VersaBank : Earnings Document

Management's Discussion and Analysis

This management's discussion and analysis ("MD&A") of operations and financial condition for the first quarter of fiscal 2024, dated March 4, 2024, should be read in conjunction with the unaudited interim consolidated financial statements for the period ended January 31, 2024, which have been prepared in accordance with International Financial Reporting Standards ("IFRS"). This MD&A should also be read in conjunction with VersaBank's MD&A and Audited Consolidated Financial Statements for the year ended October 31, 2023, which are available on VersaBank's website at www.versabank.com, SEDAR at www.sedar.comand EDGAR at www.sec.gov/edgar.shtml. Except as discussed below, all other factors discussed and referred to in the MD&A for the year ended October 31, 2023, remain substantially unchanged. All currency amounts in this document are in Canadian dollars unless otherwise indicated.

Cautionary Note Regarding Forward-Looking Statements	2
About VersaBank	3
Overview of Performance	4
Selected Financial Highlights	7
Business Outlook	8
Financial Review - Earnings	12
Financial Review - Balance Sheet	17
Off-Balance Sheet Arrangements	25
Related Party Transactions	25
Capital Management and Capital Resources	26
Results of Operating Segments	28
Summary of Quarterly Results	29
Non-GAAP and Other Financial Measures	30
Significant Accounting Policies and Use of Estimates and Judgements	32
Controls and Procedures	32

	VersaBank - Q1 2024 MD&A	1

Cautionary Note Regarding Forward-Looking Statements

VersaBank's public communications often include written or oral forward-looking statements. Statements of this type are included in this document and may be included in other filings and with Canadian securities regulators or the US Securities and Exchange Commission, or in other communications. All such statements are made pursuant to the "safe harbor" provisions of, and are intended to be forward-looking statements under, the United States Private Securities Litigation Reform Act of 1995 and any applicable Canadian securities legislation. The statements in this management's discussion and analysis that relate to the future are forward-looking statements. By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific, many of which are out of VersaBank's control. Risks exist that predictions, forecasts, projections and other forward-looking statements will not be achieved. Readers are cautioned not to place undue reliance on these forward-looking statements as a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements. These factors include, but are not limited to, the strength of the Canadian and US economy in general and the strength of the local economies within Canada and the US in which VersaBank conducts operations; the effects of changes in monetary and fiscal policy, including changes in interest rate policies of the Bank of Canada and the US Federal Reserve; global commodity prices; the effects of competition in the markets in which VersaBank operates; inflation; capital market fluctuations; the timely development and introduction of new products in receptive markets; the impact of changes in the laws and regulations pertaining to financial services; changes in tax laws; technological changes; unexpected judicial or regulatory proceedings; unexpected changes in consumer spending and savings habits; the impact of wars or conflicts and the impact of both on global supply chains and markets; the impact of outbreaks of disease or illness that affect local, national or international economies; the possible effects on our business of terrorist activities; natural disasters and disruptions to public infrastructure, such as transportation, communications, power or water supply; and VersaBank's anticipation of and success in managing the risks implicated by the foregoing. For a detailed discussion of certain key factors that may affect VersaBank's future results, please see VersaBank's annual MD&A for the year ended October 31, 2023.

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

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About VersaBank

VersaBank (the "Bank") adopted an electronic branchless model in 1993, becoming the world's first branchless financial institution and obtains its deposits and the majority of its loans and leases digitally. It holds a Canadian Schedule 1 chartered bank licence and is regulated by the Office of the Superintendent of Financial Institutions ("OSFI"). In addition to its core Digital Banking operations, VersaBank has established cybersecurity services and banking and financial technology development operations through its wholly owned subsidiary, DRT Cyber Inc. ("DRTC"). VersaBank's Common Shares trade on the Toronto Stock Exchange and Nasdaq under the symbol VBNK. Its Series 1 Preferred Shares trade on the Toronto Stock Exchange under the symbol VBNK.PR.A.

VersaBank is focused on increasing earnings by concentrating on underserved markets that support more attractive pricing for its products, leveraging existing distribution channels to deliver its financial products to these chosen markets and expanding its diverse deposit gathering network that provides efficient access to a range of low-cost deposit sources in order to maintain a low cost of funds.

The underlying drivers of VersaBank's performance trends for the current and comparative periods are set out in the following sections of this MD&A.

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Overview of Performance

* See definition in the "Non-GAAP and Other Financial Measures" section below.

