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VersaBank: Fourth Quarter Report October 31, 2016

Mittwoch, 30.11.2016 18:10



LONDON, Ontario --(BUSINESS WIRE)--

VersaBank (TSX:VB):

FOURTH QUARTER HIGHLIGHTS (1)
(compared to the same periods in the prior year unless otherwise noted)

  • Income of VersaBank (formerly Pacific & Western Bank of Canada) (the “Bank”) before restructuring charges and income taxes for the current quarter was $3.2 million compared to $2.5 million for the same period a year ago, an increase of 29%.
  • Income before restructuring charges and income taxes for the year was $12.9 million compared to $9.0 million for the same period a year ago, an increase of 42%.
  • Net income for the current quarter was $1.9 million or $0.07 per common share (basic and diluted), compared to $2.5 million or $0.09 per common share (basic and diluted) for the previous quarter and $2.8 million or $0.11 per common share (basic and diluted) a year ago. Net income of the Bank for the current quarter includes restructuring charges of $549,000 compared to $98,000 for the previous quarter and $nil a year ago. Net income for the same period a year ago includes an income tax recovery of $1.0 million related to previously unrecognized deferred income tax assets.
  • Net income for the year ended October 31, 2016 was $8.5 million or $0.32 per common share (basic and diluted), compared to $8.2 million or $0.33 per common share (basic and diluted) for the same period a year ago. Net income for the current year includes restructuring charges of $1.1 million compared to $nil for the same period a year ago. Net income for the same period a year ago included an income tax recovery of $1.7 million related to previously unrecognized deferred income tax assets.
  • Net interest margin or spread for the current quarter increased to 2.36% from 2.31% for the previous quarter and from 2.23% for the same period a year ago.
  • For the year ended October 31, 2016, net interest margin or spread increased to 2.31% from 2.21% for the same period a year ago.
  • Credit quality remains exceptional with no gross impaired loans at October 31, 2016 or at July 31, 2016, or a year ago.

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

PRESIDENT’S COMMENTS

I am pleased to report that our Bank has completed another very successful year. Our strategy to use new technologies to better serve certain niche markets is paying off. Mainly due to a substantial decrease in our costs of funds, income before taxes and restructuring charges increased by more than 42% over the previous year.

Our well established Commercial Lending Division again made a significant contribution to the Bank’s overall earnings. The total loans in this division declined by about 5% over the previous year, reducing the year-end balance to $685 million. This division finances well established real estate developers with projects mainly located in Ontario and other commercial businesses located throughout Canada. A few years ago we became concerned over the rapid increase in real estate prices in some of Canada’s major centres and decided to limit our lending activity in these centres to only the most credit worthy borrowers.

Our relatively new Structured Finance Division continued to grow rapidly. The balance of total loans and leases acquired and warehoused through our electronic Bulk Purchase Program increased more than 27% over the previous year, with the year-end balance reaching over $783 million. We purchase loans and leases from an increasing number of non-bank and fintech financiers who operate throughout Canada in a variety of industries, many of which are taking advantage of new technologies to reach their customers. Our program facilitates this type of financing and indirectly provides much needed financing for small businesses and greater choice for consumers across Canada. We have developed state of the art high capacity systems that allow us to process large numbers of these small ticket transactions. Credit risk is reduced to acceptable levels by the substantial cash deposits made by our partners to offset potential credit losses. Our Bank is at the leading edge of this new method of financing and this business is now a major portion of the Bank’s total assets and revenue stream.

Asset quality remained industry leading with the Bank again reporting no impaired loans. The Bank prides its self on maintaining stellar credit adjudication and processes that consistently deliver industry leading results.

Many years ago the Bank developed custom software to enable it to gather deposits without the need for traditional branches. Our Bank now has a substantial network of over 100 deposit gathering partners that includes many of the larger banks’ brokerage firms. This channel provides a steady reliable stream of low cost deposits. In addition, our Bank opened up a new channel for gathering deposits that involved developing a custom banking solution for niche markets that may have unique challenges in dealing with the generic services provided by traditional banks. This new channel for deposit gathering is not only diversifying our Bank’s deposit base, but is also serving to significantly lower its cost of funds. During the 4th Quarter, our Bank’s cost of funds decreased to 1.73%. This figure represents one of the lowest costs of funds figure in the industry and about a 90 basis point improvement over what it was four years ago.

Total revenue for the year increased by 12% to $39.7 million and net interest margin increased by 6% to an industry leading 2.36% over the previous year’s figures. This gave rise to a substantial increase in Income before taxes and restructuring charges that increased by more than 42% over the previous year.

We have designed a state of the art Bank that, through utilization of specialized software and well-experienced staff, is able to rapidly acquire large amounts of loans, leases and deposits with minimal transactional costs. And by targeting niche markets that are not well served by the larger financial institutions, our Bank is able to pay less for its deposits and invest in lower risk loans, but still earn an industry leading NIM. The financial market place is embracing innovative new ideas and your Bank is at the forefront of prudently applying new ideas and technology to provide Canadians with greater choice and more economical financing solutions

On November 15, 2016 we announced amended terms to the planned amalgamation with PWC Capital Inc. Both the Bank and PWC would benefit significantly from this amalgamation and I recommend that you vote in favour of this amalgamation, as I intend to do. For further information about the proposed amalgamation, please review the information circular and joint disclosure booklet which is available on VersaBank’s issuer profile on www.sedar.com and on our website: www.VersaBank.com.

