final revised IFRS 9 standard which addresses classification,
measurement and impairment of financial instruments and hedge
accounting. IFRS 9 specifies that financial assets be classified into
one of three categories: financial assets measured at amortized cost,
financial assets measured at fair value through profit or loss or
financial assets measured at fair value through other comprehensive
income. The standard also includes an expected credit loss model and a
general hedging model.

IFRS 9 will be mandatorily effective for the Bank’s fiscal year
beginning on November 1, 2018, although early adoption is permitted. In
January 2015, OSFI determined that Domestic Systematically Important
Banks (D-SIBs) should adopt IFRS 9 for their annual periods beginning
November 1, 2017, while early adoption is permitted but not required for
other federally regulated Canadian banks with October year ends such as
the Bank. The Bank plans to adopt IFRS 9 on November 1, 2018.

Leases (IFRS 16)

In January, 2016, the IASB issued IFRS 16, requiring most leases to be
recorded on the balance sheet. For lessees, most operating leases other
than short-term or low-value leases will be capitalized, and will result
in a balance sheet increase in lease assets and lease liabilities, and a
decrease in operating lease expenses and increase in financing costs and
amortization expense on the income statement. The new standard will not
impact lessor accounting beyond additional disclosures. The new standard
is effective for the Bank’s fiscal year beginning November 1, 2019 with
early adoption permitted if IFRS 15 Revenue from Contracts with
Customers
is also applied. The Bank is currently reviewing IFRS 16
to determine the impact of adoption on its consolidated financial
statements.

Controls and Procedures

During the quarter ended January 31, 2017, there were no changes in the
Bank’s internal controls over financial reporting, that have materially
affected, or are reasonably likely to materially affect, the Bank’s
internal controls over financial reporting.

Forward-Looking Statements

The statements in this management’s discussion and analysis that relate
to the future are forward-looking statements. By their very nature,
forward-looking statements involve inherent risks and uncertainties,
both general and specific, many of which are out of our control. Risks
exist that predictions, forecasts, projections and other forward-looking
statements will not be achieved. Readers are cautioned not to place
undue reliance on these forward-looking statements as a number of
important factors could cause actual results to differ materially from
the plans, objectives, expectations, estimates and intentions expressed
in such forward-looking statements. These factors include, but are not
limited to, the strength of the Canadian economy in general and the
strength of the local economies within Canada in which we conduct
operations; the effects of changes in monetary and fiscal policy,
including changes in interest rate policies of the Bank of Canada;
global commodity prices, the effects of competition in the markets in
which we operate; inflation; capital market fluctuations; the timely
development and introduction of new products in receptive markets; the
impact of changes in the laws and regulations regulating financial
services; changes in tax laws; technological changes; unexpected
judicial or regulatory proceedings; unexpected changes in consumer
spending and savings habits; and our anticipation of and success in
managing the risks implicated by the foregoing. For a detailed
discussion of certain key factors that may affect our future results,
please see our annual MD&A for the year ended October 31, 2016.

The foregoing list of important factors is not exhaustive. When relying
on forward-looking statements to make decisions, investors and others
should carefully consider the foregoing factors and other uncertainties
and potential events. The forward-looking information contained in the
management’s discussion and analysis is presented to assist our
shareholders in understanding our financial position and may not be
appropriate for any other purposes. Except as required by securities
law, we do not undertake to update any forward-looking statement that is
contained in this management’s discussion and analysis or made from time
to time by the Bank or on its behalf.

