Exhibit 99.2
Consolidated Financial Statements
Years ended October 31, 2023 and 2022
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of VersaBank
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of VersaBank (the Bank) as of October 31, 2023, the related consolidated statement of income and comprehensive income, statement of changes in shareholders’ equity, and cash flows for the year ended October 31, 2023, and the related notes (collectively referred to as, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Bank as at October 31, 2023, and its consolidated financial performance and its consolidated cash flows for the year ended October 31, 2023, in conformity with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board.
Basis for Opinion
These consolidated financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on the Bank’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting and Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Bank in accordance with the U.S. federal securities laws and the applicable regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Bank is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Bank’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ Ernst & Young LLP
Chartered Professional Accountants
Licensed Public Accountants
We have served as the Bank’s auditor since 2023.
London, Canada
December 12, 2023
KPMG LLP
Bay Adelaide Centre
333 Bay Street, Suite 4600
Toronto, ON M5H 2S5
Canada
Tel 416-777-8500
Fax 416-777-8818
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
VersaBank:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of VersaBank (the Bank) as of October 31, 2022, the related consolidated statements of income and comprehensive income, changes in shareholders’ equity and cash flows for the year then ended, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Bank as of October 31, 2022, its financial performance and its cash flows for the year then ended, in conformity with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board.
Basis for Opinion
These consolidated financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Bank in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Bank is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Bank’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provide a reasonable basis for our opinion.
/s/ KPMG LLP
Chartered Professional Accountants, Licensed Public Accountants
We have served as the Bank’s auditor since 2002 and its predecessor trust company since 1989.
Toronto, Canada
December 6, 2022
KPMG LLP, an Ontario limited liability partnership and member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee.
KPMG Canada provides services to KPMG LLP.
VERSABANK
Consolidated Balance Sheets
As at October 31, 2023 and 2022
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Assets | ||||||||
| Cash (note 4) | $ | $ | ||||||
| Securities (note 5) | ||||||||
| Loans, net of allowance for credit losses (note 6) | ||||||||
| Other assets (note 10) | ||||||||
| $ | $ | |||||||
| Liabilities and Shareholders' Equity | ||||||||
| Deposits (note 11) | $ | $ | ||||||
| Subordinated notes payable (note 12) | ||||||||
| Other liabilities (note 13) | ||||||||
| Shareholders' equity: | ||||||||
| Share capital (note 14) | ||||||||
| Contributed surplus | ||||||||
| Retained earnings | ||||||||
| Accumulated other comprehensive income | ||||||||
| $ | $ | |||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
On behalf of the Board:
 |
 |
| David R. Taylor President and Chief Executive Officer |
Hon. Thomas A. Hockin Chair of the Board |
VERSABANK
Consolidated Statements of Income and Comprehensive Income
Years ended October 31, 2023 and 2022
| (thousands of Canadian dollars, except per share amounts) | ||||||||
| 2023 | 2022 | |||||||
| Interest income: | ||||||||
| Loans | $ | $ | ||||||
| Other | ||||||||
| Interest expense: | ||||||||
| Deposits and other | ||||||||
| Subordinated notes | ||||||||
| Net interest income | ||||||||
| Non-interest income | ||||||||
| Total revenue | ||||||||
| Provision for credit losses (note 6(b)) | ||||||||
| Non-interest expenses: | ||||||||
| Salaries and benefits | ||||||||
| General and administrative | ||||||||
| Premises and equipment | ||||||||
| Income before income taxes | ||||||||
| Income tax provision (note 16) | ||||||||
| Net income | $ | $ | ||||||
| Other comprehensive income: | ||||||||
| Items that may subsequently be reclassified to net income: | ||||||||
| Foreign exchange gain on translation of foreign operations | ||||||||
| Comprehensive income | $ | $ | ||||||
| Basic and diluted income per common share (note 17) | $ | $ | ||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
VERSABANK
Consolidated Statements of Changes in Shareholders’ Equity
Years ended October 31, 2023 and 2022
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Common shares (note 14): | ||||||||
| Balance, beginning of the year | $ | $ | ||||||
| Options exercised during the year | ||||||||
| Purchased and cancelled during the year | ( | ) | ( | ) | ||||
| Balance, end of the year | $ | $ | ||||||
| Preferred shares (note 14): | ||||||||
| Series 1 preferred shares | ||||||||
| Balance, beginning and end of the year | $ | $ | ||||||
| Total share capital | $ | $ | ||||||
| Contributed surplus: | ||||||||
| Balance, beginning of the year | $ | $ | ||||||
| Stock-based compensation (note 15) | ||||||||
| Balance, end of the year | $ | $ | ||||||
| Retained earnings: | ||||||||
| Balance, beginning of the year | $ | $ | ||||||
| Adjustment for purchased and cancelled common shares | ( | ) | ( | ) | ||||
| Net income | ||||||||
| Dividends paid on common and preferred shares | ( | ) | ( | ) | ||||
| Balance, end of the year | $ | $ | ||||||
| Accumulated other comprehensive income (loss), net of taxes: | ||||||||
| Balance, beginning of the year | $ | $ | ( | ) | ||||
| Other comprehensive income | ||||||||
| Balance, end of the year | $ | $ | ||||||
| Total shareholders' equity | $ | $ | ||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
VERSABANK
Consolidated Statements of Cash Flows
Years ended October 31, 2023 and 2022
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Cash provided by (used in): | ||||||||
| Operations: | ||||||||
| Net income | $ | $ | ||||||
| Adjustments to determine net cash flows: | ||||||||
| Items not involving cash: | ||||||||
| Provision for credit losses | ||||||||
| Stock-based compensation | ||||||||
| Income tax provision | ||||||||
| Interest income | ( | ) | ( | ) | ||||
| Interest expense | ||||||||
| Amortization | ||||||||
| Accretion of discount on securities | ( | ) | ( | ) | ||||
| Foreign exchange rate change on assets and liabilities | ||||||||
| Interest received | ||||||||
| Interest paid | ( | ) | ( | ) | ||||
| Income taxes paid | ( | ) | ( | ) | ||||
| Change in operating assets and liabilities: | ||||||||
| Loans | ( | ) | ( | ) | ||||
| Deposits | ||||||||
| Change in other assets and liabilities | ||||||||
| ( | ) | |||||||
| Investing: | ||||||||
| Purchase of securities (note 27) | ( | ) | ( | ) | ||||
| Purchase of property and equipment | ( | ) | ( | ) | ||||
| ( | ) | ( | ) | |||||
| Financing: | ||||||||
| Issuance of common shares | ||||||||
| Purchase and cancellation of common shares | ( | ) | ( | ) | ||||
| Dividends paid | ( | ) | ( | ) | ||||
| Repayment of lease obligations | ( | ) | ( | ) | ||||
| ( | ) | ( | ) | |||||
| Change in cash | ( | ) | ||||||
| Effect of exchange rate changes on cash | ( | ) | ( | ) | ||||
| Cash, beginning of year | ||||||||
| Cash, end of year | $ | $ | ||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
| 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 Canada (“OSFI”). The Bank, whose shares trade on the Toronto Stock Exchange and Nasdaq Stock Exchange, provides commercial lending and banking services to select niche markets in Canada and the United States as well as cybersecurity services through the operations of its wholly owned subsidiary DRT Cyber Inc., (“DRTC”). The Bank is incorporated and domiciled in Canada, and maintains its registered office at Suite 2002, 140 Fullarton Street, London, Ontario, Canada, N6A 5P2.
| 2. | Basis of preparation: |
These Consolidated Financial Statements have been prepared in accordance with the Bank Act (Canada). OSFI has instructed that the financial statements are to be prepared in accordance with International Financial Reporting Standards (“IFRS”). The significant accounting policies used in the preparation of these consolidated financial statements, including the accounting requirements of OSFI, are summarized below.
| a) | Statement of compliance: |
These Consolidated Financial Statements have been prepared in accordance with IFRS as issued by the International Accounting Standards Board (“IASB”).
| b) | Date authorized for issuance: |
These Consolidated Financial Statements were approved and authorized for issue by the Board of Directors of the Bank on December 12, 2023.
| c) | Basis of measurement: |
These Consolidated Financial Statements have been prepared on the historical cost basis except for assets and liabilities acquired in a business combination which are measured at fair value at the date of acquisition (see note 26), derivatives (see note 18), and the investment in Canada Stablecorp Inc. (see note 10) which is also measured at fair value in the Consolidated Balance Sheets.
| d) | Functional and presentation currency: |
These Consolidated Financial Statements are presented in Canadian dollars which is the Bank’s functional currency. Functional currency is also determined for each of the Bank’s subsidiaries and items included in the financial statements of the subsidiaries are measured using their functional currency (see note 3m – Foreign currency translation).
| 2. | Basis of preparation – continued: |
| e) | Use of estimates and judgments: |
In preparing these 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 judgement was applied include assessing significant increases in credit risk on financial assets since initial recognition and in the selection of relevant forward-looking information as described in note 3e – Financial instruments. Estimates are applied in the determination of the allowance for expected credit losses on financial assets, the fair value of stock options granted, the fair value of derivatives, the impairment test applied to intangible assets and goodwill, 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 development 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 known.
| 3. | Significant accounting policies: |
The significant accounting policies used in the preparation of these Consolidated Financial Statements were applied consistently to all years and are summarized below:
| a) | Principles of consolidation: |
The Bank holds
| b) | Segment reporting: |
The Bank’s management has established
| 3. | Significant accounting policies – continued: |
| c) | Business combinations |
The Bank expects to apply IFRS 3 Business Combinations in its accounting for the proposed acquisition of Stearns Bank Holdingford, N.A. as described in note 26 – Acquisitions using the acquisition method. The cost of an acquisition is measured at the fair value of the consideration, including contingent consideration if applicable, at the acquisition date. Contingent consideration is a financial instrument and, as such, is remeasured each period thereafter with the adjustment recorded to acquisition-related fair value changes in the consolidated statements of income and comprehensive income. Acquisition-related costs are recognized as an expense in the income statement in the period in which they are incurred. The acquired identifiable assets, liabilities and contingent liabilities are measured at fair value at the date of acquisition. Goodwill is measured as the excess of the aggregate of the consideration transferred, including, if applicable, any amount of any non-controlling interest in the acquiree, over the net of the recognized amounts of the identifiable assets acquired and the liabilities assumed.
| d) | Revenue recognition: |
Interest income on cash, securities and loans is recognized in net interest income using the effective interest rate method over the expected life of the instrument. Interest income earned but not yet collected on cash, securities and loans is included in the respective cash, securities and loans categories on the Consolidated Balance Sheets.