FINANCIAL HIGHLIGHTS

(unaudited)       for the three months ended   for the year ended
    October 31   October 31 October 31   October 31
($CDN thousands except per share amounts )   2016   2015     2016   2015
Results of operations
Net interest income $ 10,066 $ 8,961 $ 38,404 $ 33,974
Non-interest income 320 384 1,273 1,394
Total revenue 10,386 9,345 39,677 35,368
Provision for credit losses 422 319 871 1,545
Non-interest expenses 6,779 6,562 25,956 24,784
Income before restructuring charges and income taxes* 3,185 2,464 12,850 9,039
Restructuring charges 549 - 1,092 -
Net income 1,896 2,770 8,470 8,218
Income per common share:
Basic $ 0.07 $ 0.11 $ 0.32 $ 0.33
    Diluted     $ 0.07 $ 0.11   $ 0.32 $ 0.33
Yield* 4.09% 4.15% 4.18% 4.19%
Cost of funds* 1.73% 1.92% 1.87% 1.98%
Net interest margin* 2.36% 2.23% 2.31% 2.21%
Return on average common equity* 3.43% 6.11% 4.15% 4.50%
Book value per common share* $ 7.79 $ 7.47 $ 7.79 $ 7.47
Gross impaired loans to total loans 0.00% 0.00% 0.00% 0.00%
  Provision for credit losses as a % of average loans   0.03%   0.02%     0.06%   0.12%
          as at
Balance Sheet Summary
Cash and securities $ 103,922 $ 149,511 $ 103,922 $ 149,511
Total loans 1,563,612 1,447,660 1,563,612 1,447,660
Average loans 1,531,309 1,411,949 1,505,636 1,335,954
Total assets 1,704,400 1,625,806 1,704,400 1,625,806
Average assets 1,694,847 1,594,454 1,665,103 1,535,833
Deposits 1,369,647 1,325,828 1,369,647 1,325,828
Subordinated notes payable 14,067 13,959 14,067 13,959
Shareholders' equity 185,884 174,622 185,884 174,622
Capital ratios*
Risk-weighted assets $ 1,425,171 $ 1,320,158 $ 1,425,171 $ 1,320,158
Total capital 189,122 178,291 189,122 178,291
Common Equity Tier 1 (CET1) ratio 10.52% 10.32% 10.52% 10.32%
Tier 1 capital ratio 12.58% 12.54% 12.58% 12.54%
Total capital ratio 13.27% 13.51% 13.27% 13.51%
  Leverage ratio     9.82%   9.53%     9.82%   9.53%
* 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 fourth quarter of fiscal 2016, dated November 28, 2016, should be read in conjunction with the unaudited interim consolidated financial statements for the period ended October 31, 2016, 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, 2015, 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, 2015, remain substantially unchanged.

Basis of Presentation

Non-GAAP and Additional GAAP Measures

Yield

Yield is calculated as net interest income (as presented in the Consolidated Statements of Income) divided by average 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 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 non-interest expenses before restructuring charges, 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.

Non-Interest Expenses to Total Assets Ratio

The ratio of non-interest expenses to total assets is determined by dividing non-interest expenses by total average assets.

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 its lending staff. Effective May 13, 2016, the Bank changed its name from Pacific & Western Bank of Canada to VersaBank.

The Bank is the principal subsidiary of PWC Capital Inc. (“PWC”) whose shares also trade on the Toronto Stock Exchange. At October 31, 2016 PWC owned approximately 63% (October 31, 2015 – 68%) of the common shares of the Bank. On March 7, 2016, PWC and the Bank announced they were undertaking a review of their strategic alternatives. Subsequently, on September 12, 2016 and November 15, 2016 PWC and the Bank jointly announced that they have entered into an agreement to merge by amalgamation under the Bank Act (Canada). After the amalgamation, which is subject to regulatory and other approvals, including approvals by the various security holders of both entities, the combined entity will continue to be named VersaBank. At this time, there can be no assurance that the amalgamation will take place or its nature, terms or timing. See Note 16 to the interim consolidated financial statements.

Net income for the current quarter was $1.9 million or $0.07 per common share (basic and diluted), compared to $2.5 million or $0.09 per common share (basic and diluted) for the previous quarter and $2.8 million or $0.11 per common share (basic and diluted) a year ago. Net income of the Bank for the current quarter includes restructuring charges of $549,000 compared to $98,000 for the previous quarter and $nil a year ago. Income before restructuring charges and income taxes for the current quarter was $3.2 million compared to $2.5 million for the same period a year ago, an increase of 28%. Net income for the current quarter reflects growth in net interest income compared to the previous quarter and the same period a year ago. Net income for the same period a year ago included an income tax recovery of $1.0 million related to previously unrecognized deferred income tax assets.

Net income for the year ended October 31, 2016 was $8.5 million or $0.32 per common share (basic and diluted), compared to $8.2 million or $0.33 per common share (basic and diluted) for the same period a year ago. Net income for the current year includes restructuring charges of $1.1 million and also reflects growth in net interest income. Income before restructuring charges and income taxes for the year was $12.9 million compared to $9.0 million for the same period a year ago, an increase of 43%. Net income for the same period a year ago included an income tax recovery of $1.7 million related to previously unrecognized deferred income tax assets.

Total assets at October 31, 2016 were $1.70 billion compared to $1.69 billion at the end of the previous quarter and $1.63 billion a year ago. Lending assets totaled $1.56 billion compared to $1.50 billion at the end of the previous quarter and $1.45 billion a year ago. Credit quality remains strong with no gross impaired loans at October 31, 2016, or at July 31, 2016 or 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 October 31, 2016, total revenue increased to $10.4 million from $10.2 million for the previous quarter and from $9.3 million for the same period a year ago, an increase of 11%, with the increases due to growth in net interest income.

For the year ended October 31, 2016, total revenue increased by 12% to $39.7 million from $35.4 million a year ago with the increase also due to growth in net interest income.