VERSABANK
Consolidated Balance Sheets
(Unaudited)

       
(thousands of Canadian dollars)                  
  January 31 October 31 January 31
As at             2017     2016     2016
 
Assets
 
Cash and cash equivalents $ 135,606 $ 93,964 $ 147,982
Securities (note 4) 343 9,958 22,440
Loans, net of allowance for credit losses (note 5) 1,590,470 1,563,612 1,501,889
Other assets (note 6) 46,585 36,866 29,704
                       
              $ 1,773,004   $ 1,704,400   $ 1,702,015
 
Liabilities and Shareholders’ Equity
 
Deposits $ 1,430,359 $ 1,369,647 $ 1,396,502
Subordinated notes payable (note 7) 14,095 14,067 13,984
Securitization liabilities (note 8) 33,382 43,585 43,655
Other liabilities (note 9)           92,585     91,217     71,500
1,570,421 1,518,516 1,525,641
 
Shareholders’ equity:
Share capital (notes 10 and 18) 182,094 176,706 171,706
Retained earnings 20,486 9,172 4,664
Accumulated other comprehensive income     3     6     4
202,583 185,884 176,374
                       
              $ 1,773,004   $ 1,704,400   $ 1,702,015
 

The accompanying notes are an integral part of these interim
Consolidated Financial Statements.

VERSABANK
Consolidated Statements of Income
(Unaudited)

   
(thousands of Canadian dollars, except per share amounts)        
              for the three months ended
  January 31 January 31
                2017       2016
 
Interest income:
Loans $ 18,324 $ 16,920
Securities             262       306
18,586 17,226
 
Interest expense:
Deposits and other 7,085 7,733
Subordinated notes           356       351
7,441 8,084
                   
Net interest income 11,145 9,142
 
Non-interest income           287       325
Total revenue 11,432 9,467
 
Provision for credit losses (note 5b)         303       212
11,129 9,255
 
Non-interest expenses:
Salaries and benefits 3,328 3,389
General and administrative 2,560 2,145
Premises and equipment         570       517
6,458 6,051
Restructuring charges         470      
6,928 6,051
                   
Income before income taxes 4,201 3,204
 
Income tax provision (recovery) (note 11a) (7,663 ) 893
                   
Net income           $ 11,864     $ 2,311
 
Basic and diluted income per common share (note 12) $ 0.56 $ 0.09
 
Weighted average number of
common shares outstanding 20,095,000 19,437,000
 

The accompanying notes are an integral part of these interim
Consolidated Financial Statements.

VERSABANK
Consolidated Statements of Comprehensive Income
(Unaudited)

   
(thousands of Canadian dollars)        
          for the three months ended
  January 31 January 31
            2017     2016
 
Net income $ 11,864 $ 2,311
 
Other comprehensive income (loss), net of tax
Net unrealized gains (losses) on assets held as available-for-sale (1) (3 ) (9 )
               
Comprehensive income     $ 11,861     $ 2,302  
 
(1)     Net of income tax benefit for the three months of $1 (2016 – $3
benefit).
 

The accompanying notes are an integral part of these interim
Consolidated Financial Statements.

VERSABANK
Consolidated Statements of Changes in
Shareholders’ Equity
(Unaudited)

   
(thousands of Canadian dollars)          
            for the three months ended
  January 31 January 31
              2017     2016
 
Common shares (note 10):
 
Balance, beginning of the period $ 147,224 $ 142,224
Impact of amalgamation of PWC Capital Inc. (note 18) 5,388
                 
Balance, end of the period       $ 152,612     $ 142,224  
 
Preferred shares (note 10):
 
Series 1 preferred shares
                 
Balance, beginning and end of the period   $ 13,647     $ 13,647  
 
Series 3 preferred shares
                 
Balance, beginning and end of the period   $ 15,690     $ 15,690  
 
Contributed surplus:
                 
Balance, beginning and end of the period   $ 145     $ 145  
                 
Total share capital         $ 182,094     $ 171,706  
 
Retained earnings:
 
Balance, beginning of the period $ 9,172 $ 2,903
Net income 11,864 2,311
Dividends paid on preferred shares (550 ) (550 )
                 
Balance, end of the period       $ 20,486     $ 4,664  
 
Accumulated other comprehensive income, net of taxes:
 
Balance, beginning of the period $ 6 $ 13
Other comprehensive income (loss) (3 ) (9 )
                 
Balance, end of the period       $ 3     $ 4  
                 
Total shareholders’ equity       $ 202,583     $ 176,374  
 

The accompanying notes are an integral part of these interim
Consolidated Financial Statements.

