A Canadian bank’s versatile business model

I'm delighted to bring you a conversation with David Taylor. David is president CEO and founder of versa bank, which is based in London, Ontario. It's a Canadian institution with a unique business model that has just recently, just this week, in fact, closed the acquisition of a U.S. Bank, Stearns Holdingford in Minnesota, and in the process of bringing its unique business model to the United States.

I thought it was a great opportunity to talk to David, learn a little bit more about some of the things they're working on at VersaBank and what we can expect to see from versa bank USA. Here's the conversation with David. I'd love it if you could introduce the bank and your vision and purpose and your growth plans in North America.

So somewhere along the line, Evan, I thought to myself. "It's fine to work for a bank. It'd be better to own a bank," and so I had this sort of epiphany in the early nineties and it, it was that I could create a branchless digital bank, and it was sort of, they say necessity, the mother of invention in that I didn't have enough money to create a duplicate, a branch network, you know?

And I was very familiar with, the use of PC technology in that it, when I was in my biology days rather than waiting around, trying to net fish and ban birds and such, I, I gravitated towards the statistical analysis of these populations. And I wrote the various statistical software in Fortran.

So having that knowledge and then having the those two wonderful experiences, those two banks, I put together the model and, in the early days I used telephone modems and IBM PCs to, to create a, a network to, to gather deposits and to make loans. So that was the rudimentary days of what is now of the way most model FIs gather the deposits, they use a deposit broker network. But back in those days, there was no such thing as as a deposit brokers.

From those humble beginnings, I created this digital partner based bank and as Internet came along, it just got more and more efficient. And finally, in August, 2002, I managed to convince the Canadian regulator that this was a viable new business model. And I received the first federal bank license had been granted in 18 years. So it was, it was a big deal in Canada to, to launch a new type of bank, branchless. No customer interface, sort of jobbing that out to the partners and then it grew.

It did take a lot longer than I expected to convince the various regulatory bodies that it was a viable model. I was lectured fairly often in the early, early years about the need for branches and. One guy told me I had to have pillars in front of the bracket, , "you know, Dave, people are not gonna come in and give you their money. There have to be pillars and all that."

And I use the exact the same software. We, of course, in the early days, there was no banking software. So we created it ourselves. We call. The asset side AMS, asset management system and deposit side DMS, deposit management system.

So what we thought is an analogous way to gather loans would be to go to point of sale finance companies and say to them you know, how you get your funding to fund these loans to make motorcycles and cars and hot tubs and, you know, virtually everything is finance at the point of sale. So 12 years ago in Canada.

I dubbed it the Receivable Purchase Program and developed the software to enable us to purchase loans and leases as they were, as they were originated by these point of sale finance companies. And so the idea was that they could do what they do best, i. e. origination, marketing, all that stuff. And we would do what we do best inventorying or warehousing their loans and leases on our balance sheet.

Okay. And dealing with the the various regulators, you know, covered the regulators that we were looking after those risk averse depositors money in the most prudent fashion and doing away with the traditional need for collection departments and customer service people and all, all that sort of stuff. So we're very unlike the banks you would probably normally think about. It's just two tech facilities, software engineers, about a hundred people, four and a half billion in assets.

No loan losses in our history, no provision for losses, the widest margin in the country fastest growth rate, you know, although that right now, I think we posted a 38 percent efficiency ratio, it should be down in the. In the teens, but it's, it's dependent on asset size and our cloud based facilities in Iowa. So 100 percent cloud based bank; theoretically it will operate in the, where in the world.

But as I say, metaphorically, but only where our wheels touched down can we actually do business because we need a license, to be able legally do business. So, most recently thankfully the U. S. regulatory authorities granted us that ability to, to in effect do business in the, all throughout the United States, but with the acquisition of Stearns Holdingford

So it is sort of unique and novel, but not that much different than the the present way that the point of sale finance companies are dealing with the numerous mainly community banks. The point of sale finance companies would be financed, usually by loans from community banks, and usually when they get larger and larger, a syndicate of community banks that provide loans to the point of sale finance company, that the funds are then on lent to the end consumer which is a good way.