Interest income is recognized on impaired loans and is accrued using the rate of interest used to discount the future cash flows for purposes of measuring the impairment loss. Loan fees integral to the yield on the loan are amortized to interest income using the effective interest rate method; otherwise, the fees are recorded in non-interest income.
The Bank’s non-interest income stream is substantially derived from the operations of DRTC and its wholly owned subsidiaries. DRTC generates professional services revenue primarily from fees charged for IT security assurance services, supervisory control and data acquisition system assessments, as well as IT security training. Revenue is recognized when service is rendered and performance obligations have been satisfied and no material uncertainties remain as to the collection of receivables.
| e) | Financial instruments: |
Classification and measurement
Under IFRS 9, all financial assets, with the exception of equity and derivatives, must be classified at initial recognition as a function of the financial asset’s contractual cash flow characteristics and the business model under which the financial asset is managed. These financial assets are initially measured at fair value, and are classified and subsequently measured at amortized cost, fair value
| 3. | Significant accounting policies – continued: |
| e) | Financial instruments – continued: |
through profit or loss or fair value through other comprehensive income. Financial assets are required to be reclassified when the business model under which they are managed has changed. Any reclassifications are applied prospectively from the reclassification date. All financial liabilities are measured at amortized cost unless elected otherwise.
Debt instruments
Financial assets that are debt instruments are categorized into one of the following measurement categories:
| • | amortized cost; |
| • | fair value through other comprehensive income (“FVOCI”); |
| • | fair value through profit and loss (“FVTPL”). |
The characterization of a debt instrument’s cashflows is determined through a solely payment of principal and interest (“SPPI”) test. The SPPI test is conducted to identify whether the contractual cash flows of a debt instrument are in fact solely payments of principal and interest and are consistent with a basic lending arrangement. In the context of the SPPI test, “Principal” is defined as the fair value of the debt instrument at origination or initial recognition, which may change over the life of the instrument as a function of a number of variables including principal repayments, prepayments, or amortization of a premium/discount. In the context of the SPPI test “Interest” is defined as the consideration for the time value of money and credit risk. The rationale for the SPPI test is to ensure that debt instruments that include structural features that are incongruent with a basic lending arrangement, such as conversion options, are classified as, and measured at FVTPL.
The Bank’s loans are categorized and measured as amortized cost. Debt instruments with contractual cash flows that meet the SPPI test and are managed on a hold to collect basis are measured at amortized cost. These financial instruments are recognized initially at fair value plus direct and incremental transaction costs, and are subsequently measured at amortized cost, using the effective interest rate method, net of an allowance for credit losses. The effective interest rate is the rate that discounts estimated future cashflows through the expected life of the instrument to the gross carrying amount of the instrument. Amortized cost is calculated as a function of the effective interest rate, taking into account any discount or premium on acquisition, transaction costs and fees. Amortization of these costs is included in interest income in the consolidated statement of income.
The Bank’s securities are measured at fair value and categorized as FVOCI.
| 3. | Significant accounting policies – continued: |
| e) | Financial instruments – continued: |
Equity instruments
Equity instruments are measured at fair value and categorized as FVTPL unless an irrevocable designation is made at initial recognition to categorize as FVOCI. Gains or losses from changes in the fair value of equity financial instruments designated at FVOCI, including any related foreign exchange gains or losses, are recognized in other comprehensive income (“OCI”). Amounts recognized in OCI are not to be subsequently reclassed to profit or loss, with the exception of dividends. Dividends received are recorded in non-interest income in the consolidated statement of income. Cumulative gains or losses upon derecognition of the equity instrument will be transferred within equity from accumulated OCI to retained earnings.
The Bank has categorized its investment in Canada Stablecorp Inc. as FVOCI and it is carried at fair value.
Allowance for expected credit losses
The Bank must maintain an allowance for expected credit losses (“ECL”) that is adequate, in management’s opinion, to absorb all credit related losses in the Bank’s lending and treasury portfolios. The Bank’s allowance for expected credit losses is estimated using the ECL methodology and is comprised of expected credit losses recognized on all financial assets that are debt instruments, classified either as amortized cost or as FVOCI, and on all loan commitments and financial guarantees that are not measured at FVTPL.
Expected credit losses represent unbiased and probability-weighted estimates that are modeled as a function of a range of possible outcomes as well as the time value of money, and reasonable and supportable information about past events, current conditions and forecasts of future economic conditions, or more specifically forward-looking information (“FLI”) (see Forward-looking information below).
The Bank’s ECL or impairment model estimates 12 months of expected credit losses for performing loans that have not experienced a significant increase in credit risk, (“SICR”) since initial recognition. Additionally, the ECL model estimates lifetime expected credit losses on performing loans that have experienced a SICR since initial recognition. Further, individual allowances are estimated for loans that are determined to be credit impaired.
Loans or other financial instruments that have not experienced a SICR since initial recognition are designated as stage 1, while loans or other financial instruments that have experienced a SICR since initial recognition are designated as stage 2, and loans or other financial instruments that are determined to be credit impaired are designated as stage 3. Subsequent to the initial stage
| 3. | Significant accounting policies – continued: |
| e) | Financial instruments – continued: |
designation, the Bank’s loans or other financial instruments may transfer between stages due to these loans or financial instruments experiencing a significant change in credit risk
Assessment of significant increase in credit risk
At each reporting date, the Bank assesses whether or not there has been a SICR for loans since initial recognition by comparing, at the reporting date, the risk of default occurring over the remaining expected life against the risk of default at initial recognition. The determination of a SICR is a function of the loan’s internal risk rating assignment, internal watchlist status, loan review status and delinquency status which are updated as necessary in response to changes including, but not limited, to changes in macroeconomic and/or market conditions, changes in a borrower’s credit risk profile, and changes in the strength of the underlying security, including guarantor status, if a guarantor exists.
Quantitative models may not always be able to capture all reasonable and supportable information that may indicate a SICR. As a result, qualitative factors may be considered to supplement such a gap. Examples include changes in adjudication criteria for a particular group of borrowers or asset categories or changes in portfolio composition.
With regards to delinquency and monitoring, there is a rebuttable presumption that the credit risk of a loan or other financial instrument has increased since initial recognition when contractual payments are more than 30 days delinquent. The Bank chose to use 60 days delinquency as an appropriate indicator of increased credit risk as it serves as a stable early warning indicator that the cashflows associated with the loan or other financial instrument under consideration may be uncertain and may not be realized by the Bank under the contractual repayment terms.
Expected credit loss model - Estimation of expected credit losses
Expected credit losses are an estimate of a loan’s expected cash shortfalls discounted at the effective interest rate, where a cash shortfall is the difference between the contractual cash flows that are due to the Bank and the cash flows that the Bank actually expects to receive. The ECL calculation is a function of the credit risk parameters; probability of default, loss given default, and exposure at default associated with each loan, sensitized to future market and macroeconomic conditions through the incorporation of FLI derived from multiple economic forecast scenarios, including baseline, upside, and downside scenarios.
| 3. | Significant accoun |
ting policies – continued: |
| e) | Financial instruments – continued: |
For clarity:
| • | The probability of default (“PD”) for a loan or a financial instrument is an estimate of the likelihood of default of that instrument over a given time horizon; |
| • | The loss given default (“LGD”) for a loan or financial instrument is an estimate of the loss arising in the case where a default of that instrument occurs at a given time or over a given period; and, |
| • | The exposure at default (“EAD”) for a loan or financial instrument is an estimate of the Bank’s exposure derived from that instrument at a future default date. |
The Bank’s ECL model develops contractual cashflow profiles for loans as a function of a number of underlying assumptions and a broad range of input variables. The expected cashflow schedules are subsequently derived from the contractual cashflow schedules, adjusted for incremental default amounts, forgone interest, and recovery amounts. The finalized contractual and expected cashflow schedules are subsequently discounted at the effective interest rate to determine the expected cash shortfall or expected credit losses for each individual loan or financial instrument.
Individual allowances are estimated for loans or other financial instruments that are determined to be credit impaired and that have been designated as stage 3. A loan or other financial instrument is classified as credit impaired when the Bank becomes aware that, before taking into consideration collateral or credit enhancements, all of, or a portion of the contractual cashflows associated with the loan or other financial instrument may be impacted and as a result may not be realized by the Bank under the repayment schedule set out in the contractual terms associated with the loan or other financial instrument. Loans or other financial instruments for which interest or principal is contractually past due 90 days are automatically recognized as stage 3, however in estimating expected credit losses for stage 3 loans or other financial instruments, management takes into consideration whether the loan or other financial instrument is fully secured or is in the process of collection and whether collection efforts are reasonably expected to result in repayment of the loan or other financial instrument. The ECL model requires the recognition of credit losses based on 12 months of expected losses for performing loans which is reflected in the Bank’s stage 1 grouping. The Bank recognizes lifetime expected losses on loans that have experienced a significant increase in credit risk since origination which is reflected in the Bank’s stage 2 grouping. Impaired loans require recognition of lifetime losses and are reflected in the Bank’s stage 3 grouping.
| 3. | Significant accounting policies – continued: |
| e) | Financial instruments – continued: |
Forward-looking information
IFRS 9 requires consideration of past events, current market conditions and reasonable, supportable information about future economic conditions that is available without undue cost and effort in the estimation of the expected credit losses for loans or other financial instruments. More specifically, under IFRS 9 expected credit losses represent an unbiased, probability-weighted estimate of the present value of cash shortfalls (i.e., the weighted average of credit losses, with the respective risks of a default occurring in a given time period used as the weights). Additionally, IFRS 9 stipulates that future economic conditions are to be based on an unbiased, probability-weighted assessment of possible future outcomes. The estimation and application of forward-looking information in an attempt to capture the impact of future economic conditions requires judgement.
The Bank incorporates the impact of future economic conditions, or more specifically forward-looking information into the estimation of expected credit losses at the credit risk parameter level. This is accomplished via the credit risk parameter models and proxy datasets that the Bank utilizes to develop PD and LGD term structure forecasts for its loans. The Bank has sourced credit risk modeling systems and forecast macroeconomic scenario data from Moody’s Analytics, a third-party service provider, for the purpose of computing forward-looking risk parameters under multiple macroeconomic scenarios that consider both market-wide and idiosyncratic factors and influences. These systems are used in conjunction with the Bank’s internally developed ECL models. Given that the Bank has experienced very limited historical losses and, therefore, does not have available statistically significant loss data inventory for use in developing forward-looking expected credit loss trends, the use of unbiased, third-party forward-looking credit risk parameter modeling systems is particularly important for the Bank in the context of the estimation of expected credit losses.