VERSABANK
Consolidated Statements of Cash Flows
(Unaudited)

   
(thousands of Canadian dollars)          
  January 31 January 31
For the three months ended       2017     2016
 
Cash provided by (used in):
 
Operations:
Net income $ 11,864 $ 2,311
Adjustments to determine net cash flows:
Items not involving cash:
Provision for credit losses 303 212
Income tax provision (recovery) (7,663 ) 893
Interest income (18,586 ) (17,226 )
Interest expense 7,441 8,084
Interest received 18,586 17,053
Interest paid (10,246 ) (8,805 )
Change in operating assets and liabilities:
Loans (27,135 ) (53,775 )
Deposits 63,650 71,496
  Change in other assets and liabilities     5,656       2,310  
43,870 22,553
Investing:
Purchase of securities (9,583 )
Proceeds from sale and maturity of securities 9,585 9,321
Purchase of property, plant and equipment (369 )
Cash acquired on amalgamation 1,569
Transaction costs associated with share issuance     (1,852 )      
8,933 (262 )
Financing:
Redemption of securitization liability (10,307 )
Dividends paid (550 ) (550 )
Income taxes paid         (304 )     (837 )
(11,161 ) (1,387 )
                   
Increase in cash and cash equivalents 41,642 20,904
 
Cash and cash equivalents, beginning of the period 93,964 127,078
                   
Cash and cash equivalents, end of the period   $ 135,606     $ 147,982  
 
Cash and cash equivalents is represented by:
Cash $ 52,602 $ 48,013
Cash equivalents 83,004 99,969
                   
Cash and cash equivalents, end of the period   $ 135,606     $ 147,982  
 

The accompanying notes are an integral part of these interim
Consolidated Financial Statements.

VERSABANK
Notes to Interim Consolidated Financial Statements
(Unaudited)

Three month periods ended January 31, 2017 and 2016

1. Reporting entity:

VersaBank (the “Bank”) operates as a Schedule I bank under the Bank
Act (Canada)
and is regulated by the Office of the Superintendent of
Financial Institutions (OSFI). The Bank, whose shares trade on the
Toronto Stock Exchange, is involved in the business of providing
commercial lending services to selected niche markets.

The Bank is incorporated and domiciled in Canada, and maintains its
registered office at Suite 2002, 140 Fullarton Street, London, Ontario,
Canada, N6A 5P2. On January 31, 2017, the Bank and PWC Capital Inc.
(“PWC”), its former parent, whose shares also traded on the Toronto
Stock Exchange, amalgamated pursuant to section 228 of the Bank Act
(Canada) with the amalgamated entity continuing under the name VersaBank
(see Note 18). Prior to the Amalgamation PWC owned approximately 63%
(January 31, 2016 – 65%) of the common shares of the Bank.

2. Basis of preparation:

a) Statement of compliance:

These interim Consolidated Financial Statements have been prepared in
accordance with International Financial Reporting Standards (IFRS) as
issued by the International Accounting Standards Board (IASB) and have
been prepared in accordance with International Accounting Standard (IAS)
34 – Interim Financial Reporting and do not include all of the
information required for full annual financial statements. These
interim Consolidated Financial Statements should be read in conjunction
with the Bank’s audited Consolidated Financial Statements for the year
ended October 31, 2016.

The interim Consolidated Financial Statements for the three months ended
January 31, 2017 and 2016 were approved by the Audit Committee of the
Board of Directors on March 16, 2017.

b) Basis of measurement:

These interim Consolidated Financial Statements have been prepared on
the historical cost basis except for securities designated as
available-for-sale that are measured at fair value in the Consolidated
Balance Sheets.

c) Functional and presentation currency:

These interim Consolidated Financial Statements are presented in
Canadian dollars which is the Bank’s functional currency. Except as
indicated, the financial information presented has been rounded to the
nearest thousand.

d) Use of estimates and judgments:

In preparing these interim Consolidated Financial Statements,
management has exercised judgment and developed estimates in applying
accounting policies and generating reported amounts of assets and
liabilities at the date of the financial statements and income and
expenses during the reporting period. Areas where significant judgment
was applied were in the assessments of impairment of financial
instruments. Estimates include the calculation of the allowance for
credit losses and the measurement of deferred income taxes.