And in Canada, that's how it was too. We come along and we say, "that's wonderful. And I'm sure you've got wonderful relationships and endured for decades. Wouldn't it be nice to diversify a little bit?" we certainly look, not looking to replace the relationships that have long have endured a lot of time, but we're looking to sort of provide them with an alternate source of maybe a little more economically priced funding, and it comes with two significant advantages over the traditional method.

And the the 1st is that traditionally the lenders require a certain amount of equity in the loan from the point of sale finance company. Earlier on, it used to be about a, a 75 percent margin. So they would say, "okay, you've got 100 million in in receivables and we're going to margin by lending you 75 million." They would say, "okay, you've got 100 million in in receivables and we're going to margin by lending you 75 million."

So that would mean that 25 million is actually the equity of the point of sale company. In the last while, I've seen community banks get a little more comfortable with various point of sale companies, and maybe improve that margin 80%, even 85%. So, but there's still a significant equity component going in to each and every loan that the point of sale company is doing. Our model is usually a hundred percent.

So that's pretty damn attractive that means that they're, they're generating loans and then they just sell them to us and they got their money back and they're sort of refreshed. They're on their way to make the next loan. So that's, that's pretty attractive.

So the, the the requirement that eliminates all the problems, and it means that, or I don't have 30 years a, a loan loss in the a collection department is a catch, and the catch says that we can put back delinquent loans as they occur, back to you, the vendor. We limit that put back to something reasonable. It's not a hundred percent put back or else it wouldn't be off balance sheet financing. It would be taking no risk. It'd be a straight.

So what we say is, okay, let's have a look at the risk profile of, of your loan portfolio. And let's look, we try to go we try to deal with portfolio companies have been in existence for a good long time. Successful history. So say, say they're in the automobile financing in the industry and you know, say they've got a delinquency rate of about four or 5 percent and we say, "okay, and you've been through the cycle 10 years. This is as bad as it gets."

We might want three times that much in cash collateral held back. And how it works is this. If the yield on the loan is, say, 12 percent and we're buying it, our buy rate is eight. Then the premium that we would be paying for that loan, that's more or less the arithmetic is that that premium say that's to 2, 000 that ends up as the cash collateral, the whole back when you run the math, it sort of works out because that is the that premium they're getting.

Is what they pay their bills with and absorb losses with, and hopefully some left over for return on it on their shareholders. So the math basically, it's, it's mainly it's a true partnership. We're funding the, the loans at a very economical rate to leave enough on the table for them to be able to absorb the loan losses, do their administration. And because we're not looking for a lot of equity, their return on equity figures go through the roof.

If we leave other partners funding too, then say we don't want to buy used car loans anymore, or maybe our appetite reduces because of our own internal risk modeling, we say, "gee, we got a lot of exposure to the automobile whose car market, maybe we better be less aggressive in buying."

We don't want our partners to suffer and you know That's why they should have other lines open to the next guy might be charging a little more interest but it's Our our market strategy has never been to take it over. It's always been to be complementary. It seems to sell well too. It makes the pitch a lot easier

And thanks again to Alkami for sponsoring this episode. Do you have any investment in direct in consumer or direct to business or direct to consumer marketing or relationship or a product? Or is it just brokered? Or you know, is it just the brokered deposits and the point of sale finance?

Some of the large Canadian banks uses now, and some of your U. S. Banks to your energy companies, do your transportation lines, your state, some of your police departments. But that's sort of a side business that probably somewhere in the future, you'll see me divest of that. I believe in focusing and your point of sale market is a big market . So, you know, , I don't wanna be distracted, is the motherlode right in front of me.

And this other stuff is good stuff, but it is probably better for somebody else to sort of own it and bend it to the small bank industry.

And so at the beginning, I hired two professors out of the department and sort of unveiled what I had in mind. I was the architect and these two guys wrote it up for me. And I, I said, "who's your best students?" They told me, and these still got, one of those guys is heading up my IT department right now.

So it, what I tried to do was encourage keen young software engineers who want some excitement to join up with me and some lasted the duration, some kind of got bored with banking and moved on. One guy moved to Google, New York and headed up was very senior guy engineer, software engineer at Google. We have the classic facility. We got ping pong tables. We have a cafe here. We have picnics. We have a huge picnic going up my place on July 7th. There'll be a rock and roll band playing.