Net Interest Income

Net interest income for the three months ended October 31, 2016 increased to $10.1 million from $9.8 million for the previous quarter and from $9.0 million for the same period a year ago, an increase of 12%. The increase in net interest income from a year ago was due primarily to growth in lending assets which grew to $1.56 billion at October 31, 2016 from $1.45 billion last year, an increase of 8%, and from a decrease in the Bank’s cost of funds which decreased to 1.73% for the quarter from 1.92% a year ago.

Net interest income for the year ended October 31, 2016 increased to $38.4 million from $34.0 million for the same period year ago, an increase of 13%, due primarily to growth in lending assets and a decrease in the Bank’s cost of funds which decreased to 1.87% for the year from 1.98% a year ago.

Net Interest Margin

Net interest margin or spread for the three months ended October 31, 2016 increased to 2.36% from 2.31% for the previous quarter and 2.23% for the same period a year ago. Net interest margin increased as a result of a decrease in the Bank’s cost of deposits as noted above.

Net interest margin or spread for the year ended October 31, 2016 increased to 2.31% from 2.21% for the same period a year ago with the increase due to the factors described 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 $422,000 compared to $24,000 for the previous quarter and $319,000 for the same period a year ago. The provision for credit losses increased from the previous quarter as a result of an increase in the collective allowance and increased from a year ago due to a higher amount of write-offs related to credit card receivables.

The provision for credit losses for the year ended October 31, 2016 was $871,000 or 6 basis points of average loans compared to $1.5 million or 12 basis points of average loans for the same period a year ago with the decrease due primarily to the change in loan mix over the past year with a decrease in commercial mortgages and loans offset by growth in loan and lease receivables sourced through the bulk finance program which require a lower collective allowance due to the cash holdbacks that are retained.

Non-Interest Expenses

Non-interest expenses of the Bank, excluding restructuring costs, totalled $6.8 million for the current quarter compared to $6.7 million for the previous quarter and $6.6 million for the same period a year ago. The increase in non-interest expenses from a year ago was due primarily to an increase in employee compensation as a result of an increase in employee complement and an increase in premises costs.

Non-interest expenses of the Bank, excluding restructuring costs, for the year ended October 31, 2016 totalled $26.0 million compared to $24.8 million for the prior year with the increase due to higher employee compensation as a result of an increase in employee complement and an increase in premises costs. The Bank continues to see economies of scale as non-interest expenses as a percentage of average assets for the current year decreased to 1.56% from 1.61% for the same period a year ago.

Restructuring Charges

During the three months ended October 31, 2016, the Bank incurred restructuring charges totalling $549,000 and for the year ended October 31, 2016 incurred restructuring charges of $1.1 million relating to costs associated with the review of strategic alternatives commenced by the Bank earlier in the year as noted above.

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 October 31, 2016, the provision (recovery) for income taxes was $740,000 compared to $947,000 for the previous quarter and ($306,000) for the same period a year ago. The decrease in the provision for income taxes from the previous quarter was due to a lower level of earnings in the Bank caused by restructuring charges. The provision for income taxes for the same period a year ago included a recovery of $1.0 million related to previously unrecognized deferred income tax assets.

For the year ended October 31, 2016, the provision for income taxes was $3.3 million compared to $821,000 for the same period a year ago with the change due to a higher level of earnings in the Bank, even after restructuring charges, and an income tax recovery of $1.7 million recorded last year as noted above.

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 October 31, 2016 was $1.9 million compared to $2.5 million for the previous quarter and $2.8 million a year ago.

For the year ended October 31, 2016, comprehensive income of the Bank was $8.5 million compared to $8.2 million a year ago. 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 October 31, 2016 were $1.70 billion compared to $1.69 billion at the end of the previous quarter and $1.63 billion a year ago. The increase from a year ago was due to growth in lending assets which grew to $1.56 billion from $1.45 billion last year. Growth in lending assets was primarily a result of an increase in loan and lease receivables sourced through the Bank’s bulk purchase program as discussed below.

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 liquidity needs, investment yield and capital management considerations. Cash and securities, which are held primarily for liquidity purposes, totalled $104 million or 6.1% of total assets compared to $152 million or 9.0% of total assets at the end of the previous quarter and $150 million or 9.2% of total assets a year ago.

The level of cash and securities as a percentage of total assets decreased over the past year as a result of a decrease in deposits maturing in the upcoming months which allows the Bank to hold lower levels of liquidity. The current level of cash and securities as a percentage of total assets is expected to remain at the current level.

Loans

At October 31, 2016, loans totalled $1.56 billion compared to $1.50 billion at the end of the previous quarter and $1.45 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, partially offset by repayments in the commercial mortgage portfolio.

At October 31, 2016, the balances of individual loan categories compared to the end of the previous quarter reflects a continuation of the change in lending strategy where focus on government loans has decreased due to market conditions and has been replaced by an emphasis on loan and lease receivables purchased through the bulk purchase program. Compared to a year ago, individual loan categories showed growth in construction mortgages and loan and lease receivables and a decrease in government loans as discussed above. The decreases in residential and commercial mortgages were due primarily to timing of repayments.

As noted above, loan and lease receivables purchased through the bulk purchase program continued to show strong growth during the year and increased to $784 million at October 31, 2016 from $740 million at the end of the previous quarter, a net increase of $44 million, and from $618 million last year, a net increase of $166 million or 27%. The bulk purchase program, which consists of the purchase of individual loan and lease receivables, continues to be a key initiative and the primary driver for growth of the lending portfolio. The credit quality of these loan and lease receivables is strong and normally attracts a lower collective allowance due to the level of cash holdbacks that are retained.

Total new lending for the quarter was $262 million compared to $234 million for the previous quarter and $338 million a year ago. Loan repayments for the quarter totalled $198 million compared to $259 million for the previous quarter and $268 million a year ago. For the year ended October 31, 2016, new lending totalled $924 million compared to $1.1 billion for the same period a year ago and loan repayments totalled $808 million compared to $859 million last year. At October 31, 2016, loan commitments representing loans in the Bank’s pipeline totalled $266 million compared to $301 million at the end of the previous quarter and $243 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 October 31, 2016 totalled $637,000 compared to $647,000 at the end of the previous quarter and $761,000 a year ago. The Bank did not have any HELOC’s outstanding at October 31, 2016, or at the end of the previous quarter or a year ago.