It is reasonably possible, on the basis of existing knowledge, that
actual results may vary from that expected in the generation of these
estimates. This could result in material adjustments to the carrying
amounts of assets and/or liabilities affected in the future.

Estimates and their underlying assumptions are reviewed on an ongoing
basis. Revisions to accounting estimates are applied prospectively once
they are recognized.

3. Significant accounting policies:

The accounting policies applied by the Bank in these interim
Consolidated Financial Statements are the same as those applied by the
Bank as at and for the year ended October 31, 2016 and are detailed in
Note 3 of the Bank’s 2016 Audited Consolidated Financial Statements.

4. Securities:

Portfolio analysis:

             
  January 31   October 31   January 31
      2017     2016     2016
 
Available-for-sale securities
Securities issued or guaranteed by:
Canadian provincial governments $ $ 9,687 $ 9,635
Canadian municipal governments     343     271     271
Total available-for-sale securities   $ 343   $ 9,958   $ 9,906
 
Held-to-maturity security
Debt of other financial institutions   $   $   $ 12,534
Total securities   $ 343   $ 9,958   $ 22,440
 

Canadian provincial government securities are carried at fair value
based on quoted market prices (Level 1). Canadian municipal debt falls
into Level 2 of the fair value hierarchy. See Note 3 (c) of the October
31, 2016 audited consolidated financial statements for more information.

5. Loans:

a) Portfolio analysis:

             
  January 31   October 31   January 31
      2017     2016     2016
 
 
Government loans $ 64,126 $ 66,016 $ 69,734
Loan and lease receivables 796,766 783,669 670,923
Residential mortgages 90,555 95,624 113,376
Commercial mortgages 237,079 227,816 286,628
Construction mortgages 258,811 256,429 228,774
Commercial loans 114,434 102,265 99,809
Credit card receivables and other     26,238       29,373       30,687  
1,588,009 1,561,192 1,499,931
 
Collective allowance (3,032 ) (3,031 ) (3,163 )
Accrued interest 5,493 5,451 5,121
             
Total loans, net of allowance for credit losses   $ 1,590,470     $ 1,563,612     $ 1,501,889  
 

The collective allowance for credit losses relates to the following loan
portfolios:

             
  January 31   October 31   January 31
      2017     2016     2016
 
Government loans $ 13 $ 14 $ 16
Loan and lease receivables 358 344 299
Residential mortgages 24 26 28
Commercial mortgages 593 551 788
Construction mortgages 773 765 796
Commercial loans 287 276 173
Credit card receivables and other     984     1,055     1,063
    $ 3,032   $ 3,031   $ 3,163
 

The Bank holds security against the majority of its loans in the form of
either mortgage interests over property, other registered securities
over assets, guarantees and holdbacks on loan and lease receivables (see
Note 9).

b) Allowance for credit losses:

The allowance for credit losses results from the following:

                   
      January 31   January 31
2017 2016
For the three months ended   Collective   Individual  

Total
Allowance

 

Total
Allowance

 
Balance, beginning of the period $ 3,031 $ $ 3,031 $ 3,212
Provision for credit losses 303 303 212
Write-offs (302 ) (302 ) (261 )
                   
Balance, end of the period   $ 3,032     $   $ 3,032     $ 3,163  
 

c) Impaired loans:

At January 31, 2017, there were $nil impaired loans (October 31, 2016 –
$nil). At January 31, 2017, loans, other than credit card receivables,
past due were $nil (October 31, 2016 – $936,000). At January 31, 2017,
credit card receivables overdue by one day or more totalled $2,386,000
(October 31, 2016 – $2,290,000).