The Bank utilizes macroeconomic indicator data derived from multiple macroeconomic scenarios comprised of baseline, upside, and downside scenarios in order to mitigate volatility in the estimation of expected credit losses as well as to satisfy the IFRS 9 requirement that future economic conditions are to be based on an unbiased, probability-weighted assessment of possible future outcomes. More specifically, the macroeconomic indicators set out in the macroeconomic scenarios are used as inputs for the credit risk parameter models utilized by the Bank to sensitize the individual PD and LGD term structure forecasts to the respective macroeconomic trajectory set out in each of the scenarios. The weighted average of the individual, sensitized PD and LGD values that comprise each individual term structure forecast is subsequently computed to define unbiased PD and LGD term structure forecasts, which in turn are applied as inputs to the Bank’s internal ECL model in the estimation of expected credit losses for the Bank’s loans. Macroeconomic indicator data derived from the baseline, upside and downside scenarios referenced above is also utilized in the development of credit risk parameter proxy datasets and applied to the Bank’s consumer loan and small and medium enterprise (“SME”) loan portfolios.
| 3. | Significant accounting policies – continued: |
| e) | Financial instruments – continued: |
The macroeconomic indicator data utilized by the Bank for the purpose of sensitizing PD and LGD term structure data to forward economic conditions include, but are not limited to: real GDP, the national unemployment rate, long term interest rates, the consumer price index, the price of oil, and the S&P/TSX Index. These specific macroeconomic indicators were selected in an attempt to ensure that the spectrum of fundamental macroeconomic influences on the key drivers of the credit risk profile of the Bank’s balance sheet, including: corporate, consumer and real estate market dynamics; corporate, consumer and SME borrower performance; geography; as well as collateral value volatility, are appropriately captured and incorporated into the Bank’s forward macroeconomic sensitivity analysis.
Modified financial instruments
If the terms of a financial instrument are modified or an existing financial instrument is replaced with a new one, an assessment is made to determine if the financial instrument should be derecognized.
Where the modification does not result in derecognition, the date of origination continues to be used to determine SICR. Where modification results in derecognition, the modified financial instrument is considered to be a new instrument.
Fair value of financial instruments
Estimates of fair value are developed using a variety of valuation methods and assumptions. The Bank follows a fair value hierarchy to categorize the inputs used to measure fair value for its financial instruments. The fair value hierarchy is based on quoted prices in active markets (Level 1), models using inputs other than quoted prices but with observable market data (Level 2), or models using inputs that are not based on observable market data (Level 3).
Valuation models may require the use of inputs, transaction values derived from models and input assumptions sourced from pricing services. Valuation inputs are either observable or unobservable. The Bank makes use of external, readily observable market inputs when available and may include certain prices and rates for shorter-dated Canadian yield curves and banker’s acceptances. Unobservable inputs may include credit spreads, probability of default and recovery rates.
| 3. | Significant accounting policies – continued: |
| f) | Property and equipment: |
Property and equipment is carried at cost less accumulated amortization and impairment. Amortization on property and equipment is calculated primarily using the straight-line method over the useful life of the equipment which typically ranges between
Property and equipment is subject to an impairment review if there are events or changes in circumstances which indicate that the carrying amounts may not be recoverable. Amortization expense and impairment write-downs are included in premises and equipment expense in the Consolidated Statements of Comprehensive Income.
| g) | Goodwill and intangible assets: |
Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the value allocated to the tangible and intangible assets, less liabilities assumed, based on their fair values. Goodwill is not amortized but rather tested for impairment annually or more frequently if events or a change in circumstances indicate that the asset might be impaired. Impairment is determined for goodwill by assessing if the carrying value of cash generating units (“CGUs”) which comprise the CGU segment, including goodwill, exceeds its recoverable amount determined as the greater of the estimated fair value less costs to sell and the value in use. Impairment losses recognized in respect of the CGUs are first allocated to the carrying value of goodwill and any excess is allocated to the carrying amount of assets in the CGUs. Any goodwill impairment is recorded in profit or loss in the reporting year in which the impairment is identified. Impairment losses on goodwill are not subsequently reversed.
Intangible assets acquired in a business acquisition are recorded at their fair value. In subsequent reporting periods, intangible assets are carried at cost less accumulated amortization and accumulated impairment losses. Amortization is recorded on a straight-line basis over the expected useful life of the intangible asset. At each reporting date, the carrying value of intangible assets are reviewed for indicators of impairment. If such an indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment, if any. For the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generate cash flows from continuing use that are largely independent of the cash inflows of other assets or groups of assets or CGU’s. If the recoverable amount of an asset or CGU is estimated to be less than its carrying amount, the carrying amount is reduced to its recoverable amount and the impairment loss is recognized in profit or loss. The recoverable amount of an asset or CGU is the higher of fair value less costs to sell and value in use. In assessing fair value less cost to sell the estimated future cash flows are discounted at a rate that reflects current market assessments of the time value of money and the risks specific to the assets. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount.
| 3. | Significant accounting policies – continued: |
| g) | Goodwill and intangible assets – continued: |
When an impairment loss is subsequently reversed, the carrying amount of the asset is increased to the revised estimate of its recoverable amount so that the increased carrying amount does not exceed the carrying amount that would have been recorded had no impairment losses been recognized for the asset in prior years.
The Bank develops proprietary cybersecurity, banking and financial technology. Any research or early-stage scoping activities are expensed as incurred in the period. The Bank recognizes internally generated intangible assets on the development of proprietary technology when it has determined that there is technical feasibility and resources available to complete a product, demonstrated an existence of an established market for the product as well as support to generate future revenues or derive future economic benefits from the product. As these intangible assets are not yet available for use, the Bank tested these assets for impairment annually by comparing the carrying amount with the recoverable amount. Recoverable amount is determined by fair value less cost to sell method.
| h) | Income taxes: |
Current income taxes are calculated based on taxable income for the reporting period. Taxable income differs from accounting income because of differences in the inclusion and deductibility of certain components of income which are established by 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 the end of each reporting period.
Current and deferred income taxes are recorded in income for the period, except to the extent that the tax arose from a transaction that is recorded either in Other Comprehensive Income or Equity, in which case the income tax on the transaction will also be recorded either in Other Comprehensive
| 3. | Significant accounting policies – continued: |
| h) | Income taxes – continued: |
Income or Equity. Accordingly, current and deferred income taxes are presented in the Consolidated Financial Statements as a component of income, or as a component of Other Comprehensive Income.
| i) | Employee benefits: |
| i) | Short-term benefits: |
Short-term employee benefit obligations are recognized as employees render their services and are measured on an undiscounted basis.
A liability is recognized for the amount expected to be paid under a short-term cash bonus plan if the Bank has an obligation to make such payments as a result of past service provided by the employee and the obligation can be estimated reliably.
| ii) | Share-based payment transactions: |
Equity-settled stock options
Employee stock options are measured using the Black-Scholes pricing model which is used to estimate the fair value of the options at the date of grant. Inputs to the Black-Scholes model include the closing share price on the grant date, the exercise price, the expected option life, the expected dividend yield, the expected volatility and the risk-free interest rate. Once the expected option life is determined, it is used in formulating the estimates of expected volatility and the risk-free rate. Expected future volatility is estimated using a historical volatility look-back period that is consistent with the expected life of the option.
The fair value of options which vest immediately are recognized in full as of the grant date, whereas the fair value of options which vest over time are recognized over the vesting period using the graded method which incorporates management’s estimates of the options which are not expected to vest. The effect of a change in the estimated number of options expected to vest is a change in estimate and the cumulative effect of the change is recognized prospectively once the estimate is revised. The fair value of stock options granted is recorded in salaries and benefits expense in the Consolidated Statements of Income and in Contributed Surplus in the Consolidated Balance Sheets. When options are exercised, the consideration received and the estimated fair value previously recorded in Contributed Surplus is recorded as Share Capital. The Bank’s stock option plan is described in note 15.
| 3. | Significant accounting policies – continued: |
| j) | Share capital: |
The Bank’s share capital consists of common shares and preferred shares. Costs directly incurred with raising new share capital are charged against equity. Other costs are expensed as incurred.
| k) | Contributed surplus: |
Contributed surplus consists of the fair value of stock options granted since inception, less amounts reversed for exercised stock options. If granted options vest and then subsequently expire or are forfeited, no reversal of contributed surplus is recognized.
| l) | Leases: |
At inception of a contract, the Bank assesses whether a contract is, or contains a lease arrangement based on whether the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
The Bank recognizes a right-of-use asset and a lease obligation at the lease commencement date. The right-of-use asset is initially measured based on the initial amount of the lease obligation adjusted for any lease payments made at or before the commencement date, plus any initial direct costs incurred and an estimate of costs to dismantle and remove the underlying asset or to restore the underlying asset and/or the site on which it is located, less any lease incentives received. The assets are depreciated to the earlier of the end of useful life of the right-of-use asset or the lease term using the straight-line method as this methodology most closely reflects the expected pattern of consumption of the associated future economic benefits. The lease term includes periods covered by an option to extend if there is reasonable certainty that the Bank will exercise that option. In addition, the right-of-use asset is periodically reduced by impairment losses, if any, and adjusted for certain remeasurements of the lease obligation.
The lease obligation is measured at amortized cost using the effective interest rate method. It is remeasured when there is a change in future lease payments arising from a change in an index or rate, if there is a change in the Bank’s estimate of the amount expected to be payable under a residual value guarantee, or if the Bank changes its assessment of whether it will exercise a purchase, extension or termination option. When the lease obligation is remeasured in this way, a corresponding adjustment is made to the carrying amount of the right-of-use asset, or the remeasured amount is recorded in profit or loss if the carrying amount of the right-of-use asset has been reduced to zero.
The Bank elects to apply the practical expedient to account for leases for which the lease term ends within 12 months of the date of initial application as short-term leases.
| 3. | Significant accounting policies – continued: |
| m) | Foreign currency translation: |
Transactions in foreign currencies are translated into the respective functional currencies of the Bank and its subsidiaries at the exchange rate at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at the exchange rate at the reporting date. Foreign currency differences are recognized in profit and loss. Investments classified as fair value through other comprehensive income denominated in a foreign currency are translated into Canadian dollars at the exchange rate at the reporting date. All resulting changes are recognized in other comprehensive income.
Foreign operations
The assets and liabilities of Digital Boundary Group Inc., a US operation of the Bank, has a functional currency other than the Canadian dollar, and is translated into Canadian dollars at the exchange rate at the reporting date. The income and expenses of this operation are translated into Canadian dollars at the exchange rate at the date of transaction and the foreign currency differences are recognized in other comprehensive income. All other US operations are recognized as having functional currency based on the Canadian dollar.
| n) | Derivative instruments: |
Derivatives are measured at FVTPL except to the extent that they are designated in a hedging relationship.