Credit Quality

Gross impaired loans at October 31, 2016, were $nil, unchanged from the end of the previous quarter and a year ago. At October 31, 2016, the collective allowance totalled $3.0 million compared to $2.9 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 require a lower collective allowance due to the cash holdbacks that are retained. Included in the collective allowance at October 31, 2016 was $1.1 million relating to credit card receivables which is similar to the end of the previous quarter and a year ago.

Based on results from ongoing stress testing of the loan portfolio under various scenarios and 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. The Bank’s exposure to loan losses in Western Canada and to the oil and gas industry is not significant. As well, the Bank is not concentrated in the housing markets in Toronto and Western Canada.

The geographic concentration of the Bank’s lending portfolio at October 31, 2016 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 of the Bank. Other assets totalled $36.9 million at October 31, 2016, compared to $34.3 million at the end of the previous quarter and $28.6 million a year ago with the change from a year ago due to an increase in funds held for securitization liabilities.

The deferred income tax asset of the Bank was $6.4 million at October 31, 2016, compared to $6.9 million at the end of the previous quarter and $8.8 million a year ago. The changes from previous periods were primarily a result of the utilization of loss carry-forwards due to taxable income earned by the Bank. The deferred income tax asset is a result of income tax losses of the Bank totalling approximately $18.0 million incurred in previous years. These income tax loss carry-forwards are not scheduled to begin expiring until 2027 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 October 31, 2016, totalled $1.37 billion compared to $1.36 billion at the end of the previous quarter and $1.33 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 the growth in lending assets.

Of the total amount of deposits outstanding, $17.5 million or approximately 1.27% of total deposits at the end of the current quarter were in the form of demand savings accounts compared to $17.3 million or 1.28% of total deposits at the end of the previous quarter and $17.0 million or approximately 1.29% of total deposits a year ago. In addition, the Bank has chequing accounts related to trustees in the Canadian bankruptcy industry as discussed below.

In order to further diversify its sources of deposits and reduce its cost of new deposits, the Bank has another source of funds, that being 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 with these services provided to trustees across Canada. At October 31, 2016, balances for these low cost chequing accounts totalled $189.1 million compared to $160.3 million at the end of the previous quarter and $110.6 million a year ago.

Other liabilities typically consist of accounts payable and accruals and holdbacks payable related to the bulk purchase program. At October 31, 2016, other liabilities totalled $91.2 million compared to $85.1 million at the end of the previous quarter and $67.9 million a year ago with the increase due primarily to holdbacks associated with loan and lease receivables purchased through the bulk purchase program which have shown significant growth over the past year. These holdbacks payable totalled $82.6 million at October 31, 2016 compared to $77.7 million at the end of previous quarter and $61.0 million a year ago.

An additional source of financing growth in assets and a source of liquidity is the use of margin lines and securities sold under repurchase agreements. At October 31, 2016, there were no amounts outstanding from these sources compared to none outstanding at the end of the previous quarter and a year ago.

Securitization Liabilities

Securitization liabilities relate to amounts payable to counterparties for cash received upon initiation of securitization transactions. At October 31, 2016, securitization liabilities totalled $43.6 million compared to $43.7 million at the end of the previous quarter and $43.5 million a year ago. The amounts payable to counterparties bear interest at rates ranging from 1.97% - 3.95% and mature between December 2016 and 2020. Residential mortgages and other assets are pledged as collateral for securitized liabilities. There have been no securitization transactions in the past several years.

Subordinated Notes Payable

Subordinated notes payable, net of issue costs, totalled $14.1 million at October 31, 2016 compared to $14.0 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 and were issued by the Bank to an unrelated party. These subordinated notes, which are currently callable, bear interest at rates ranging from 8.00% to 11.00% and mature between 2019 and 2021.

Shareholders’ Equity

At October 31, 2016, shareholders’ equity was $185.9 million compared to $184.5 million at the end of the previous quarter and $174.6 million a year ago. The increase from previous periods was due to earnings and proceeds received from the issue of 657,894 common shares for cash proceeds of $5.0 million on March 9, 2016.

Common shares outstanding at October 31, 2016 totalled 20,095,065 unchanged from the end of the previous quarter and compared to 19,437,171 a year ago with the increase due to the issue of 657,894 common shares on a private placement basis as noted above. Common share options totalled 40,000 at October 31, 2016, unchanged from the previous quarter and a year ago.

The Bank’s book value per common share at October 31, 2016 was $7.79 compared to $7.72 at the end of the previous quarter and $7.47 a year ago.

See Note 9 to the unaudited interim consolidated financial statements for additional information relating to share capital.

Updated Share Information

As at November 28, 2016, there were no changes since October 31, 2016 in the number of outstanding common shares, Series 1 and Series 3 Preferred Shares and common share options.

Off-Balance Sheet Arrangements

As at October 31, 2016, 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 11 to the unaudited interim consolidated financial statements for more information.

Related Party Transactions

During the three months and year ended October 31, 2016, the Bank incurred management and other fees totalling $225,000 (October 31, 2015 - $150,000) and $751,000 (October 31, 2015 - $600,000) respectively to PWC.

The Bank’s and PWC’s Board of Directors and Senior Executive Officers represent key management personnel. See Note 12 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, 2015, and are found on pages 39 to 46 of the Bank’s 2015 Annual Report.

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 $189.1 million at October 31, 2016 compared to $187.2 million at the end of the previous quarter and $178.3 million a year ago. The increase in total regulatory capital from the previous periods was due primarily to earnings in the Bank during the periods and a private placement of common shares totalling $5.0 million by the Bank in March 2016.