6. Other Assets

               
  January 31   October 31   January 31
        2017     2016     2016
 
Accounts receivable $ 1,098 $ 1,820 $ 1,706
Funds held for securitization liabilities 4,613 14,719 4,512
Prepaid expenses and other 7,554 9,599 11,079
Property and equipment 6,600 4,330 4,273
Deferred income tax asset (note 11b) 26,720 6,398 8,134
               
      $ 46,585   $ 36,866   $ 29,704
 

7. Subordinated notes payable:

                     
          January 31   October 31   January 31
              2017     2016     2016
 

Ten year term, unsecured, callable, subordinated notes
payable
by the Bank to an unrelated party, maturing
between 2019 and
2021, net of issue costs of $405
(October 31, 2016 – $433)
effective interest of 10.06%

$ 14,095 $ 14,067 $ 13,984
                     
            $ 14,095   $ 14,067   $ 13,984
 

8. Securitization liabilities:

Securitization liabilities include amounts payable to counterparties for
cash received upon initiation of securitization transactions, accrued
interest on amounts payable to counterparties, and the unamortized
balance of deferred costs and discounts which arose upon initiation of
the securitization transactions.

The amounts payable to counterparties bear interest at rates ranging
from 3.55% – 3.95% and mature in 2020. Securitized residential insured
mortgages and other assets are pledged as collateral for these
liabilities.

During the quarter ended January 31, 2017, a securitization liability
matured totalling $10,307,000 with an interest rate of 1.97%.

9. Other liabilities:

               
    January 31   October 31   January 31
        2017     2016     2016
 
Accounts payable and other $ 11,209 $ 8,653 $ 5,111
Holdbacks payable on loan and lease receivables 81,376 82,564 66,389
               
      $ 92,585   $ 91,217   $ 71,500
 

10. Share capital:

a) Common shares:

At January 31, 2017, there were 21,123,559 (October 31, 2016 –
20,095,065) common shares outstanding. The net increase of 1,028,494
shares was issued as part of the Amalgamation with PWC Capital Inc. (see
Note 18). In March 2016, 657,894 common shares were issued for cash
proceeds of $5,000,000 under a private placement.

b) Preferred shares:

At January 31, 2017, there were 1,461,460 (October 31, 2016 – 1,461,460)
Series 1 preferred shares and 1,681,320 (October 31, 2016 – 1,681,320)
Series 3 preferred shares outstanding. These shares are Basel III
compliant, non-cumulative rate reset preferred shares which includes
non-viability contingent capital provisions (NVCC). As a result, these
shares qualify as Additional Tier 1 Capital (see Note 15).

c) Stock options:

At January 31, 2017, there were 47,059 common share stock options
outstanding (October 31, 2016 – 40,000).

11. Income taxes:

a) Income tax provision (recovery):

               
          for the three months ended
      January 31   January 31
            2017       2016
 
Income tax on earnings $ 1,168 $ 893
Recognition of previously unrecognized deferred income tax asset (8,831 )
               
          $ (7,663 )   $ 893
 

b) Deferred income tax asset:

               
  January 31   October 31   January 31
        2017     2016     2016
 
Balance, beginning of period $ 6,398 $ 6,919 $ 8,804
Income taxes on earnings (1,168 ) (740 ) (893 )
Recognition of previously unrecognized deferred income tax asset 8,831
Recognition of deferred income tax asset on amalgamation 11,939
Income taxes on transaction costs 500
Deferred income tax impact of payment of dividends 219 220 220
Income taxes on other comprehensive income 1 (1 ) 3
               
Balance, end of period     $ 26,720     $ 6,398     $ 8,134  
 

12. Income per common share:

             
        for the three months ended
    January 31   January 31
          2017     2016
 
Net income $ 11,864 $ 2,311
Less: dividends on preferred shares   (550 )     (550 )
11,314 1,761
 
Average number of common shares outstanding 20,095,000 19,437,000
             
Income per common share:     $ 0.56     $ 0.09  
 

Employee stock options do not have a dilutive impact as the exercise
price is greater than the average market price. The Series 1 and Series
3 NVCC preferred shares are contingently issuable shares and do not have
a dilutive impact.