Derivatives are reported as other assets when they have a positive fair value and as other liabilities when they have a negative fair value. Derivatives may be embedded in other financial instruments. Derivatives embedded in other financial instruments are valued as separate derivatives when: the economic characteristics and risks associated are not clearly and closely related to those of the host contract; the terms of the embedded derivative would meet the definition of a derivative if it was a stand-alone, independent instrument; and the combined contract is not held for trading or designated at fair value through profit or loss. For financial statement disclosure purposes, embedded derivatives are combined with the host contract.
Hedge accounting
The Bank has elected, as permitted, to apply the hedge accounting requirements of IAS 39. Interest rate swap agreements are entered into for asset liability management purposes. When hedge accounting criteria are met, derivative contracts are accounted for as described below.
To meet the criteria for hedge accounting, the Bank documents all relationships between hedging instruments and hedged items, how hedge effectiveness is assessed, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives to specific assets or liabilities on the Consolidated Balance Sheet. The Bank also formally assesses, both at the inception of the hedge and on an ongoing basis,
| 3. | Significant accounting policies – continued: |
| n) | Derivative instruments - continued: |
whether the derivatives that are used in hedging transactions are effective in offsetting changes in fair values or cash flows of the hedged items.
There are three main types of hedges: (i) fair value hedges, (ii) cash flow hedges and (iii) net investment hedges.
At the inception of a hedge relationship, the Bank formally designates and documents the hedge relationship to which it wishes to apply hedge accounting and the risk management objective and strategy for undertaking the hedge.
The documentation includes identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the Bank will assess whether the hedging relationship meets the hedge effectiveness requirements (including an analysis of sources of hedge ineffectiveness and how the hedge effectiveness is assessed). In order to qualify for hedge accounting, a hedging relationship must be expected to be highly effective on a prospective basis and it needs to be demonstrated that it was also highly effective in the previous designated period (i.e., three month). A hedge is considered to be highly effective if the changes in fair value or cash flows attributable to the hedged risk are expected to be offset by the hedging instrument in a range of between 80% to 125%.
The Bank has only fair value hedges outstanding. In a fair value hedge, the change in the fair value of the hedging derivative is recognized in non-interest income in the Consolidated Statements of Income and Comprehensive Income. The change in the fair value of the hedged item attributable to hedge risk is recorded as part of the carrying value of the hedged item (basis adjustment) and is also recognized in non-interest income in the Consolidated Statements of Income and Comprehensive Income. The Bank utilizes fair value hedges primarily to convert fixed rate financial assets to floating rate financial assets. The primary financial instruments designated in fair value hedging relationships are loans. If the derivative expires or is sold, terminated, no longer meets the criteria for hedge accounting, or the designation is revoked, hedge accounting is discontinued. Any basis adjustment up to that point made to a hedged item for which the effective interest method is used is amortized to the Consolidated Statements of Income and Comprehensive Income as part of the recalculated effective interest rate of the item over its remaining term. If the hedged item is derecognized, the unamortized fair value is recognized immediately in the Consolidated Statements of Income and Comprehensive Income.
In fair value hedges, ineffectiveness arises to the extent that the change in fair value of the hedging items differs from the change in fair value of the hedge risk in the hedged item. Any hedge ineffectiveness is measured and recorded in non-interest income in the Consolidated Statements of Income and Comprehensive Income.
Derivative contracts which do not qualify for hedge accounting are marked-to-market and the resulting net gains or losses are recognized in non-interest income in the Consolidated Statement of Income and Comprehensive Income.
| 3. | Significant accounting policies – continued: |
| o) | Future accounting standard pronouncements: |
The following accounting standards amendments issued by the IASB will be effective for the Bank’s fiscal year beginning on November 1, 2024 (the Bank’s fiscal 2025 year end):
| i) | Amendments to IFRS 16: Lease Liability in a Sale and Leaseback - In September 2022, the IASB issued amendments to IFRS 16 to specify the requirements that a seller-lessee uses in measuring the lease liability arising in a sale and leaseback transaction, to ensure the seller-lessee does not recognise any amount of the gain or loss that relates to the right of use it retains. The amendments must be applied retrospectively to sale and leaseback transactions entered into after the date of initial application of IFRS 16. Earlier application is permitted and that fact must be disclosed. |
| ii) | Amendments to IAS 1: Classification of Liabilities as Current or Non-current - In January 2020 and October 2022, the IASB issued amendments to paragraphs 69 to 76 of IAS 1 to specify the requirements for classifying liabilities as current or non-current. The amendments clarify: |
| • | What is meant by a right to defer settlement; |
| • | That a right to defer must exist at the end of the reporting period; |
| • | That classification is unaffected by the likelihood that an entity will exercise its deferral right; and, |
| • | That only if an embedded derivative in a convertible liability is itself an equity instrument would the terms of a liability not impact its classification. |
In addition, a requirement has been introduced to require disclosure when a liability arising from a loan agreement is classified as non-current and the entity’s right to defer settlement is contingent on compliance with future covenants within twelve months. The amendments must be applied retrospectively.
The amendments noted above are not expected to have a material impact on the Bank’s financial results.
| 4. | Cash: |
Cash is comprised of deposits with regulated financial institutions.
| 5. | Securities: |
As at October 31, 2023, the Bank held securities totalling $
| 6. | Loans, net of allowance for credit losses: |
The Bank organizes its lending portfolio into the following four broad asset categories: Point-of-Sale Loans and Leases, Commercial Real Estate Mortgages, Commercial Real Estate Loans, and Public Sector and Other Financing. These categories have been established in the Bank’s proprietary, internally developed asset management system and have been designed to catalogue individual lending assets as a function primarily of their key risk drivers, the nature of the underlying collateral, and the applicable market segment.
The Point-of-Sale Loans and Leases (“POS Financing”) asset category is comprised of point-of-sale loan and lease receivables acquired from the Bank’s network of origination and servicing partners as well as warehouse loans that provide bridge financing to the Bank’s origination and servicing partners for the purpose of accumulating and seasoning practical volumes of individual loans and leases prior to the Bank purchasing the cashflow receivables derived from same.
The Commercial Real Estate Mortgages (“CRE Mortgages”) asset category is comprised primarily of Residential Construction, Term, Insured and Land Mortgages. All of these loans are business-to-business loans with the underlying credit risk exposure being primarily consumer in nature given that the vast majority of the loans are related to properties that are designated primarily for residential use. The portfolio benefits from diversity in its underlying security in the form of a broad range of such collateral properties.
The Commercial Real Estate Loans (“CRE Loans”) asset category is comprised primarily of condominium corporation financing loans.
The Public Sector and Other Financing (“PSOF”) asset category is comprised primarily of public sector loans and leases, a small balance of corporate loans and leases and single family residential conventional and insured mortgages.
| 6. | Loans – continued: |
| a) | Portfolio analysis: |
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Point-of-sale loans and leases | $ | $ | ||||||
| Commercial real estate mortgages | ||||||||
| Commercial real estate loans | ||||||||
| Public sector and other financing | ||||||||
| Allowance for credit losses | ( | ) | ( | ) | ||||
| Accrued interest | ||||||||
| Total loans, net of allowance for credit losses | $ | $ | ||||||
The following table provides a summary of loan amounts, ECL allowance amounts, and expected loss (“EL”) rates by lending asset category:
| As at October 31, 2023 | As at October 31, 2022 | |||||||||||||||||||||||||||||||
| (thousands of Canadian dollars) | Stage 1 | Stage 2 | Stage 3 | Total | Stage 1 | Stage 2 | Stage 3 | Total | ||||||||||||||||||||||||
| Point-of-sale loans and leases | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| ECL allowance | ||||||||||||||||||||||||||||||||
| EL % | % | % | % | % | % | % | % | % | ||||||||||||||||||||||||
| Commercial real estate mortgages | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| ECL allowance | ||||||||||||||||||||||||||||||||
| EL % | % | % | % | % | % | % | % | % | ||||||||||||||||||||||||
| Commercial real estate loans | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| ECL allowance | ||||||||||||||||||||||||||||||||
| EL % | % | % | % | % | % | % | % | % | ||||||||||||||||||||||||
| Public sector and other financing | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| ECL allowance | ||||||||||||||||||||||||||||||||
| EL % | % | % | % | % | % | % | % | % | ||||||||||||||||||||||||
| Total loans | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Total ECL allowance | ||||||||||||||||||||||||||||||||
| Total EL % | % | % | % | % | % | % | % | % | ||||||||||||||||||||||||
The Bank’s maximum exposure to credit risk is the carrying value of its financial assets. 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 cash reserves (holdbacks) on loan and lease receivables included in the POS Financing portfolio (note 13).
| 6. | Loans – continued: |
Allowance for credit losses
As set out previously, the Bank must maintain an allowance for expected credit losses that is adequate, in management’s opinion, to absorb all credit related losses in the Bank’s lending and treasury portfolios. Under IFRS 9 the Bank’s allowance for expected credit losses is estimated using the expected credit loss methodology and is comprised of expected credit losses recognized on both performing loans, and non-performing, or impaired loans even if no actual loss event has occurred.
The expected credit loss methodology requires the recognition of credit losses based on 12 months of expected losses for performing loans which is reflected in the Bank’s Stage 1 grouping. The Bank recognizes lifetime expected losses on loans that have experienced a significant increase in credit risk since origination which is reflected in the Bank’s Stage 2 grouping. Impaired loans require recognition of lifetime losses and is reflected in Stage 3 grouping.
Assessment of significant increase in credit risk (“SICR”)
At each reporting date, the Bank assesses whether there has been a SICR for loans since initial recognition by comparing, at the reporting date, the risk of default occurring over the remaining expected life against the risk of default at initial recognition.
SICR is a function of the loan’s internal risk rating assignment, internal watchlist status, loan review status and delinquency status which are updated as necessary in response to changes including, but not limited to, changes in macroeconomic and/or market conditions, changes in a borrower’s credit risk profile, and changes in the strength of the underlying security, including guarantor status, if a guarantor exists. Notwithstanding the above, the assessment of a significant increase in credit risk will require experienced credit judgement.
Quantitative models may not always be able to capture all reasonable and supportable information that may indicate a SICR. As a result, qualitative factors may be considered to supplement such a gap. Examples include changes in adjudication criteria for a particular group of borrowers or asset categories or changes in portfolio composition as well as changes in Canadian and US macroeconomic trends attributable to changes in monetary policy, inflation, employment rates, consumer behaviour and geo-political risks.