At October 31, 2016, the Bank exceeded the current minimum Basel III regulatory capital requirements referred to above with a CET1 ratio of 10.52% compared to 10.70% at the end of the previous quarter and 10.32% a year ago. At October 31, 2016, the Bank’s Tier 1 capital ratio was 12.58% compared to 12.82% at the end of the previous quarter and 12.54% a year ago. In addition, the Bank’s total capital ratio was 13.27% at October 31, 2016, compared to 13.53% at the end of the previous quarter and 13.51% a year ago. At October 31, 2016, the Bank’s leverage ratio was 9.82% compared to 9.77% at the end of the previous quarter and 9.53% a year ago.

See Note 13 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.

         
      October 31, 2016 October 31, 2015
     

Increase 100
bps

 

Decrease 100
bps

Increase 100
bps

 

Decrease 100
bps

 
Impact on projected net interest
income during a 12 month period $ 2,387 $ (2,243) $ 3,371 $ (3,114)
Impact on reported equity
during a 60 month period $ (1,631) $ 1,667 $ 295 $ (86)
             
Duration difference between assets and
liabilities (months)     0.6     0.8  

The Bank’s sensitivity to changes in interest rates and its duration difference between assets and liabilities at October 31, 2016 has not changed significantly since October 31, 2015. 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 $2.4 million and the impact on net interest income of a 100 basis point decrease would be approximately ($2.2 million). Similarly at October 31, 2016, the impact on equity during a 60 month period of a 100 basis point increase would be approximately ($1.6 million) and the impact on equity of a 100 basis point decrease would be approximately $1.7 million. At October 31, 2016 the duration difference between assets and liabilities is less than 1 month compared to approximately 1 month at October 31, 2015 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 year ended October 31, 2016 shows cash provided by (used in) operations of ($46.7 million) compared to ($57.4 million) for the same period last year. The operating cash flow is primarily affected by the change in the balance of its deposits (a positive change in deposits has a positive impact on cash flow and a negative change in deposits has a negative impact on cash flow) as compared to the change in the balance of its loans (a positive change in loans has a negative impact on cash flow and a negative change 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 its MD&A and audited consolidated financial statements for the year ended October 31, 2015, have not changed significantly as at October 31, 2016.

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)   2016   2015
Q4   Q3   Q2   Q1 Q4   Q3   Q2   Q1
 
Results of operations:
Total interest income $ 17,462 $ 17,628 $ 17,346 $ 17,226 $ 16,685 $ 16,513 $ 15,630 $ 15,629
Yield on assets (%) 4.09% 4.13% 4.14% 4.11% 4.15% 4.24% 4.21% 4.18%
Interest expense 7,396 7,792 7,986 8,084 7,724 7,786 7,375 7,598
Cost of funds (%) 1.73% 1.82% 1.91% 1.93% 1.92% 2.00% 1.99% 2.03%
Net interest income 10,066 9,836 9,360 9,142 8,961 8,727 8,255 8,031
Net interest margin (%) 2.36% 2.31% 2.23% 2.18% 2.23% 2.24% 2.22% 2.15%
Non-interest income 320 343 285 325 384 368 304 338
Total revenue 10,386 10,179 9,645 9,467 9,345 9,095 8,559 8,369
Provision for credit losses 422 24 213 212 319 297 427 502
Non-interest expenses 6,779 6,654 6,472 6,051 6,562 6,421 6,264 5,537
Restructuring charges 549 98 445 - - - - -
Income before income taxes 2,636 3,403 2,515 3,204 2,464 2,377 1,868 2,330
Income tax provision (recovery) 740 947 708 893 (306) 670 (194) 651
Net income $ 1,896 $ 2,456 $ 1,807 $ 2,311 $ 2,770 $ 1,707 $ 2,062 $ 1,679
 
Income per common share
Basic $ 0.07 $ 0.09 $ 0.06 $ 0.09 $ 0.11 $ 0.05 $ 0.09 $ 0.07
Diluted $ 0.07 $ 0.09 $ 0.06 $ 0.09   $ 0.11 $ 0.05 $ 0.09 $ 0.07

The financial results for each of the last eight quarters are summarized above. Total interest income and net interest income continued to increase through 2015 and 2016 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 in 2016 relate to rebranding of the Bank and costs associated with the review of strategic alternatives commenced by the Bank in the second quarter as discussed previously.

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 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 2015 Audited Consolidated Financial Statements. There have been no material changes in accounting policies since October 31, 2015.

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. 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.

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 October 31, 2016, 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 page 46 of our 2015 Annual Report.

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
(formerly Pacific & Western Bank of Canada)
Consolidated Balance Sheets
(Unaudited)

(thousands of Canadian dollars)              
  October 31 October 31
As at             2016   2015
 
Assets
 
Cash and cash equivalents $ 93,964 $ 127,078
Securities (note 4) 9,958 22,433
Loans, net of allowance for credit losses (note 5) 1,563,612 1,447,660
Other assets 36,866 28,635
               
            $ 1,704,400 $ 1,625,806
 
Liabilities and Shareholders' Equity
 
Deposits $ 1,369,647 $ 1,325,828
Subordinated notes payable (note 6) 14,067 13,959
Securitization liabilities (note 7) 43,585 43,525
Other liabilities (note 8)         91,217   67,872
1,518,516 1,451,184
 
Shareholders' equity:
Share capital (note 9) 176,706 171,706
Retained earnings 9,172 2,903
Accumulated other comprehensive income   6   13
185,884 174,622
               
            $ 1,704,400 $ 1,625,806

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

VERSABANK
(formerly Pacific & Western Bank of Canada)
Consolidated Statements of Income
(Unaudited)