13. Commitments and contingencies:

The amount of credit related commitments represents the maximum amount
of additional credit that the Bank could be obligated to extend. Under
certain circumstances, the Bank may cancel loan commitments at its
option. The amounts with respect to the letters of credit are not
necessarily indicative of credit risk as many of these arrangements are
contracted for a limited period of usually less than one year and will
expire or terminate without being drawn upon. Undrawn credit card lines
at January 31, 2017 were zero as a result of the termination of the
credit card agreement with Home Hardware Stores Limited on December 31,
2016.

             
  January 31   October 31   January 31
      2017     2016     2016
 
Loan commitments $ 209,678 $ 265,631 $ 253,389
Undrawn credit card lines 127,116 135,500
Letters of credit 45,171 42,809 43,740
             
    $ 254,849   $ 435,556   $ 432,629
 

14. Related party transactions:

During the three months ended January 31, 2017 the Bank incurred
management and other fees totalling $225,000 (January 31, 2016 –
$150,000) to PWC.

The Bank’s Board of Directors and senior executive officers represent
key management personnel.

The Bank has loans to employees and key management personnel. At January
31, 2017, amounts due from related parties totalled $742,000 (October
31, 2016 – $748,000). The interest rates charged on these loans are
similar to those charged in an arms-length transaction. Interest income
earned on the above loans for the three months ended January 31, 2017
was $5,000 (January 31, 2016 – $5,000). There were no provisions for
credit losses related to loans issued to key management personnel for
the three months ended January 31, 2017 and 2016.

15. Capital management:

a) Overview:

The Bank’s policy is to maintain a strong capital base so as to maintain
investor, creditor and market confidence and to sustain future
development of the business. The impact of the level of capital on
shareholders’ return is also important and the Bank recognizes the need
to maintain a balance between the higher returns that might be possible
with greater leverage and the advantages and security afforded by a
sound capital position.

OSFI sets and monitors capital requirements for the Bank. Capital is
managed in accordance with policies and plans that are regularly
reviewed and approved by the Board of Directors and take into account
forecasted capital needs and conditions in financial markets.

The goal is to maintain adequate regulatory capital to be considered
well capitalized, protect consumer deposits and provide capacity for
internally generated growth and strategic opportunities that do not
otherwise require accessing the public capital markets, all the while
providing a satisfactory return to shareholders. The Bank’s regulatory
capital is comprised of share capital, retained earnings and unrealized
gains and losses on available-for-sale securities (Common Equity Tier 1
capital), preferred shares (Additional Tier 1 capital) and the
qualifying amount of subordinated notes (Tier 2 capital).

The Bank monitors its capital adequacy and related capital ratios on a
daily basis and has policies setting internal maximum and minimum
amounts for its capital ratios. These capital ratios consist of the
leverage ratio and the risk-based capital ratios.

During the period ended January 31, 2017, there were no material changes
in the Bank’s management of capital.

b) Risk-Based Capital Ratios:

The Basel Committee on Banking Supervision has published the Basel III
rules supporting more stringent global standards on capital adequacy and
liquidity (Basel III).

OSFI requires that all Canadian banks must comply with the Basel III
standards on an “all-in” basis that became effective January 1, 2013 for
purposes of determining its risk-based capital ratios. Required minimum
regulatory capital ratios are a 7.0% Common Equity Tier 1 (CET1) capital
ratio and effective January 1, 2014, an 8.5% Tier 1 capital ratio and
10.5% total capital ratio, all of which include a 2.50% capital
conservation buffer. The Basel III rules provide for “transitional”
adjustments whereby certain aspects of the new rules will be phased in
between 2013 and 2019. The only available transition allowed by OSFI for
capital ratios is related to the 10 year phase out of non-qualifying
capital instruments.