Q1 2024 vs Q1 2023

• Loans increased 23% to $3.98 billion, driven primarily by continued strong growth in the Bank's Point- of-Sale Loans and Leases ("POS Financing") portfolio, which increased 28%, as well as growth in its commercial lending portfolio, which increased 9%;
• Total revenue increased 11% to $28.9 million and was comprised of net interest income of $26.6 million and non-interest income of $2.3 million, derived primarily from the Bank's technology and cybersecurity business;
• Net interest margin ("NIM") was 2.48% compared with 2.83% and NIM on loans was 2.63% compared with 3.03%. The decreases were due primarily to the strong growth of the POS Financing portfolio

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(which is composed of lower risk-weighted, lower yielding but higher Return on Common Equity ("ROCE") assets than the commercial real estate ("CRE") portfolio), the impact of the planned transition of some higher yielding, higher risk-weighted CRE loans to lower yielding, lower risk-weighted CRE loans as part of the Bank's strategy to capitalize on opportunities for lower-risk loans with a higher return on capital deployed, as well as higher rates on term deposits experienced during the quarter. This was offset partially by higher yields earned on the Bank's lending assets;

• Recovery of credit losses was $127,000 compared with a provision for credit losses of $385,000 last year, with the trend being attributable primarily to the recalibration of the Bank's POS Financing portfolio's static, legacy loss rate floor to align more closely with empirical loss rate data and general credit performance and changes in the forward-looking information used by VersaBank in its credit risk models offset partially by higher CRE lending asset balances;
• Provision for credit losses as a percentage of average loans was -0.01% compared to 0.05% last year. The Bank's Provision for credit losses ("PCL") continues to remain among the lowest of the publicly traded Canadian Schedule I (federally licensed) Banks;
• Non-interestexpenses decreased 3% to $12.0 million, due primarily to a favourable adjustment in compensation obligations, offset partially by lower capital tax expense in the prior year attributable to a shift in the provincial allocation of the Bank's loan and deposit originations and higher general operating expense levels in the current year to support expanded business activity;
• Net income increased 35% to $12.7 million, driven primarily by the 11% increase in revenue and 3% decrease in non-interest expenses;
• Earnings per share ("EPS") increased 41% to $0.48, due primarily to the 35% increase in net income, as well as the impact of a lower number of common shares outstanding in the current year as a result of the purchase and cancellation of common shares under the Bank's Normal Course Issuer Bid ("NCIB");
• Return on average common equity increased 262 bps to 13.41% driven by strong earnings and lower number common shares outstanding; and,
• Efficiency ratio for the Digital Banking operations (excluding DRTC) improved to 40% from 42% last year.

Q1 2024 vs Q4 2023

• Loans increased 3% to $3.98 billion, driven primarily by continued strong growth in the Bank's POS Financing portfolio, which increased 7%, offset partially by a transitory contraction in its CRE portfolio, which decreased 7%, under the Bank's strategy to transition some higher yielding, higher risk-weighted CRE loans to lower yielding, lower risk-weighted CRE loans as part of the Bank's strategy to balance risk and ROCE;
• Total revenue decreased 1% to $28.9 million and was comprised of net interest income of $26.6 million and non-interest income of $2.3 million, the latter derived primarily from the Bank's technology and cybersecurity business, attributable primarily to the operations of DRT Cyber Inc., ("DRTC"), which includes the gross margin generated by its cybersecurity component Digital Boundary Group's cybersecurity services business;

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• NIM was 2.48% compared with 2.54% and NIM on loans was 2.63% compared with 2.69%. The decreases were due primarily to the strong growth of the POS Financing portfolio (which is composed of lower-risk weighted, lower yielding but higher ROCE assets than the CRE portfolio), the impact of the planned transition of some higher yielding, higher risk-weighted CRE loans to lower yielding, and lower risk-weighted CRE loans as part of the Bank's strategy to capitalize on opportunities for lower- risk loans with a higher return on capital deployed;
• Recovery of credit losses was $127,000 compared with a recovery of credit losses of $184,000 last quarter;
• PCL as a percentage of average loans was -0.01% compared to -0.02% last quarter;
• Non-interestexpenses decreased 3% to $12.0 million, due primarily to a favourable adjustment in compensation obligations, offset partially by higher salary and benefits and general operating expenses to support expanded business activities;
• Net income and earnings per share were $12.7 million and $0.48 per share, respectively, compared with $12.5 million and $0.47 per share, respectively, with the increase due primarily to lower non- interest expenses, offset partially by lower revenues as noted above;
• Return on average common equity decreased 17 bps to 13.41%; and,
• Efficiency ratio for the Digital Banking operations (excluding DRTC) improved to 40% from 45% last quarter.