Expected credit loss model - Estimation of expected credit losses
Expected credit losses are an estimate of a loan’s expected cash shortfalls discounted at the effective interest rate, where a cash shortfall is the difference between the contractual cash flows that are due to the Bank and the cash flows that the Bank actually expects to receive.
| 6. | Loans – continued: |
Forward-looking information
The Bank incorporates the impact of future economic conditions, or more specifically forward-looking information into the estimation of expected credit losses at the credit risk parameter level. This is accomplished via the credit risk parameter models and proxy datasets that the Bank utilizes to develop PD and LGD term structure forecasts for its loans. The Bank has sourced credit risk modeling systems and forecast macroeconomic scenario data from Moody’s Analytics, a third-party service provider for the purpose of computing forward-looking credit risk parameters under multiple macroeconomic scenarios that consider both market-wide and idiosyncratic factors and influences. These systems are used in conjunction with the Bank’s internally developed ECL models. Given that the Bank has experienced very limited historical losses and, therefore, does not have available statistically significant loss data inventory for use in developing internal, forward-looking expected credit loss trends, the use of unbiased, third-party forward-looking credit risk parameter modeling systems is particularly important for the Bank in the context of the estimation of expected credit losses.
The Bank utilizes macroeconomic indicator data derived from multiple macroeconomic scenarios in order to mitigate volatility in the estimation of expected credit losses, as well as to satisfy the IFRS 9 requirement that future economic conditions are to be based on an unbiased, probability-weighted assessment of possible future outcomes. More specifically, the macroeconomic indicators set out in the macroeconomic scenarios are used as inputs for the credit risk parameter models utilized by the Bank to sensitize the individual PD and LGD term structure forecasts to the respective macroeconomic trajectory set out in each of the scenarios (see Expected Credit Loss Sensitivity below). Currently the Bank utilizes upside, downside and baseline forecast macroeconomic scenarios, and assigns discrete weights to each for use in the estimation of its reported ECL. The Bank has also applied expert credit judgement, where appropriate, to reflect, amongst other items, uncertainty in the Canadian and US macroeconomic environments.
The macroeconomic indicator data utilized by the Bank for the purpose of sensitizing PD and LGD term structure data to forward economic conditions include, but are not limited to: real GDP, the national unemployment rate, long term interest rates, the consumer price index, the S&P/TSX Index and the price of oil. These specific macroeconomic indicators were selected in an attempt to ensure that the spectrum of fundamental macroeconomic influences on the key drivers of the credit risk profile of the Bank’s balance sheet, including: corporate, consumer and real estate market dynamics; corporate, consumer and SME borrower performance; geography; as well as collateral value volatility, are appropriately captured and incorporated into the Bank’s forward macroeconomic sensitivity analysis.
Key assumptions driving the baseline macroeconomic forecast trends included: elevated inflation persisting until late 2024 and high interest rates remaining through at least the mid-point of 2024 continue to apply pressure to household finances and slow consumption generally; real GDP growth decelerates through the end of 2023 and into early 2024 attributable to high interest rates and slowing job growth which also combine to curb consumer spending over the same timeframe; current geo-political risks do not escalate materially and have a limited impact on global commodity prices and
| 6. | Loans – continued: |
supply chains; and, while COVID 19 infections return, public health restrictions do not and the virus is assumed to have very little impact on the Canadian and US economies.
Management developed ECL estimates using credit risk parameter term structure forecasts sensitized to individual baseline, upside and downside forecast macroeconomic scenarios, each weighted at 100%, and subsequently computed the variance of each to the Bank’s reported ECL as at October 31, 2023 in order to assess the alignment of the Bank’s reported ECL with the Bank’s credit risk profile, and further, to assess the scope, depth and ultimate effectiveness of the credit risk mitigation strategies that the Bank has applied to its lending portfolios (see Expected Credit Loss Sensitivity below).
Expected credit loss sensitivity:
The following table presents the sensitivity of the Bank’s estimated ECL to a range of individual macroeconomic scenarios, that in isolation may not reflect the Bank’s actual expected ECL exposure, as well as the variance of each to the Bank’s reported ECL as at October 31, 2023:
| (thousands of Canadian dollars) | ||||||||||||||||
| Reported | 100% | 100% | 100% | |||||||||||||
| ECL | ||||||||||||||||
| Upside | Baseline | Downside | ||||||||||||||
| Allowance for expected credit losses | $ | $ | $ | $ | ||||||||||||
| Variance from reported ECL | ( | ) | ( | ) | ||||||||||||
| Variance from reported ECL (%) | ( | %) | ( | %) | % | |||||||||||
| 6. | Loans – continued: |
| b) | Allowance for credit losses: |
The following table provides a reconciliation of the Bank’s ECL allowance by lending asset category for the year ended October 31, 2023:
| (thousands of Canadian dollars) | Stage 1 | Stage 2 | Stage 3 | Total | ||||||||||||
| Point-of-sale loans and leases | ||||||||||||||||
| Balance at beginning of period | $ | $ | $ | $ | ||||||||||||
| Transfer in (out) to Stage 1 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 2 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 3 | ||||||||||||||||
| Net remeasurement of loss allowance | ( | ) | ( | ) | ( | ) | ||||||||||
| Loan originations | ||||||||||||||||
| Derecognitions and maturities | ||||||||||||||||
| Provision for (recovery of) credit losses | ( | ) | ( | ) | ||||||||||||
| Write-offs | ||||||||||||||||
| Recoveries | ||||||||||||||||
| Balance at end of period | $ | $ | $ | $ | ||||||||||||
| Commercial real estate mortgages | ||||||||||||||||
| Balance at beginning of period | $ | $ | $ | $ | ||||||||||||
| Transfer in (out) to Stage 1 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 2 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 3 | ( | ) | ||||||||||||||
| Net remeasurement of loss allowance | ( | ) | ||||||||||||||
| Loan originations | ||||||||||||||||
| Derecognitions and maturities | ( | ) | ( | ) | ( | ) | ||||||||||
| Provision for (recovery of) credit losses | ||||||||||||||||
| Write-offs | ||||||||||||||||
| Recoveries | ||||||||||||||||
| Balance at end of period | $ | $ | $ | $ | ||||||||||||
| Commercial real estate loans | ||||||||||||||||
| Balance at beginning of period | $ | $ | $ | $ | ||||||||||||
| Transfer in (out) to Stage 1 | ||||||||||||||||
| Transfer in (out) to Stage 2 | ||||||||||||||||
| Transfer in (out) to Stage 3 | ||||||||||||||||
| Net remeasurement of loss allowance | ( | ) | ( | ) | ||||||||||||
| Loan originations | ||||||||||||||||
| Derecognitions and maturities | ( | ) | ( | ) | ||||||||||||
| Provision for (recovery of) credit losses | ( | ) | ( | ) | ||||||||||||
| Write-offs | ||||||||||||||||
| Recoveries | ||||||||||||||||
| Balance at end of period | $ | $ | $ | $ | ||||||||||||
| Public sector and other financing | ||||||||||||||||
| Balance at beginning of period | $ | $ | $ | $ | ||||||||||||
| Transfer in (out) to Stage 1 | ||||||||||||||||
| Transfer in (out) to Stage 2 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 3 | ||||||||||||||||
| Net remeasurement of loss allowance | ||||||||||||||||
| Loan originations | ||||||||||||||||
| Derecognitions and maturities | ||||||||||||||||
| Provision for (recovery of) credit losses | ||||||||||||||||
| Write-offs | ||||||||||||||||
| Recoveries | ||||||||||||||||
| Balance at end of period | $ | $ | $ | $ | ||||||||||||
| Total balance at end of period | $ | $ | $ | $ | ||||||||||||
| 6. | Loans – continued: |
| b) | Allowance for credit losses (continued): |
The following table provides a reconciliation of the Bank’s ECL allowance by lending asset category for the year ended October 31, 2022:
| (thousands of Canadian dollars) | Stage 1 | Stage 2 | Stage 3 | Total | ||||||||||||
| Point-of-sale loans and leases | ||||||||||||||||
| Balance at beginning of period | $ | $ | $ | $ | ||||||||||||
| Transfer in (out) to Stage 1 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 2 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 3 | ||||||||||||||||
| Net remeasurement of loss allowance | ( | ) | ||||||||||||||
| Loan originations | ||||||||||||||||
| Derecognitions and maturities | ||||||||||||||||
| Provision for (recovery of) credit losses | ||||||||||||||||
| Write-offs | ||||||||||||||||
| Recoveries | ||||||||||||||||
| Balance at end of period | $ | $ | $ | $ | ||||||||||||
| Commercial real estate mortgages | ||||||||||||||||
| Balance at beginning of period | $ | $ | $ | $ | ||||||||||||
| Transfer in (out) to Stage 1 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 2 | ( | ) | ||||||||||||||
| Transfer in (out) to Stage 3 | ||||||||||||||||
| Net remeasurement of loss allowance | ( | ) | ||||||||||||||
| Loan originations | ||||||||||||||||
| Derecognitions and maturities | ( | ) | ( | ) | ( | ) | ||||||||||
| Provision for (recovery of) credit losses | ||||||||||||||||
| Write-offs | ||||||||||||||||
| Recoveries | ||||||||||||||||
| Balance at end of period | $ | $ | $ | $ | ||||||||||||
| Commercial real estate loans | ||||||||||||||||
| Balance at beginning of period | $ | $ | $ | $ | ||||||||||||
| Transfer in (out) to Stage 1 | ||||||||||||||||
| Transfer in (out) to Stage 2 | ||||||||||||||||
| Transfer in (out) to Stage 3 | ||||||||||||||||
| Net remeasurement of loss allowance | ||||||||||||||||
| Loan originations | ||||||||||||||||
| Derecognitions and maturities | ||||||||||||||||
| Provision for (recovery of) credit losses | ||||||||||||||||
| Write-offs | ||||||||||||||||
| Recoveries | ||||||||||||||||
| Balance at end of period | $ | $ | $ | $ | ||||||||||||
| Public sector and other financing | ||||||||||||||||
| Balance at beginning of period | $ | $ | $ | $ | ||||||||||||
| Transfer in (out) to Stage 1 | ||||||||||||||||
| Transfer in (out) to Stage 2 | ||||||||||||||||
| Transfer in (out) to Stage 3 | ||||||||||||||||
| Net remeasurement of loss allowance | ( | ) | ||||||||||||||
| Loan originations | ||||||||||||||||
| Derecognitions and maturities | ( | ) | ( | ) | ||||||||||||
| Provision for (recovery of) credit losses | ( | ) | ( | ) | ||||||||||||
| Write-offs | ||||||||||||||||
| Recoveries | ||||||||||||||||
| Balance at end of period | $ | $ | $ | $ | ||||||||||||
| Total balance at end of period | $ | $ | $ | $ | ||||||||||||
| 6. | Loans – continued: |
| c) | Maturities and yields: |
| (thousands of Canadian dollars) | ||||||||||||||||||||||||||||||||
| Within | 3 months to | 1 year to | 2 years to | Over | 2023 | 2022 | ||||||||||||||||||||||||||
| Floating | 3 months | 1 year | 2 years | 5 years | 5 years | Total | Total | |||||||||||||||||||||||||
| Total loans | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Average effective yield | % | % | % | % | % | % | % | % | ||||||||||||||||||||||||
Average effective yields are based on book values and contractual interest rates, adjusted for the amortization of any deferred income and expenses.