(thousands of Canadian dollars, except per share amounts)            
            for the three months ended for the year ended
    October 31 October 31 October 31 October 31
              2016   2015   2016   2015
 
Interest income:
Loans $ 17,209 $ 16,409 $ 68,496 $ 62,973
Securities           253   276   1,166   1,484
17,462 16,685 69,662 64,457
 
Interest expense:
Deposits and other 7,043 7,372 29,855 29,091
Subordinated notes         353   352   1,403   1,392
7,396 7,724 31,258 30,483
                   
Net interest income 10,066 8,961 38,404 33,974
 
Non-interest income         320   384   1,273   1,394
Total revenue 10,386 9,345 39,677 35,368
 
Provision for credit losses (note 5b)       422   319   871   1,545
9,964 9,026 38,806 33,823
 
Non-interest expenses:
Salaries and benefits 3,597 3,637 14,090 13,041
General and administrative 2,611 2,404 9,481 9,648
Premises and equipment       571   521   2,385   2,095
6,779 6,562 25,956 24,784
Restructuring charges (note 16)       549   -   1,092   -
7,328 6,562 27,048 24,784
                   
Income before income taxes 2,636 2,464 11,758 9,039
 
Income tax provision (recovery) 740 (306) 3,288 821
                   
Net income         $ 1,896 $ 2,770 $ 8,470 $ 8,218
 
Basic and diluted income per common share (note 10) $ 0.07 $ 0.11 $ 0.32 $ 0.33
 
Weighted average number of
common shares outstanding 20,095,000 19,437,000 19,861,000 19,437,000


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

VERSABANK
(formerly Pacific & Western Bank of Canada)
Consolidated Statements of Comprehensive Income
(Unaudited)

(thousands of Canadian dollars)                  
          for the three months ended   for the year ended
  October 31   October 31 October 31   October 31
            2016   2015   2016   2015
 
Net income $ 1,896 $ 2,770 $ 8,470 $ 8,218
 
Other comprehensive income (loss), net of tax

Net unrealized gains (losses) on assets
held as available-for-sale (1)

2 (12) (7) (6)
                 
Comprehensive income     $ 1,898 $ 2,758 $ 8,463 $ 8,212

(1) Net of income tax expense for the three months of $1 (2015 – $5 benefit) and income tax benefit for the year of $3 (2015 – $2)

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

VERSABANK
(formerly Pacific & Western Bank of Canada)
Consolidated Statements of Changes in Shareholders’ Equity
(Unaudited)

(thousands of Canadian dollars)                    
          for the three months ended   for the year ended
  October 31   October 31 October 31   October 31
            2016   2015   2016   2015
 
Common shares (note 9):
 
Balance, beginning of the period $ 147,224 $ 142,224 $ 142,224 $ 142,224
Issued during the period - - 5,000 -
                 
Balance, end of the period     $ 147,224 $ 142,224 $ 147,224 $ 142,224
 
Preferred shares (note 9):
 
Series 1 preferred shares
                 
Balance, beginning and end of the period $ 13,647 $ 13,647 $ 13,647 $ 13,647
 
Series 3 preferred shares
Balance, beginning of the period $ 15,690 $ 15,690 $ 15,690 $ -
Issued during the period, net of issue costs and income taxes - - - 15,690
                 
Balance, beginning and end of the period $ 15,690 $ 15,690 $ 15,690 $ 15,690
 
Contributed surplus:
 
Balance, beginning of the period $ 145 $ 141 $ 145 $ 122
Fair value of stock options granted - 4 - 23
                 
Balance, end of the period     $ 145 $ 145 $ 145 $ 145
                 
Total share capital       $ 176,706 $ 171,706 $ 176,706 $ 171,706
 
Retained earnings (deficit):
 
Balance, beginning of the period $ 7,827 $ 683 $ 2,903 $ (3,493)
Net income 1,896 2,770 8,470 8,218
Dividends paid on preferred shares (note 10) (551) (550) (2,201) (1,822)
                 
Balance, end of the period     $ 9,172 $ 2,903 $ 9,172 $ 2,903
 
Accumulated other comprehensive income, net of taxes:
 
Balance, beginning of the period $ 4 $ 25 $ 13 $ 19
Other comprehensive income (loss) 2 (12) (7) (6)
                 
Balance, end of the period     $ 6 $ 13 $ 6 $ 13
                 
Total shareholders' equity     $ 185,884 $ 174,622 $ 185,884 $ 174,622

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

VERSABANK
(formerly Pacific & Western Bank of Canada)
Consolidated Statements of Cash Flows
(Unaudited)

(thousands of Canadian dollars)          
  October 31 October 31
For the year ended       2016   2015
 
Cash provided by (used in):
 
Operations:
Net income $ 8,470 $ 8,218
Adjustments to determine net cash flows:
Items not involving cash:
Provision for credit losses 871 1,545
Stock-based compensation - 23
Income tax provision 3,288 821
Interest income (69,662) (64,457)
Interest expense 31,258 30,483
Amortization of property and equipment 776 393
Interest received 68,268 63,297
Interest paid (31,418) (29,909)
Change in operating assets and liabilities:
Loans (114,892) (223,565)
Deposits 44,146 131,612
  Change in other assets and liabilities   12,176   24,102
(46,719) (57,437)
Investing:
Purchase of securities (9,583) -
Proceeds from sale and maturity of securities   21,846   25,922
12,263 25,922
Financing:
Proceeds from shares issued, net of costs 5,000 15,275
Dividends paid (2,201) (1,822)
Income taxes paid       (1,457)   -
1,342 13,453
               
Decrease in cash and cash equivalents (33,114) (18,062)
 
Cash and cash equivalents, beginning of the year 127,078 145,140
               
Cash and cash equivalents, end of the year $ 93,964 $ 127,078
 
Cash and cash equivalents is represented by:
Cash $ 93,964 $ 39,091
Cash equivalents - 87,987
               
Cash and cash equivalents, end of the year $ 93,964 $ 127,078

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

VERSABANK
(formerly Pacific & Western Bank of Canada)
Notes to Interim Consolidated Financial Statements
(Unaudited)

Three month period and year ended October 31, 2016 and 2015

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. Effective May 13, 2016, the Bank changed its name from Pacific & Western Bank of Canada to VersaBank.