OSFI also requires banks to measure capital adequacy in accordance with
guidelines for determining risk adjusted capital and risk-weighted
assets including off-balance sheet credit instruments as specified in
the Basel III regulations. Based on the deemed credit risk for each type
of asset, assets held by the Bank are assigned a weighting of 0% to 150%
to determine the risk-based capital ratios.

The Bank’s risk-based capital ratios are calculated as follows:

                         
            January 31, 2017   October 31, 2016
            “All-in”   “Transitional”   “All-in”   “Transitional”
         
Common Equity Tier 1 (CET1) capital
Directly issued qualifying common share capital $ 152,757 $ 152,757 $ 147,369 $ 147,369
Retained earnings 20,486 20,486 9,172 9,172
  Accumulated other comprehensive income     3       3       6       6  
CET1 capital before regulatory adjustments 173,246 173,246 156,547 156,547
  Total regulatory adjustments to CET1     (28,869 )     (23,095 )     (6,562 )     (3,937 )
Common Equity Tier 1 capital     $ 144,377     $ 150,151     $ 149,985     $ 152,610  
 
Additional Tier 1 (AT1) capital
  Directly issued qualifying AT1 instruments   $ 29,337     $ 29,337     $ 29,337     $ 29,337  
Tier 1 capital       $ 173,714     $ 179,488     $ 179,322     $ 181,947  
 
Tier 2 capital
Directly issued capital instruments subject to
  phase out from Tier 2     $ 9,800     $ 9,800     $ 9,800     $ 9,800  
Tier 2 capital before regulatory adjustments 9,800 9,800 9,800 9,800
  Total regulatory adjustments to Tier 2 capital                        
Tier 2 capital         $ 9,800     $ 9,800     $ 9,800     $ 9,800  
Total capital         $ 183,514     $ 189,288     $ 189,122     $ 191,747  
Total risk-weighted assets     $ 1,403,760     $ 1,409,534     $ 1,425,171     $ 1,427,796  
Capital ratios
CET1 Ratio 10.28 % 10.65 % 10.52 % 10.69 %
Tier 1 Capital Ratio 12.37 % 12.73 % 12.58 % 12.74 %
  Total Capital Ratio         13.07 %     13.43 %     13.27 %     13.43 %
 

c) Leverage Ratio:

The leverage ratio, which is prescribed under the Basel III Accord, is a
supplementary measure to the risk-based capital requirements and is
defined as the ratio of Tier 1 capital to its total exposures. The
leverage ratio is calculated as follows:

           
  January 31   October 31
        2017     2016
 
On-balance sheet assets $ 1,773,004 $ 1,704,400
Asset amounts deducted in determining Basel III “all in” Tier 1
Capital
    (28,869 )     (6,562 )
Total on-balance sheet exposures       1,744,135       1,697,838  
 
Off-balance sheet exposure at gross notional amount $ 254,849 $ 435,556
Adjustments for conversion to credit equivalent amount     (161,329 )     (306,877 )
Off-balance sheet exposures       93,520       128,679  
 
Tier 1 Capital       173,714       179,322  
Total Exposures 1,837,655 1,826,517
 
Leverage Ratio       9.45 %     9.82 %
 

The Bank was in compliance with the leverage ratio prescribed by OSFI
throughout the periods presented.

16. Interest rate position:

The Bank is subject to interest rate risk which is the risk that a
movement in interest rates could negatively impact net interest margin,
net interest income and the economic value of assets, liabilities and
shareholders’ equity. The following table provides the duration
difference between the Bank’s assets and liabilities and the potential
after-tax impact of a 100 basis point shift in interest rates on the
Bank’s earnings during a 12 month period and the potential after-tax
impact of a 100 basis point shift in interest rates on the Bank’s
shareholders’ equity over a 60 month period if no remedial actions are
taken.