| d) | Impaired loans: |
At October 31, 2023, the Bank held one impaired loan totalling $
| 7. | Property and equipment: |
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Cost | $ | $ | ||||||
| Accumulated amortization | ( | ) | ( | ) | ||||
| $ | $ | |||||||
| 8. | Goodwill: |
Goodwill relates to the Bank’s acquisition of Digital Boundary Group and for the purpose of conducting an annual test for impairment, the Bank’s CGU relates specifically to the operations of Digital Boundary Group. The Bank considered the fair value less carrying value calculation in assessing impairment. The key assumptions underlying the impairment test included: 5-years of projected cash flow, a discount rate of
The Bank did not recognize an impairment charge on the goodwill as the recoverable amount of the CGU exceeded the carrying value of the goodwill. Sensitivity analysis performed by management suggested that if the average annual growth rate were to decrease by
| 9. | Intangible assets: |
As at October 31, 2023, total intangible assets were $
| 10. | Other assets: |
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Accounts receivable | $ | $ | ||||||
| Prepaid expenses and other (note 10a) | ||||||||
| Property and equipment (note 7) | ||||||||
| Right-of-use assets (note 10b) | ||||||||
| Deferred income tax asset (note 16) | ||||||||
| Interest rate swap (note 18) | ||||||||
| Investment (note 10c) | ||||||||
| Goodwill (note 8) | ||||||||
| Intangible assets (note 9) | ||||||||
| $ | $ | |||||||
| a) | The Bank, internally through its DRTC segment has developed proprietary cybersecurity, banking and financial technology products. Costs associated with the development of these products and services have been capitalized in accordance with IAS 38 Intangible Assets. As at October 31, 2023, capitalized costs were $ million ( October 31, 2022 - $ |
| b) | The right-of-use assets relate to the Bank’s office facility leases. Capitalized leases of $ |
For the year ended October 31, 2023, the amortization expense for the right-of-use assets totaled $
| c) | The Bank has an |
| 11. | Deposits: |
| (thousands of Canadian dollars) | ||||||||||||||||||||||||||||||||||||
| Maturity period | Demand/ | Within | 3 months to | 1 year to | 2 years to | Over | Accrued | 2023 | 2022 | |||||||||||||||||||||||||||
| Floating | 3 months | 1 year | 2 years | 5 years | 5 years | Interest | Total | Total | ||||||||||||||||||||||||||||
| Total deposits | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Average effective interest rate | % | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Average effective interest rates are based on book values and contractual interest rates.
| 12. | Subordinated notes payable: |
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Issued March 2019, unsecured, non-viability contingent capital compliant, subordinated notes payable, principal amount of $5.0 million, $500,000 is held by related party (note 22), fixed effective interest rate of 10.41%, maturing March 2029. | $ | $ | ||||||
| Issued April 2021, unsecured, non-viability contingent capital compliant, subordinated notes payable, principal amount of US $75.0 million, fixed effective interest rate of 5.38%, maturing May 2031. | ||||||||
| $ | $ | |||||||
| 13. | Other liabilities: |
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Accounts payable and other | $ | $ | ||||||
| Current income tax liability | ||||||||
| Deferred income tax liability (note 16) | ||||||||
| Lease obligations | ||||||||
| Cash collateral and amounts held in escrow (note 6) | ||||||||
| Cash reserves on loan and lease receivables (note 6) | ||||||||
| $ | $ | |||||||
Lease obligations reflect the Bank’s liabilities for right-of-use assets which capture the Bank’s multiple leased premises. The portion of the Bank’s leasing obligations that were not captured as part of the right-of-use assets continue to be expensed in premises and equipment. The Bank had total cash outflows for these leases of $
The current leasing arrangements associated with these lease obligations expire between October 2025 and December 2045 with options to renew the leases after the initial lease period. Lease payments are adjusted every to years to reflect market rates.
The future lease payments for these non-cancellable lease contracts are $
| 14. | Share capital: |
| a) | Authorized: |
The Bank is authorized to issue an unlimited number of voting common shares with
The Bank is authorized to issue an unlimited number of Series 1 preferred shares with a par value of $
| b) | Issued and outstanding: |
| (thousands of Canadian dollars) | ||||||||||||||||
| 2023 | 2022 | |||||||||||||||
| Shares | Amount | Shares | Amount | |||||||||||||
| Common shares: | ||||||||||||||||
| Balance, beginning of the year | $ | $ | ||||||||||||||
| Options exercised during the year | ||||||||||||||||
| Purchased and cancelled during the year | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Outstanding, end of year | $ | $ | ||||||||||||||
| Series 1 preferred shares: | ||||||||||||||||
| Outstanding, beginning and end of year | $ | $ | ||||||||||||||
| Total share capital | $ | $ | ||||||||||||||
Common shares
On August 5, 2022, the Bank received approval from the Toronto Stock Exchange (“TSX”) to proceed with a Normal Course Issuer Bid (“NCIB”) for its common shares. On September 21, 2022, the Bank received approval from the Nasdaq to proceed with a NCIB for its common shares. Pursuant to the NCIB, VersaBank was authorized to purchase for cancellation up to
The Bank was eligible to make purchases commencing on August 17, 2022 and the NCIB was terminated on August 16, 2023. The purchases were made by VersaBank through the facilities of the TSX and alternate trading systems and the Nasdaq in accordance with the rules of the TSX and such alternate trading systems and the Nasdaq, as applicable, and the prices that VersaBank paid for the Common Shares was at the market price of such shares at the time of acquisition. VersaBank made no purchases of Common Shares other than open market purchases. All shares purchased under the NCIB were cancelled.
| 14. | Share capital - continued: |
For the year ended October 31, 2023, the Bank purchased and cancelled
For the year ended October 31, 2023, the Bank declared and paid dividends of $
Series 1 Preferred shares
The Bank is authorized to issue an unlimited number of Series 1 preferred shares with a par value of $
The holders of the Series 1 preferred shares are entitled to receive a non-cumulative fixed dividend in the amount of $
The Bank maintains the right to redeem, subject to the approval of OSFI, up to all of the outstanding Series 1 preferred shares on October 31, 2024 and on October 31 every years thereafter at a price of $
Upon the occurrence of a trigger event (as defined by OSFI), each Series 1 or 2 preferred share will be automatically converted, without the consent of the holders, into common shares of the Bank. Conversion to common shares will be determined by dividing the preferred share conversion value ($
For the year ended October 31, 2023, the Bank declared and paid dividends of $
| 15. | Stock-based compensation: |
Equity-settled stock options
The Bank has a stock option plan for its employees and officers. Options are granted at an exercise price set at the closing market price of the Bank’s common shares on the day preceding the date on which the option is granted and are exercisable within years of issue. Options are usually granted with graded vesting terms. One vests on the first anniversary of the grant date, one vests on the second anniversary of the grant date, and one third vests on the anniversary of the grant date.
| 2023 | 2022 | |||||||||||||||
| Weighted | Weighted | |||||||||||||||
| Number of | average | Number of | average | |||||||||||||
| options | exercise price | options | exercise price | |||||||||||||
| Outstanding, beginning of period | $ | $ | ||||||||||||||
| Granted | ||||||||||||||||
| Exercised | ( | ) | ||||||||||||||
| Forfeited/cancelled | ( | ) | ( | ) | ||||||||||||
| Expired | ||||||||||||||||
| Outstanding, end of period | $ | $ | ||||||||||||||
For the year ended October 31, 2023, the Bank recognized stock-based compensation expense of $
| 16. | Income taxes: |
Income taxes, including both the current and deferred portions, vary from the amounts that would be computed by applying the aggregated statutory federal tax rates and provincial tax rates of
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Income before income taxes | $ | $ | ||||||
| Income tax rate | % | % | ||||||
| Expected income tax provision | ||||||||
| Tax rate differential | ( | ) | ||||||
| Unrecognized deferred tax asset | ||||||||
| Other permanent differences | ||||||||
| Income taxes | $ | $ | ||||||
Income taxes is comprised of the following:
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Current income taxes | $ | $ | ||||||
| Deferred income taxes | ( | ) | ||||||
| Income taxes | $ | $ | ||||||
| 16. | Income taxes – continued: |
The components of the recognized deferred income tax assets (liabilities) and related changes, as recognized in net income, equity or accumulated comprehensive income, are as follows:
| (thousands of Canadian dollars) | ||||||||||||
| Recognized | ||||||||||||
| November 1, | in net | October 31, | ||||||||||
| 2022 | income | 2023 | ||||||||||
| Allowance for credit losses | $ | $ | $ | |||||||||
| Loss carry forwards | ||||||||||||
| Share issue and financing costs | ( | ) | ||||||||||
| Deposit commissions | ( | ) | ( | ) | ( | ) | ||||||
| Intangibles assets | ( | ) | ( | ) | ||||||||
| Deferred loan fees | ||||||||||||
| Other | ||||||||||||
| Net deferred income tax assets | $ | $ | 1,985 | $ | 3,327 | |||||||
| (thousands of Canadian dollars) | ||||||||||||
| Recognized | ||||||||||||
| November 1, | in net | October 31, | ||||||||||
| 2021 | income | 2022 | ||||||||||
| Allowance for credit losses | $ | $ | $ | |||||||||
| Loss carry forwards | ( | ) | ||||||||||
| Share issue and financing costs | ( | ) | ||||||||||
| Deposit commissions | ( | ) | ( | ) | ( | ) | ||||||
| Intangibles assets | ( | ) | ( | ) | ||||||||
| Deferred loan fees | ( | ) | ||||||||||
| Other | ||||||||||||
| Net deferred income tax assets | $ | $ | ( | ) | $ | |||||||
The net deferred taxes are comprised of:
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Deferred tax assets | $ | $ | ||||||
| Deferred tax liabilities | ( | ) | ( | ) | ||||
| Net deferred income tax assets | $ | $ | ||||||
A deferred tax asset in the amount of $
| 16. | Income taxes – continued: |
relates. The Bank has forecasted earnings in this tax jurisdiction which will allow for the use of these deferred tax assets.