The Bank is incorporated and domiciled in Canada, and maintains its registered office at Suite 2002, 140 Fullarton Street, London, Ontario, Canada, N6A 5P2. It is the principal subsidiary of PWC Capital Inc. (“PWC”) whose shares also trade on the Toronto Stock Exchange. At October 31, 2016 PWC owned approximately 63% (October 31, 2015 – 68%) 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, 2015.

The interim Consolidated Financial Statements for the three months and year ended October 31, 2016 and 2015 were approved by the Audit Committee of the Board of Directors on November 28, 2016.

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 interimConsolidated 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 interimConsolidated 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, 2015 and are detailed in Note 3 of the Bank’s 2015 Audited Consolidated Financial Statements.

4. Securities:

Portfolio analysis:

         
October 31 October 31
    2016   2015
 
Available-for-sale securities
Securities issued or guaranteed by:
Canadian provincial governments $ 9,687 $ 9,607
Canadian municipal governments   271   279
Total available-for-sale securities $ 9,958 $ 9,886
 
Held-to-maturity security
Debt of other financial institutions $ - $ 12,547
Total securities $ 9,958 $ 22,433

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, 2015 consolidated financial statements for more information.

5. Loans:

a) Portfolio analysis:

         
October 31 October 31
    2016   2015
 
 
Government loans $ 66,016 $ 72,181
Loan and lease receivables 783,669 618,432
Residential mortgages 95,624 112,759
Commercial mortgages 227,816 269,193
Construction mortgages 256,429 237,100
Commercial loans 102,265 104,996
Credit card receivables and other   29,373   31,168
1,561,192 1,445,829
 
Collective allowance (3,031) (3,212)
Accrued interest 5,451 5,043
     
Total loans, net of allowance for credit losses $ 1,563,612 $ 1,447,660

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

         
October 31 October 31
    2016   2015
 
Government loans $ 14 $ 18
Loan and lease receivables 344 269
Residential mortgages 165 268
Commercial mortgages 412 587
Construction mortgages 765 776
Commercial loans 276 228
Credit card receivables and other   1,055   1,066
  $ 3,031 $ 3,212

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 (note 8).

b) Allowance for credit losses:

The allowance for credit losses results from the following:

                   
October 31 October 31
2016 2015
For the three months ended Collective Individual

Total
Allowance

Total
Allowance

 
Balance, beginning of the period $ 2,894 $ - $ 2,894 $ 3,118
Provision for credit losses 422 - 422 319
Write-offs (285) - (285) (225)
           
Balance, end of the period $ 3,031 $ - $ 3,031 $ 3,212
 
           
October 31 October 31
2016 2015
For the year ended   Collective Individual

Total
Allowance

Total
Allowance

 
Balance, beginning of the period $ 3,212 $ - $ 3,212 $ 2,905
Provision for credit losses 871 - 871 1,545
Write-offs (1,052) - (1,052) (1,238)
           
Balance, end of the period $ 3,031 $ - $ 3,031 $ 3,212

c) Impaired loans:

At October 31, 2016, there were $nil impaired loans (October 31, 2015 - $nil). At October 31, 2016, loans, other than credit card receivables, past due were $936,000 (October 31, 2015 - $nil). At October 31, 2016, credit card receivables overdue by one day or more totalled $2,290,000 (October 31, 2015 - $2,773,000).

6. Subordinated notes payable:

                 
          October 31 October 31
              2016   2015
 

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 $433
(October 31, 2015 - $541) effective interest of 10.06%

$ 14,067 $ 13,959
               
            $ 14,067 $ 13,959

7. 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 1.97% - 3.95% and mature between December, 2016 and 2020. Securitized residential insured mortgages and other assets are pledged as collateral for these liabilities.

8. Other liabilities:

           
  October 31 October 31
      2016   2015
 
Accounts payable and other $ 8,653 $ 6,869
Holdbacks payable on loan and lease receivables 82,564 61,003
       
    $ 91,217 $ 67,872

9. Share capital:

a) Common shares:

At October 31, 2016, there were 20,095,065 (October 31, 2015 – 19,437,171) common shares outstanding. In March 2016, 657,894 common shares were issued for cash proceeds of $5,000,000 under private placement.

b) Preferred shares:

At October 31, 2016, there were 1,461,460 (October 31, 2015 – 1,461,460) Series 1 preferred shares and 1,681,320 (October 31, 2015 – 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 13).

c) Stock options:

At October 31, 2016, there were 40,000 common share stock options outstanding (October 31, 2015 – 40,000).

10. Income per common share:

          for the three months ended   for the year ended
  October 31   October 31 October 31   October 31
          2016   2015   2016   2015
 
Net income $ 1,896 $ 2,770 $ 8,470 $ 8,218
Less: dividends on preferred shares   (551)   (550)   (2,201)  

(1,822)

1,345 2,220 6,269

6,396

 
Average number of common shares outstanding 20,095,000 19,437,000 19,861,000 19,437,000
               
Income per common share:     $ 0.07 $ 0.11 $ 0.32

0.33

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.

11. 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.

         
October 31 October 31
    2016   2015
 
Loan commitments $ 265,631 $ 243,253
Undrawn credit card lines 127,116 140,071
Letters of credit 42,809 39,015
     
  $ 435,556 $ 422,339

12. Related party transactions:

During the three months and year ended October 31, 2016 the Bank incurred management and other fees totalling $225,000 (October 31, 2015 - $150,000) and $751,000 (October 31, 2015 - $600,000) respectively to PWC.