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Selected Financial Highlights

(unaudited)		For the three months ended
	January 31	October 31	January 31
(thousands of Canadian dollars except per share amounts)		2024		2023		2023
Results of operations
Interest income	$	69,292	$	66,089	$	49,561
Net interest income		26,568		26,239		24,274
Non-interest income		2,283		2,934		1,644
Total revenue		28,851		29,173		25,918
Provision (recovery) for credit losses		(127)		(184)		385
Non-interest expenses		12,024		12,441		12,335
Digital Banking		10,415		11,384		10,169
DRTC		1,946		2,137		2,357
Net income		12,699		12,479		9,417
Income per common share:
Basic	$	0.48	$	0.47	$	0.34
Diluted	$	0.48	$	0.47	$	0.34
Dividends paid on preferred shares	$	247	$	247	$	247
Dividends paid on common shares	$	650	$	650	$	663
Yield*		6.47%		6.40%		5.78%
Cost of funds*		3.99%		3.86%		2.95%
Net interest margin*		2.48%		2.54%		2.83%
Net interest margin on loans*		2.63%		2.69%		3.03%
Return on average common equity*		13.41%		13.58%		10.79%
Book value per common share*	$	14.46	$	14.00	$	12.77
Efficiency ratio*		42%		43%		48%
Efficiency ratio - Digital banking*		40%		45%		42%
Return on average total assets*		1.16%		1.19%		1.07%
Provision (recovery) for credit losses as a % of average loans*		(0.01%)		(0.02%)		0.05%
				As at
Balance Sheet Summary
Cash	$	127,509	$	132,242	$	201,372
Securities		133,005		167,940		49,847
Loans, net of allowance for credit losses		3,984,281		3,850,404		3,235,083
Average loans		3,917,343		3,756,038		3,113,881
Total assets		4,309,635		4,201,610		3,531,690
Deposits		3,638,656		3,533,366		2,925,452
Subordinated notes payable		103,355		106,850		102,765
Shareholders' equity		389,034		377,158		351,177
Capital ratios**
Risk-weighted assets	$	3,194,696	$	3,095,092	$	2,917,048
Common Equity Tier 1 capital		363,798		350,812		326,411
Total regulatory capital		485,309		476,005		447,472
Common Equity Tier 1 (CET1) capital ratio		11.39%		11.33%		11.19%
Tier 1 capital ratio		11.81%		11.78%		11.66%
Total capital ratio		15.19%		15.38%		15.34%
Leverage ratio		8.44%		8.30%		9.21%

• See definition in "Non-GAAP and Other Financial Measures" section below.
• Capital management and leverage measures are in accordance with OSFI's Capital Adequacy Requirements and Basel III Accord.

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Business Outlook

VersaBank is active in underserved banking markets in Canada and the US in which its innovative, value- added, business-to-business (B2B) digital banking products command more attractive pricing for its lending products, and further, continues to develop and expand its diverse deposit gathering network that provides efficient access to a range of low-cost deposit sources. In addition, VersaBank remains highly committed to, and focused on, further developing and enhancing its technology advantage, a key component of its value proposition that not only provides efficient access to VersaBank's chosen underserved lending and deposit markets, but also delivers superior financial products and better customer service to its clients.

Management is closely monitoring geo-political, economic and financial market risk precipitated by current wars or conflicts, as well as the condition of the US banking sector and the potential impact on VersaBank's business. At this time, management has not identified any material direct or indirect risk exposure to VersaBank resulting from these geo-political risks or the uncertainty in the US banking sector but will continue to assess the relevant data and information as it becomes available.

While VersaBank does not provide guidance on specific performance metrics, the commentary provided below discusses aspects of VersaBank's business and certain anticipated trends related to same that, in management's view, could potentially impact future performance.

Potential acquisition of Stearns Bank Holdingford

• The Bank continues to advance the process seeking approval of its proposed acquisition of OCC- chartered US bank, Stearns Bank Holdingford N.A., and expects a decision with respect to approval of its application from US regulators during the second calendar quarter of 2024. If favourable, the Bank will proceed toward completion of the acquisition as soon as possible, subject to Canadian regulatory (OSFI) approval.

Lending Assets

• Canadian Point-of-Sale Financing: Consumer spending and business investment in Canada are expected to remain steady over the course of fiscal 2024 following modest contraction in growth the prior year with the impact of higher interest rates, inflationary pressures (albeit moderated from those recently) and a softening labour market still countering GDP growth. It remains management's view that the impact of the continued softness in the Canadian economy on the Bank's POS Financing portfolio in fiscal 2024 will be mitigated by the onboarding of new origination partners and the continued expansion of business with existing partners over the balance of the year. As a result, management expects to see continued growth in the Canadian POS Financing portfolio over the course of fiscal 2024;
• US Receivable Purchase Program ("RPP"): Despite higher interest rates and continuing inflationary pressures in the US, the US labour market remains resilient, which, combined with the broad expectation that the Federal Reserve's tightening cycle has come to an end will continue to support consumer spending. Management views the current trajectory of the US economy to be favourable in the context

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of continued, stable demand for durable goods as a function of enduring consumption. Management believes that the anticipated US macroeconomic and industry trends described above will continue to support healthy growth in the Bank's RPP portfolio over the course of fiscal 2024, which would be expected to contribute meaningful additional growth should VersaBank receive regulatory approval for, and complete, the proposed acquisition of a U.S. bank and broadly launch its RPP; and,

