When VersaBank (CA:VBNK) reported second-quarter results Wednesday, the little-known bank was able to do something that none of Canada’s big five lenders did: Increase net earnings from Q1 2023. 

In fact, the London, Ontario-based digital bank delivered excellent results relative to Q1 2023 and Q2 2022. 

While it’s not a very big bank, with a market cap of $253 million (All figures in Canadian dollars, unless specified), and its stock is down 4.4% year-to-date, compared to a 2.0% decline for the BMO Equal Weight Banks Index ETF (CA:ZEB), it is a Canadian bank that investors should take more seriously.  That equal-weighted exchange-traded fund tracks Canada’s six biggest banks.

With a Fintel Value score of 91.29, VBNK stock ranks as the most undervalued of the Canadian bank stocks tracked on that dashboard. The Value score is derived from a proprietary model that ranks companies based on their relative valuation. Scores range from 0 to 100, with 100 being the most undervalued. 

Net Income Up Nearly 10%

VersaBank reported $26.7 million in revenue in the second quarter, 3% higher than $25.9 million in the previous quarter and 43% higher than Q2 2022. On the bottom line, it showed net income of $10.3 million, 9% higher than in Q1 2023 and 108% above Q2 2022. 

The increase in earnings comes despite an 11% increase in its cost of funds, to $3.27%, and a 2% decline in net interest margin, to 2.78%. 

Every one of the Big 5 had hefty year-over-year increases in their provision for credit losses (PCL) in the first half of 2023. Through the second quarter, the group had a combined PCL of $5.74 billion, 808% higher than a year earlier. 

VersaBank’s PCL through Q2 2023 was $622,000, 678% higher than $80,000 a year earlier. Its PCL as a percentage of loans increased by three basis points from 0.01% to 0.04%. That’s considerably less than the Big 5, whose PCL as a percentage of loans varied from 0.20% to 0.42%.  

Some of the other highlights in the quarter include a return on average common equity of 11.4% through the first six months, 81% higher than a year ago; a book value per common share of $13.19, 10.5% higher than a year ago. Its efficiency ratio -- defined as non-interest expenses divided by revenue -- was 48%, down from 61% in the first six months of 2022, a sign the company’s business is doing a good job controlling its overhead. 

It was an excellent quarter. 

What to Watch

VersaBank became a branchless financial institution in 1993. It is a Canadian Schedule 1 chartered bank that obtains deposits and makes its loans digitally. 

However, in addition to its digital banking operations, it operates a second segment through its wholly owned subsidiary, DRT Cyber, which provides cybersecurity services and financial technology development to other financial institutions. 

In the first six months of 2023, DRT Cyber’s revenue was $3.98 million, up from $2.89 million a year earlier. However, its expenses were $623,000 higher than its revenue. That’s up from $122,000 a year earlier. The business continues to scale, adding employees and increasing expenses faster than revenues.

The cyber division will ultimately generate an operating profit, but until it does, it’s something to be aware of that will reduce VersaBank’s overall profitability. 

Investors should also know that most of its loans are Point-of-Sale Loans and Leases, and Commercial Real Estate loans for multi-unit residential real estate properties. Should a recession happen, both revenue streams will be somewhat affected. 

More Canadians are becoming renters, property management firm Morguard said in January. “After a decline in spring 2020, demand for purpose-built, multi-family rental properties strengthened during the second half of 2021, extending to the midway point of 2022,” Storeys reported.

Record Loans

VersaBank finished the second quarter with record loans of $3.42 billion, 40% higher than a year earlier and 6% higher than in Q1 2023, with the big growth from its Point-of-Sale financing portfolio. 

“We anticipate continued strong growth in our loan portfolio in the second half of 2023, driven by continued growth in our Canadian Point of Sale portfolio, which typically benefits from higher consumer spending in the spring and summer months,” VersaBank’s Q2 2023 press release stated. 

VersaBank is acquiring a small U.S. bank with US$60 million in total assets specializing in small business lending. It’s presently going through the regulatory review. Once completed, the Minnesota-based bank will become the platform for the U.S. growth of its program to purchase business receivables. 

It is another step in VersaBank’s long-term growth strategy. If you are an investor comfortable with above-average risk, the company’s latest results suggest it’s Canada’s best-kept banking secret,