The Bank’s and PWC’s Boards of Directors and Senior Executive Officers represent key management personnel.

The Bank has loans to employees and key management personnel. At October 31, 2016, amounts due from related parties totalled $2,532,000 (October 31, 2015 - $2,303,000). 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 and year ended October 31, 2016 was $17,000 (October 31, 2015 - $18,000) and $70,000 (October 31, 2015 - $73,000) respectively. There were no provisions for credit losses related to loans issued to key management personnel for the three months and year ended October 31, 2016 and 2015.

13. 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 year ended October 31, 2016, 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:

                         
          October 31, 2016   October 31, 2015
          "All-in"   "Transitional" "All-in"   "Transitional"
 
Common Equity Tier 1 (CET1) capital
Directly issued qualifying common share capital $ 147,369 $ 147,369 $ 142,369 $ 142,369
Retained earnings 9,172 9,172 2,903 2,903
  Accumulated other comprehensive income   6     6     13     13  
CET1 capital before regulatory adjustments 156,547 156,547 145,285 145,285
  Total regulatory adjustments to CET1   (6,562 )   (3,937 )   (9,031 )   (3,612 )
Common Equity Tier 1 capital   $ 149,985   $ 152,610   $ 136,254   $ 141,673  
 
Additional Tier 1 (AT1) capital
  Directly issued qualifying AT1 instruments $ 29,337   $ 29,337   $ 29,337   $ 29,337  
Tier 1 capital     $ 179,322   $ 181,947   $ 165,591   $ 171,010  
 
Tier 2 capital
Directly issued capital instruments subject to
  phase out from Tier 2   $ 9,800   $ 9,800   $ 12,700   $ 12,700  
Tier 2 capital before regulatory adjustments 9,800 9,800 12,700 12,700
  Total regulatory adjustments to Tier 2 capital   -     -     -     -  
Tier 2 capital       $ 9,800   $ 9,800   $ 12,700   $ 12,700  
Total capital       $ 189,122   $ 191,747   $ 178,291   $ 183,710  
Total risk-weighted assets   $ 1,425,171   $ 1,427,796   $ 1,320,158   $ 1,325,576  
Capital ratios
CET1 Ratio 10.52 % 10.69 % 10.32 % 10.69 %
Tier 1 Capital Ratio 12.58 % 12.74 % 12.54 % 12.90 %
  Total Capital Ratio       13.27 %   13.43 %   13.51 %   13.86 %

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:

           
October 31 October 31
      2016   2015
 
On-balance sheet assets $ 1,704,400 $ 1,625,806
Asset amounts deducted in determining Basel III "all in" Tier 1 Capital   (6,562)   (9,031)
Total on-balance sheet exposures     1,697,838   1,616,775
 
Off-balance sheet exposure at gross notional amount $ 435,556 $ 422,339
Adjustments for conversion to credit equivalent amount   (306,877)   (301,674)
Off-balance sheet exposures     128,679   120,665
 
Tier 1 Capital     179,322   165,591
Total Exposures 1,826,517 1,737,440
 
Leverage Ratio     9.82%   9.53%

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

14. 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.

                     
      October 31, 2016   October 31, 2015
     

Increase 100
bps

 

Decrease 100
bps

Increase 100
bps

 

Decrease 100
bps

 
Impact on projected net interest
income during a 12 month period $ 2,387 $ (2,243) $ 3,371 $ (3,114)
Impact on reported equity
during a 60 month period $ (1,631) $ 1,667 $ 295 $ (86)
             
Duration difference between assets and
liabilities (months)     0.6     0.8  

15. 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, 2015 consolidated financial statements for more information on fair values.

                 
  October 31, 2016 October 31, 2015
  Fair value   Fair value
Book of assets Book of assets
  Value and liabilities Value and liabilities
 
Assets
 
Cash and cash equivalents $ 93,964 $ 93,964 $ 127,078 $ 127,078
Securities 9,958 9,958 22,433 22,386
Loans 1,563,612 1,563,299 1,447,660 1,449,567
Other financial assets 16,539 16,539 5,887 5,887
         
 
Liabilities
 
Deposits $ 1,369,547 $ 1,380,685 $ 1,325,828 $ 1,333,366
Subordinated notes payable 14,067 14,500 13,959 14,500
Securitization liabilities 43,585 46,923 43,525 47,604
Other financial liabilities 91,217 91,217 67,872 67,872

16. Proposed Amalgamation of PWC and the Bank:

On March 7, 2016, PWC and the Bank announced they were undertaking a review of their strategic alternatives. Subsequently on September 12, 2016 and November 15, 2016, PWC and the Bank jointly announced that they have entered into an agreement to merge by amalgamation under the Bank Act (Canada). After the amalgamation, which is subject to regulatory and other approvals, including approvals by the various security holders of both entities, the combined entity will continue to be named VersaBank. It is anticipated that this proposed amalgamation will not result in any significant changes to the ongoing operations of the Bank. At this time, there can be no assurance that the amalgamation will take place or of its nature, terms or timing.

During the year ended October 31, 2016, the Bank incurred restructuring charges relating to costs associated with the review of strategic alternatives commenced by the Bank earlier in the year as noted above.

VersaBank, a Schedule I chartered bank, is a branchless financial institution with approximately $1.7 billion in assets. VersaBank specializes in providing commercial lending services to selected niche markets and receives its deposits through a diversified deposit broker network across Canada.

VersaBank shares trade on the TSX and its shares trade under the symbol VB.

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

To receive company news releases, please contact:
Wade MacBain at wadem@versabank.com (519) 675-4201

Visit our website at: http://www.versabank.com

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