• Commercial Real Estate (Business-to-Business Loans with Credit Risk Exposure Predominantly Related to Residential Properties): Notwithstanding the effective risk mitigation strategies that are employed in managing the Bank's CRE portfolios, including working with well-established,well-capitalized partners and maintaining modest loan-to-value ratios on individual transactions, management continues to take a cautionary stance with respect to its broader CRE portfolios due to volatility in CRE asset valuations and the potential impact of higher interest rates on borrowers' ability to service debt. While management will continue to focus on multi-family insured mortgages in fiscal 2024 it is anticipated that Bank's CRE portfolio asset mix will transition into lower risk weighted insured assets that will drive moderate portfolio growth in fiscal 2024.

Credit Quality

• VersaBank lends to underserved markets that support more attractive pricing for its lending products but typically exhibit a lower-than-average risk profile generally as a function of the lower inherent risk associated with the underlying collateral assets and/or the structure of VersaBank's offered financing arrangements; and,
• Based on available forward-looking macroeconomic and industry data (as described above), as well as the Bank's historical credit experience, current underwriting governance, and general expectations for credit performance, management anticipates that credit risk in its portfolio may continue to increase modestly during fiscal 2024 as a function primarily of a potentially higher interest rate environment in both Canada and the US and the ability of consumers and businesses to service debt in such an environment. Further, management expects that the lower risk profile of VersaBank's unique business to business lending portfolio, which is a function of VersaBank's prudent underwriting practices, structured lending products and focus on underserved financing markets within which it has a wealth of experience, will contribute to mitigating any escalation in forward credit risk in the Bank's lending portfolio.

Funding and Liquidity

• Management expects that commercial deposits raised via VersaBank's Trustee Integrated Banking
  ("TIB") program will continue to grow throughout fiscal 2024 as a function of higher volumes of consumer and commercial bankruptcy and proposal restructuring proceedings, attributable primarily to the impact of current economic conditions. In addition, VersaBank continues to pursue a number of initiatives to grow and expand its well-established, diverse deposit broker network through which it sources personal deposits, consisting primarily of guaranteed investment certificates. The Bank's current deposit channels remain an efficient, reliable and diversified source of funding, providing access to ample reasonably

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priced deposits in volumes that comfortably support the Bank's liquidity requirements. Substantially all of the Bank's deposit volumes raised through these channels are eligible for CDIC insurance;

• Management believes that VersaBank has one of the lowest liquidity risk profiles among North American banks attributable to the quality, stability and stickiness of its deposit base. All of VersaBank's deposits are sourced through existing, third-party distribution channels, specifically wealth management firms that distribute the Bank's term deposit products and Licensed Insolvency Trustee firms that invest in the
  Bank's demand and term deposit products. The Bank does not accept deposits directly from individuals and does not offer high interest-bearing demand deposit products that are accessible to the public via the internet; and,
• Management anticipates that liquidity levels will remain reasonably consistent throughout fiscal 2024 as the Bank continues to fund anticipated balance sheet growth across each of its lines of business. Further, management will continue to deploy cash into low risk, government securities with the objective of earning a more favourable yield on its available liquidity.

Earnings and Capital

• Earnings growth in fiscal 2024 is expected to be a function primarily of anticipated organic balance sheet growth from Digital Banking operations, specifically attributable to expansion of the Bank's POS Financing and RPP portfolios in Canada and the US, respectively, as well as incremental earnings contributions from DRTC;
• Net interest income growth for fiscal 2024 is expected to be a function primarily of expansion of the Bank's POS Financing and RPP portfolios in Canada and the US, respectively, disciplined liquidity management and the expectation that growth in the TIB program in fiscal 2024 and further expansion of the Bank's diverse deposit broker network should have a favourable impact on cost of funds although the Bank expects that it could see more volatility in NIM due to the dynamics of the term deposit market;
• Non-interestincome growth for fiscal 2024 is expected to be a function primarily of DRTC revenue growth derived from its suite of cybersecurity services;
• VersaBank's capital ratios remain comfortably in excess of the Bank's targets and regulatory minimums and expectations. Management is of the view that VersaBank's current capital levels are sufficient to accommodate balance sheet growth contemplated for fiscal 2024. Notwithstanding the above, management will continue to closely monitor the capital markets to identify opportunities for VersaBank to raise additional regulatory capital on attractive terms in order to position VersaBank to support a potentially more robust growth profile in the future; and,
• Management does not anticipate increasing VersaBank's dividends over the course of fiscal 2024 to ensure that it continues to have adequate regulatory capital available to support contemplated balance sheet growth, as well as specific business development initiatives for earnings growth currently

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