The Bank is subject to Part VI.1 tax which is a 40% tax on dividends paid on taxable preferred shares under the Income Tax Act (Canada). The Part VI.1 tax of $
At October 31, 2023, the Bank had US income tax losses which can be carried forward to reduce taxable income in future years in the amount of $
In addition, the Bank has approximately $
A deferred tax liability on taxable temporary differences of approximately $
| 17. | Per share amounts: |
Basic and diluted income per common share
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Net income | $ | $ | ||||||
| Preferred share dividends paid | ( | ) | ( | ) | ||||
| Net income available to common shareholders | ||||||||
| Weighted average number of common shares outstanding | ||||||||
| Basic and diluted income per common share: | $ | $ | ||||||
The Series 1 NVCC preferred shares are contingently issuable shares and do not have a dilutive impact. The outstanding employee stock options are dilutive but are de minimis and therefore have no impact on the Bank’s income per share amounts.
| 18. | Derivative instruments: |
At October 31, 2023, the Bank had an outstanding contract established for asset liability management purposes to swap between fixed and floating interest rates with a notional amount totaling $
| 19. | Nature and extent of risks arising from financial instruments: |
Risk management involves the identification, ongoing assessment, managing and monitoring of material risks that could adversely affect the Bank. The Bank is exposed to credit risk, liquidity risk, and market risks.
Senior management is responsible for establishing the framework for identifying risks and developing appropriate risk management policies and procedures. The Bank’s Board of Directors, either directly or indirectly through its committees, reviews and approves corporate policies, including specific reporting procedures. This enables them to monitor ongoing compliance with policies, delegate limits and review management’s assessment of risk in its material risk taking activities. The Bank’s Chief Internal Auditor provides a periodic review of policies and procedures to ensure that they are appropriate, effective and being followed and that adequate controls are in place in order to mitigate risk to acceptable levels. The Chief Internal Auditor reports directly to the Audit Committee of the Board of Directors. In addition, the Bank has an ongoing risk and compliance management program with the Chief Compliance Officer, who reports directly to the Board of Directors, and the Chief Risk Officer, who reports directly to the Risk Oversight Committee.
Credit risk
Credit risk is the risk of loss associated with a borrower, guarantor, or counterparty’s inability or unwillingness to fulfill its contractual obligations. The Bank is exposed to credit risk primarily as a result of its lending activities but also, from time to time, as a result of investing in securities and derivative transactions. The Bank manages its credit risk derived from lending activity using policies that have been recommended by the Chief Credit Officer and reviewed by the Chief Risk Officer prior to submission the to the Risk Oversight Committee, who then recommends the policies to the Board of Directors for approval. These policies consist of approval procedures and limits on loan amounts, portfolio concentration, geographic concentration, industry concentration, asset category, loans to any one entity and associated groups, a risk rating policy that provides for risk rating each asset in its total asset portfolio, and early recognition of problem accounts with an action plan for each account. The Risk Oversight Committee reviews these policies on an ongoing basis.
| 19. | Nature and extent of risks arising from financial instruments – continued: |
The Bank manages credit risk associated with securities included in its Treasury portfolio by applying policies that have been recommended by the Chief Credit Officer to the Risk Oversight Committee, which then recommends the policies to the Board of Directors for approval. These policies consist of approval procedures and restrictions in the selection of security dealers, restrictions in the nature of securities selected, and in setting securities portfolio concentration limits. The Risk Oversight Committee reviews these policies on an ongoing basis.
The Risk Oversight Committee, comprised entirely of independent directors, performs the following functions related to credit risk:
| ● | Recommends policies governing management of credit risks to the Board of Directors for approval and reviews credit risk policies on an ongoing basis to ensure they are prudent and appropriate given possible changes in market conditions and corporate strategy. |
| ● | Concurs with credits exceeding the levels delegated to management, prior to commitment. |
| ● | Reviews, on a regular basis, watchlist accounts, impaired loans and accounts that have gone into arrears and expected credit loss analysis on a quarterly basis. |
The Bank assigns a risk rating to each lending asset comprising its lending portfolio. A risk rating is assigned as a function of each new credit application, annual review or an amendment to a facility. The risk rating considers the credit risk attributes of the lending asset, structure, individual borrower circumstances as well as local, regional and global macroeconomic and market conditions. The Bank aggregates its risk rating assignments into the following three broad categories:
| i) | Satisfactory – The borrower and lending asset valuation are of acceptable credit quality. |
| ii) | Watchlist – The borrower or the lending asset valuation exhibits potential credit weakness or a downward trend which, if not mitigated, will potentially weaken the Bank’s position. The lending asset requires close supervision. |
| iii) | Classified – The collection of the structural payment and/or the full repayment of the lending asset is uncertain. |
As of October 31, 2023,
See note 6 for additional information relating to credit risk associated with loans.
There was no material change in the Bank’s processes for managing credit risk during the year.
| 19. | Nature and extent of risks arising from financial instruments – continued: |
Liquidity risk
Liquidity risk is the risk that the Bank is unable to meet the demand for cash to fund obligations as they come due. The Bank is exposed to liquidity risk as a result of timing differences in the cash flows of its lending activities, security investment activities and deposit taking activities. The Bank has established policies to ensure that its cash outflows and inflows are closely matched and that its sources of deposits are diversified between funding sources and over a wide geographic area.
The Risk Oversight Committee recommends policies governing management of liquidity risk to the Board for approval and reviews liquidity policies on an ongoing basis. It receives and reviews quarterly securities portfolio reports and liquidity risk reports from management relating to its liquidity position. Additionally, an Asset Liability Committee, consisting of members of senior management, monitors liquidity risk, reviews compliance with policies and discusses strategies in this area.
See note 20 for information relating to liquidity risk associated with the Bank’s asset and liability gaps in maturities. There was no material change in the Bank’s processes for managing liquidity risk during the year.
Market risk
Market risk is the risk of a negative impact on the balance sheet and/or income statement resulting from changes or volatility in market factors such as foreign exchange risk, interest rates, or market prices. The Risk Oversight Committee is charged with recommending policies that govern market risk to the Bank’s Board of Directors for approval and with reviewing the policies on an ongoing basis.
Foreign exchange risk
Foreign exchange risk or currency risk is the risk that transacting in any currency apart from the Bank’s base currency can result in gains or losses due to currency fluctuations resulting in the possibility that a foreign denominated transaction’s value may decrease due to changes in the relative value of the currency pair. Any appreciation/depreciation in the foreign currency versus the local currency will give rise to foreign exchange risk. The Bank actively manages any material foreign exchange risk exposure derived from the Bank’s normal course business activities through, where possible, the establishment of a natural foreign currency hedge or, if necessary, through foreign exchange contracts established with high quality counterparties in order to mitigate the impact of changes in foreign exchange rates on the Bank’s financial results and position.
| 19. | Nature and extent of risks arising from financial instruments – continued: |
Interest rate risk
Interest rate risk is the risk that a movement in interest rates could negatively impact spread, net interest income and the economic value of assets, liabilities and shareholders’ equity. The Bank manages interest rate risk by employing a number of methods including income simulation analysis and interest rate sensitivity gap and duration analysis. Management prepares regular reports to the Board to allow for ongoing monitoring of the Bank’s interest rate risk position. The Asset Liability Committee reviews the results of these analyses on a monthly basis and monitors compliance with limits set by corporate policy.
The management of interest rate risk also includes stress testing the Bank’s financial assets and liabilities to various standard and non-standard interest rate scenarios. Standard scenarios that are considered include a 100 basis point (bps) parallel upward and downward shift in all yield curves applicable to the Bank.
The results of an analysis of the Bank’s sensitivity to an increase or decrease in market interest rates, assuming no asymmetrical movement in yield curves and a static balance sheet are set out below:
Interest rate position
| (thousands of Canadian dollars) | ||||||||||||||||
| 2023 | 2022 | |||||||||||||||
| Increase 100 bps | Decrease 100 bps | Increase 100 bps | Decrease 100 bps | |||||||||||||
| Increase (decrease): | ||||||||||||||||
|
| ||||||||||||||||
| Impact of projected net interest income during a 12 month period | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||
| Duration difference between assets and liabilities (months) | ) | |||||||||||||||
There was no material change in the Bank’s processes for managing interest rate risk during the year.
As at October 31, 2023, the Bank maintained one outstanding contract established for asset liability management purposes to hedge fair value exposure attributed to interest rate risk (note 18 – Derivative instruments) with a notional amount totalling $
| 20. | Interest rate risk and liquidity risk: |
The Bank is exposed to interest rate risk as a consequence of any mismatch, or gap, between assets and liabilities scheduled to mature or reset on particular dates. The gaps, which existed at October 31, 2023 are set out below:
| (thousands of Canadian dollars) | ||||||||||||||||||||||||||||||||
| Floating | Within | 3 months to | 1 year to | 2 years to | Over | Non-interest | ||||||||||||||||||||||||||
| rate | 3 months | 1 year | 2 years | 5 years | 5 years | rate sensitive | Total | |||||||||||||||||||||||||
| Assets | ||||||||||||||||||||||||||||||||
| Cash | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||
| Effective rate | % | |||||||||||||||||||||||||||||||
| Securities | ||||||||||||||||||||||||||||||||
| Effective rate | % | 4.76 | % | |||||||||||||||||||||||||||||
| Loans | ||||||||||||||||||||||||||||||||
| Effective rate | % | % | % | % | % | % | ||||||||||||||||||||||||||
| Other | ||||||||||||||||||||||||||||||||
| Effective rate | ||||||||||||||||||||||||||||||||
| Total Assets | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||||||||||
| Deposits | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Effective rate | % | % | % | % | % | |||||||||||||||||||||||||||
| Subordinated notes | ||||||||||||||||||||||||||||||||
| Effective rate | % | |||||||||||||||||||||||||||||||
| Other | ||||||||||||||||||||||||||||||||
| Effective rate | % | |||||||||||||||||||||||||||||||
| Equity | ||||||||||||||||||||||||||||||||
| Effective rate | 6.77 | % | ||||||||||||||||||||||||||||||
| Total liabilities and equity | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Interest rate swap | $ | $ | $ | $ | $ | $ | ( | ) | $ | $ | ||||||||||||||||||||||
| October 31, 2023 gap | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | $ | ( | ) | $ | ||||||||||||||||
| Cumulative | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | $ | ||||||||||||||||||
| October 31, 2022 gap | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | $ | ( | ) | $ | ||||||||||||||||
| Cumulative | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | $ | $ | ||||||||||||||||||||
| 21. | Fair value of financial instruments: |
The amounts set out in the table below represent the fair value of the Bank’s financial instruments:
| (thousands of Canadian dollars) | ||||||||||||||||||||||||||||
| 2023 | 2022 | |||||||||||||||||||||||||||
| Carrying Value | Fair value Level 1 | Fair Value Level 2 | Fair Value Level 3 | Total Fair Value | Carrying Value | Total Fair Value | ||||||||||||||||||||||
| Assets | ||||||||||||||||||||||||||||
| Cash | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Securities | ||||||||||||||||||||||||||||
| Loans | ||||||||||||||||||||||||||||
| Derivatives | ||||||||||||||||||||||||||||
| Other financial assets | ||||||||||||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||||||
| Deposits | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Subordinated notes payable | ||||||||||||||||||||||||||||
| Other financial liabilities | ||||||||||||||||||||||||||||
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 have been valued as described below and are not necessarily representative of amounts realizable upon immediate settlement.