There'll be bouncy castles for the kids. There'll be face painters and jugglers and magicians, there'll be airplanes flying around, of course. You know, it's a fun, I think it's a fun place to work. I try to make it that way. And because I'm a banker too, a little bit ulterior reason, the creativity stays up there and the collaboration.

You know, they're sitting, they're eating with my account managers, my executives that manage the relationships are having having lunch every day with my software engineers. So you know, if they're having their sandwich and something didn't work very well, they're going to be complaining over lunch, or they're going to say, "it'd be really good if we could do this."

And you know, it's, it's a collaborative lunchtime ping pong tournament thing, you know, once in a while I might try to entice one of them, go for a ride in my experimental airplane.

So, they're here to remember that cool new ideas that don't turn into money aren't really welcome at VersaBank. Now, mind you, we do have cool new ideas. I try to say, well, "is that going to turn into, are we going to make some money with this? Or is this one of those ones where it sounds really good, but maybe you should give it to somebody else?" You know, we do that. I've done that.

In the early days, we created The first router that was internet updatable before Cisco came out with one and I, I vented it to my friends. So these, the university students get somebody to go back to school with. We called it the web Weaver and, you know, it wasn't for banks to do. It was just, but I needed one. I needed everybody to have simultaneous access to the internet. So, the WebWeaver came about, and then eventually the WebWeaver formed is the great great grandfather of Google's router.

Stuff like that we've done. But it, you know, that's just sort of, it's what you'd expect with a bunch of creative guys. But we try to keep them focused on The mother load.

Key people I'll be hiring in the United States to run the programs, but the, the techie stuff for the most part, we'll, we'll stay where it is. It may very well be as time progresses, we need to Maybe duplicate something somewhere. But right now we're pretty good with what we got.

It's one thing to have the data flowing seamlessly and rapidly and having a little AI, take a look at the data as it's coming in and out to make sure nothing weird is happening. All that stuff we can do, but the actual relationships with our partners is a human relationship. So I, I, I can't skimp on that. So that's an area where we will be growing United States pretty significantly.

So no, I'm thinking more or less Florida is probably where you'd see our administrative office Set up an one our chief risk officers in Florida presently. So probably Florida is an easier place to recruit to. We'll keep Stearns Holdingford as the head office. And we, we will we will be there pretty frequently. We use technology to, to be able to be in front of the real life humans when you need to be. And then we let, we let the tech guys do what tech guys do best, handle data.

And and lean on a little bit of AI from time to time to make sure that we don't miss something.

You know, we humans are pretty good as bankers knowing when something's going a bit awry, but not as good as AI, you know, if you have data flowing in and all of a sudden the, the loan losses on the automobile industry seem to be going a little higher than expected, you know, you take a look at it and then I just get with the, one of the examples I give, it could be for some part of the United States or some part of Canada, that is suffering a little. You get a red flag right off the bat.

And then our, our, our our risk guys are taking a bright, bright to it. Say, what's happening in Alberta? What's happening in Quebec? How come we seem to be seeing this asset class showing a higher loan loss than, than we would have expected? Well, we used, we used the tech side to help us, but we don't try to, you know, replace the humans with a human relationship, hence the picnics and all that stuff.

You know, these are people, homeowners, and they've got a legitimate reason for boring. They're not buying. I shouldn't say this because I drive motorcycles, but. Let's just say the guy that throws his leg over the new bike might not be as same credit risk as the guy who just won a new energy efficient furnace for his house, right? I wouldn't want to cast aspersions at my fellow motorcyclists, but there is a difference in the, in the risk profile. Anyways yeah,

And that's another really good credit risk with hardly any defaults in that. I think

And it's, you know, what we're doing is trying to, it rests on being super efficient to ourselves because we have to be able to present our client with an attractive buy rate, or else this, you know, if we were charging them prime plus two, I mean, there's no chance they could make, they could pay it or make any money on it. It has to be in Canada. We were 250 over government Canada.

So over treasuries and For us, given our efficiency, it works, but, you know, you can't charge them too much or the model doesn't work or they get pushed into really risky loans to get enough yield and then they got loan losses and things start to fall apart.

We're excited to be back and we'll talk to you again soon.