         
                     
        January 31, 2017   October 31, 2016
       

Increase 100
bps

 

Decrease 100
bps

 

Increase 100
bps

 

Decrease 100
bps

 
Impact on projected net interest
income during a 12 month period $ 2,936 $ (2,848 ) $ 2,387 $ (2,243 )
Impact on reported equity
during a 60 month period $ 5 $ 34 $ (1,631 ) $ 1,667
                     
Duration difference between assets and
liabilities (months)       1.0         0.6      
 

17. Fair Value of Financial Instruments:

Fair values are based on management’s best estimates of market
conditions and valuation policies at a certain point in time. The
estimates are subjective and involve particular assumptions and matters
of judgment and as such, may not be reflective of future fair values.
The Bank’s loans and deposits lack an available market as they are not
typically exchanged. Therefore, they are not necessarily representative
of amounts realizable upon immediate settlement. See Note 22 to the
October 31, 2016 consolidated financial statements for more information
on fair values.

                 
    January 31, 2017   October 31, 2016
    Fair value     Fair value
Book of assets Book of assets
    Value   and liabilities   Value   and liabilities
 
Assets
 
Cash and cash equivalents $ 135,606 $ 135,606 $ 93,964 $ 93,964
Securities 343 343 9,958 9,958
Loans 1,590,470 1,589,940 1,563,612 1,563,299
Other financial assets 5,711 5,711 16,539 16,539
                 
 
Liabilities
 
Deposits $ 1,430,359 $ 1,440,552 $ 1,369,647 $ 1,380,685
Subordinated notes payable 14,095 14,500 14,067 14,500
Securitization liabilities 33,382 36,116 43,585 46,923
Other financial liabilities 92,585 92,585 91,217 91,217
                 

18. Amalgamation of PWC and the Bank:

On September 12, 2016 and November 15, 2016, PWC and the Bank jointly
announced that they had entered into an agreement to merge by
amalgamation under the Bank Act (Canada) (the “Amalgamation”). This
transaction was completed on January 31, 2017, pursuant to section 228
of the Bank Act (Canada), with the amalgamated entity continuing under
the name VersaBank. Pursuant to the Amalgamation: (i) each issued and
outstanding common share of PWC (other than PWC common shares with
respect to which dissent rights were exercised) was converted into
common shares of the Bank on the basis of 54.508758 PWC common shares
for 1 Bank common share, resulting in a total of 13,643,713 Bank common
shares being issued, (ii) 12,615,219 outstanding common shares of
VersaBank held by PWC prior to the Amalgamation were cancelled, and
(iii) each issued and outstanding security of VersaBank held prior to
the Amalgamation continues on under the same arrangement subsequent to
the Amalgamation. As a result of the above, at January 31, 2017 the
issued and outstanding common shares of the Bank increased by 1,028,494
shares to 21,123,559 common shares.

In addition, each outstanding option to acquire PWC common shares was
converted into an option to purchase Bank common shares resulting in
7,059 additional options being issued.

The estimated fair value of securities held by dissenting shareholders
is reflected in Other liabilities.

The fair values of the assets and liabilities acquired by the Bank on
Amalgamation are as follows:

         
  January 31
      2017
 
Incremental assets recognized:
Cash $ 1,569
Deferred income tax asset 11,939
Other assets 2,025
Other net liabilities assumed (8,793 )
Transaction costs, net of income taxes of $500 (1,352 )
         
Total impact of amalgamation   $ 5,388  
 

VersaBank, a technology based and digital Canadian Schedule I chartered
bank, operates using an “electronic branchless model”. It sources
deposits, consumer loans, commercial loans and leases electronically,
The Bank also makes residential development and commercial mortgages it
sources through a well-established network of brokers and direct contact
with its lending staff. Versabank’s Common Shares trade on the Toronto
Stock Exchange under the symbol of VB and its Series 1 Preferred Shares
and Series 3 Preferred Shares trade under the symbols VB.PR.A and
VB.PR.B, respectively.

On behalf of the Board of Directors: David R. Taylor, President & C.E.O.

Click to comment

TRENDING RIGHT NOW

To Top