The fair value amounts have been determined using the following valuation methods and assumptions:
| • | For securities, the combined carrying value and accrued interest approximates fair value. |
| • | The fair value of loans is based on net discounted cash flows using market interest rates and applicable credit spreads for borrowers. |
| • | The fair value of deposits is determined based on discounted cash flows using market interest rates. |
| • | The fair value of subordinated notes payable is determined based on discounted cash flows using current market interest rates. |
| • | The investment in Stablecorp which is measured at fair value at each reporting period with changes in value reflected in the Bank’s other comprehensive income. The estimated fair value of the Stablecorp investment is classified as Level 3 fair value hierarchy as the determination of fair value, did not use inputs that were based on observable market data given that the entity is privately-held. |
| • | The fair value of derivatives is based on net discounted cash flows using market interest rates and applicable credit spreads for the counterparty. |
| • | The fair value of other financial assets is approximately equal to their carrying value due primarily to the short-term nature of the instruments. |
| 21. | Fair value of financial instruments – continued: |
| • | The fair value of other financial liabilities is approximately equal to their carrying value due to the short-term nature of the instruments except for lease obligations. However, the fair value of the Bank’s lease obligations is approximately equal to their carrying value given that there has been no movement in the market interest rates associated with these leases. |
| • | Cash and derivatives are designated as FVTPL. |
| • | Loans, deposits and subordinated notes payable are designated as amortized cost. |
| • | Securities and other financial assets are designated as FVOCI. |
| 22. | Related party transactions: |
The Bank’s Board of Directors and Senior Executive Officers represent key management personnel and the Bank has issued loans and advances to some of these individuals. At October 31, 2023, amounts due from key management personnel totaled $
In March 2019, the Bank issued a $
Total compensation expense recognized for key management personnel for the year ended October 31, 2023, was $
| 23. | Commitments and contingencies: |
| a) | Credit commitments: |
The amount of credit related commitments represents the maximum amount of additional credit that the Bank could be obliged to extend. Under certain circumstances, the Bank may cancel loan commitments at its option. Letters of credit amounts are not necessarily indicative of the associated credit risk exposure 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.
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Loan commitments | $ | $ | ||||||
| Letters of credit | ||||||||
| $ | $ | |||||||
| b) | Pledged assets: |
In the ordinary course of business, assets are pledged against the off-balance sheet letters of credit in the amount of $
| c) | Other commitments: |
During the current year the Bank committed to acquire capital assets in the amount of approximately $
| 24. | Capital management: |
| a) | Overview: |
The Bank’s policy is to maintain a strong capital base so as to retain investor, creditor and market confidence as well as to support the future growth and development of the business. The impact of the level of capital held on shareholders’ return is an important consideration and the Bank recognizes the need to maintain a balance between the higher returns that may be possible with greater leverage and the advantages and security that may be afforded by a more robust 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 that take into account, amongst other items, forecasted capital requirements and current and anticipated financial market conditions.
The goal is to maintain adequate regulatory capital for the Bank to be considered well capitalized, protect consumer deposits and provide capacity to support organic growth as well as to capitalize on strategic opportunities that do not otherwise require accessing the public capital markets, all 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 fair value through other comprehensive income securities (Common Equity Tier 1 capital), preferred shares (Additional Tier 1 capital) and subordinated notes (Tier 2 capital). The Bank monitors its capital adequacy and related capital ratios on a daily basis and has policies setting internal targets and thresholds for its capital ratios. These capital ratios consist of the leverage ratio and risk-based capital ratios.
| 24. | Capital management – continued: |
| a) | Overview - continued |
The Bank makes use of the Standardized Approach for credit risk as prescribed by OSFI, and therefore, may include eligible ECL allowance amounts in its Tier 2 capital, up to a maximum of
| b) | Risk-based capital ratios: |
The Basel Committee on Banking Supervision has published the Basel III rules 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 for the purpose of determining their risk-based capital ratios. Required minimum regulatory capital ratios are a
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, both on and off balance sheet assets of the Bank are assigned a weighting ranging between 0% to 150% to determine the Bank’s risk weighted equivalent assets and its risk-based capital ratios.
| 24. | Capital management – continued: |
The Bank’s risk-based capital ratios are calculated as follows:
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| Common Equity Tier 1 (CET1) capital | ||||||||
| Directly issued qualifying common share capital | $ | $ | ||||||
| Contributed surplus | ||||||||
| Retained earnings | ||||||||
| Accumulated other comprehensive income | ||||||||
| CET1 before regulatory adjustments | ||||||||
| Regulatory adjustments applied to CET1 | ( | ) | ( | ) | ||||
| Common Equity Tier 1 capital | $ | $ | ||||||
| Additional Tier 1 capital | ||||||||
| Directly issued qualifying Additional Tier 1 instruments | $ | $ | ||||||
| Total Tier 1 capital | $ | $ | ||||||
| Tier 2 capital | ||||||||
| Directly issued Tier 2 capital instruments | $ | $ | ||||||
| Tier 2 capital before regulatory adjustments | ||||||||
| Eligible stage 1 and stage 2 allowance | ||||||||
| Total Tier 2 capital | $ | $ | ||||||
| Total regulatory capital | $ | $ | ||||||
| Total risk-weighted assets | $ | $ | ||||||
| Capital ratios | ||||||||
| CET1 capital ratio | % | % | ||||||
| Tier 1 capital ratio | % | % | ||||||
| Total capital ratio | % | % | ||||||
As at October 31, 2023 and 2022, the Bank was in compliance with all minimum capital ratios prescribed by OSFI.
| 24. | Capital management – continued: |
| 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 the Bank’s total exposures. The Basel III minimum leverage ratio is
| (thousands of Canadian dollars) | ||||||||
| 2023 | 2022 | |||||||
| On-balance sheet assets | $ | $ | ||||||
| Asset amounts adjusted in determining the Basel III Tier 1 capital | ( | ) | ( | ) | ||||
| Total on-balance sheet exposures | ||||||||
| Total off-balance sheet exposure at gross notional amount | $ | $ | ||||||
| Adjustments for conversion to credit equivalent amount | ) | ) | ||||||
| Total off-balance sheet exposures | ||||||||
| Tier 1 capital | ||||||||
| Total exposures | ||||||||
| Leverage ratio | % | % | ||||||
As at October 31, 2023 and 2022, the Bank was in compliance with the leverage ratio prescribed by OSFI.
| 25. | Operating segments: |
The Bank has established reportable operating segments, those being Digital Banking and DRTC. The two operating segments are strategic business operations providing distinct products and services to different markets and are separately managed as a function of the distinction in the nature of each business. The following summarizes the operations of each of the reportable segments:
Digital Banking – The Bank employs a business-to-business model using its proprietary financial technology to address underserved segments in the Canadian and US banking markets. VersaBank obtains its deposits and provides the majority of its loans and leases electronically via innovative deposit and lending solutions for financial intermediaries.
DRTC (cybersecurity services and banking and financial technology development) - Leveraging its internally developed IT security software and capabilities, VersaBank established a wholly-owned subsidiary, DRTC, to pursue significant large-market opportunities in cybersecurity and to develop innovative solutions to address the rapidly growing volume of cyber threats challenging financial institutions, multi-national corporations and government entities.
| 25. | Operating segments - continued: |
The basis for the determination of the reportable segments is a function primarily of the systematic, consistent process employed by our chief operating decision maker, the Chief Executive Officer, and the Chief Financial Officer in reviewing and interpreting the operations and performance of each segment. The accounting policies applied to these segments are consistent with those employed in the preparation of our consolidated financial statements, as disclosed in note 3b - Segment reporting.
Performance is measured based on segment net income, as included in the Bank’s internal management reporting. Management has determined that this measure is the most relevant in evaluating segment results and in the allocation of resources.
Following is information regarding the results of each reportable operating segment as at and for the year ended October 31, 2023 and 2022:
| (thousands of Canadian dollars) | ||||||||||||||||||||||||||||||||
| for the year ended | October 31, 2023 | October 31, 2022 | ||||||||||||||||||||||||||||||
| Digital | DRTC | Eliminations/ | Consolidated | Digital | DRTC | Eliminations/ | Consolidated | |||||||||||||||||||||||||
| Banking | Adjustments | Banking | Adjustments | |||||||||||||||||||||||||||||
| Net interest income | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Non-interest income | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Total revenue | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Provision for (recovery of) credit losses | ||||||||||||||||||||||||||||||||
| ( | ) | ( | ) | |||||||||||||||||||||||||||||
| Non-interest expenses: | ||||||||||||||||||||||||||||||||
| Salaries and benefits | ||||||||||||||||||||||||||||||||
| General and administrative | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Premises and equipment | ||||||||||||||||||||||||||||||||
| ( | ) | ( | ) | |||||||||||||||||||||||||||||
| Income (loss) before income taxes | ( | ) | ||||||||||||||||||||||||||||||
| Income tax provision | ( | ) | ||||||||||||||||||||||||||||||
| Net income (loss) | $ | $ | $ | $ | $ | $ | ( | ) | $ | $ | ||||||||||||||||||||||
| Total assets | $ | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||||||
| Total liabilities | $ | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||||||
| 26. | Acquisitions: |
Proposed acquisition of Stearns Bank Holdingford, N.A.
On June 10, 2022, VersaBank signed a definitive agreement to acquire Minnesota-based Stearns Bank Holdingford, N.A. (“SBH”), a privately held, wholly owned subsidiary of Stearns Financial Services Inc. (“SFSI”) based in St. Cloud, Minnesota, for an estimated USD $
USD $
| 27. | Comparative information: |
The financial statements have been reclassified, where applicable, to conform to the presentation used in the current year. The changes do not affect prior year earnings.
Cash flows related to investments in securities for the current and comparative periods were incorrectly reclassified from investing activity to operating activity in each of the three unaudited interim reporting periods during the year ended October 31, 2023. This classification was corrected for the annual audited financial statements for the year ended October 31, 2023. This matter had no impact on the annual audited financial statements for the year ended October 31, 2022.