VersaBank - Interim / Quarterly Report 2021

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Management’s Discussion and Analysis

This management’s discussion and analysis (“MD&A”) of operations and financial condition for the first quarter of Fiscal 2021, dated February 22, 2021, should be read in conjunction with the unaudited interim consolidated financial statements for the period ended January 31, 2021, which have been prepared in accordance with International Financial Reporting Standards (“IFRS”). This MD&A should also be read in conjunction with VersaBank’s (the “Bank”) MD&A and Audited Consolidated Financial Statements for the year ended October 31, 2020, which are available on the Bank’s website at www.versabank.com and SEDAR at www.sedar.com. Except as discussed below, all other factors discussed and referred to in the MD&A for the year ended October 31, 2020, remain substantially unchanged.

Cautionary Note Regarding Forward-Looking Statements ................................................... 2 Overview ................................................................................................................................... 3 Update on impact of COVID-19 pandemic .............................................................................. 3 Overview of Performance ........................................................................................................ 5 Selected Financial Highlights ................................................................................................. 7 Business Outlook .................................................................................................................... 8 Financial Review - Earnings ...................................................................................................11 Financial Review - Balance Sheet ..........................................................................................16 Off-Balance Sheet Arrangements ..........................................................................................27 Related Party Transactions ....................................................................................................27 Capital Management and Capital Resources ........................................................................27 Summary of Quarterly Results ...............................................................................................29 Basis of Presentation .............................................................................................................30 Significant Accounting Policies and Use of Estimates and Judgments .............................31 Future Changes in Accounting Policies ................................................................................33 Controls and Procedures .......................................................................................................34

VersaBank – Q1 2021 MD&A

Cautionary Note Regarding Forward-Looking Statements

The statements in this management’s discussion and analysis that relate to the future are forward-looking statements. By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific, many of which are out of the Bank’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 economy in general and the strength of the local economies within Canada in which the Bank conducts operations; the effects of changes in monetary and fiscal policy, including changes in interest rate policies of the Bank of Canada; global commodity prices; the effects of competition in the markets in which the Bank 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 regulating financial services; changes in tax laws; technological changes; unexpected judicial or regulatory proceedings; unexpected changes in consumer spending and savings habits; the impact of COVID-19 and the Bank’s anticipation of and success in managing the risks implicated by the foregoing. For a detailed discussion of certain key factors that may affect our future results, please see our annual MD&A for the year ended October 31, 2020.

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

VersaBank – Q1 2021 MD&A

Overview

VersaBank (the “Bank”) adopted an electronic branchless model in 1993, becoming the world’s first branchless financial institution. It holds a Canadian Schedule 1 chartered bank licence and obtains its deposits, and the majority of its loans and leases, electronically. VersaBank’s Common Shares trade on the Toronto Stock Exchange under the symbol VB and its Series 1 Preferred Shares and Series 3 Preferred Shares trade under the symbols VB.PR.A and VB.PR.B, respectively.

Update on impact of COVID-19 pandemic

The COVID-19 pandemic (“COVID-19”) remains a highly disruptive influence on Canadian society, with the resulting impact on certain segments of the Canadian economy. As a digital bank with a low-risk businessto-business, partner-based model, VersaBank was well positioned for, and highly insulated from, many of the impacts of COVID-19. The Bank has been able to significantly mitigate the impact of COVID-19, as well as benefit from opportunities created by COVID-19, both operationally and financially.

Throughout COVID-19, the Bank has operated, and continues to operate, efficiently and effectively, remaining focused on the safety and wellness of both its employees and clients as well as on continuously evaluating and, where opportunity exists, enhancing its prudent risk management processes and activities. Currently, the vast majority of its clients are reporting that they are currently in good financial health.

COVID-19 has had only a modest impact on the Bank’s financial results. Amidst the initial uncertainty of the economic impact of COVID-19 in Spring 2020, the Bank undertook appreciable precautionary measures to strengthen its liquidity position and has maintained measurably higher than normal, although declining liquidity levels over the last three quarters of fiscal 2020 and the first quarter of 2021, which dampened net income in each of those periods. The Bank continued to moderate its liquidity position in the first quarter of 2021, reducing its cash balances to $212 million, or 10% of assets as at January 31, 2021 (from a high of $395 million or 20.4% of assets early in the third quarter of 2020). During the first quarter of 2021, the Bank’s lending portfolio grew 8% quarter over quarter sequentially and 7% year over year, as the Bank redeployed its cash balances to higher interest generating loans amidst strong activity driven by certain economic shifts resulting from COVID-19 and a strengthened competitive position resulting from the Bank’s financial health due to its cautionary stance during the early days of COVID-19 and its low-risk model.

Cash holdback balances associated with the Bank’s Point-of-Sale Loan and Lease portfolio, the Bank’s largest lending portfolio, remain well in excess of what the Bank has determined to be the intrinsic at-risk loan amount for that portfolio. Initial economic uncertainty resulted in a notable increase in the measurement of expected credit losses (“ECL”) during the second quarter of 2020, however, to date have not progressed to any actual loan losses, and have since normalized. Active loan deferrals declined to nil as at January 31, 2021. The Bank continues to maintain a robust capital position having approximately $70 million in surplus total regulatory capital over the Basel III minimum as at January 31, 2021.

COVID-19 continues to subject businesses, including financial institutions, to measurable uncertainty, both financially and operationally. VersaBank management believes that the Bank remains well-insulated from

VersaBank – Q1 2021 MD&A

potential economic and other impacts of COVID-19, however, our credit risk department continues to operate at a heightened level of awareness, ensuring that our origination and underwriting practices remain highly disciplined and focused. Management also expects to continue to benefit from certain economic impacts of COVID-19. Forward-looking macroeconomic and industry data continues to change at a reasonably high frequency and as a result, management anticipates that estimated ECL amounts will continue to exhibit some volatility well into the current year but that these will continue to be mitigated by the lower risk profile of the Bank’s lending portfolio.

The Bank continues to maintain liquidity levels that are higher than normal, or more specifically higher than pre-COVID-19 levels, however; management expects that the Bank’s liquidity levels will normalize prior to the end of the first half of fiscal 2021.

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

VersaBank – Q1 2021 MD&A

Overview of Performance

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This is a non-GAAP measure. See definition in "Non-GAAP and Additional GAAP Measures" in the Basis of Presentation section below.

Q1 2021 vs Q4 2020

➢ Loans were up 8% to $1.79 billion as a function of growth in the Bank’s commercial real estate portfolio as well as the point of sale loans and leases portfolio.
➢ Net income and EPS were up 11% to $5.3 million and $0.22 respectively.
➢ Total revenue was up 12% to $15.4 million, comprised of net interest income in the amount of $14.4 million and non-interest income in the amount of $1.0 million, the latter derived primarily from the Bank’s technology and cybersecurity operations (See Acquisition of DBG in the Financial Review – Balance Sheet) .
➢ Net interest margin (NIM) was up 4 bps to 2.86%, attributable primarily to lower cost of funds.
➢ Provision for credit losses were $57,000 compared to a recovery of credit losses in the amount of $582,000.

VersaBank – Q1 2021 MD&A

Q1 2021 vs Q1 2020

➢ Total revenue was up 14% as a function of a 6% increase in net interest income and a $1.1 million contribution from the Bank’s technology and cybersecurity operations (See Acquisition of DBG in the Financial Review – Balance Sheet) .
➢ Loans were up 7% as a function of strong growth in the Bank’s commercial real estate portfolio.
➢ Net income was up 3% and EPS was unchanged.
➢ NIM was down 10 bps attributable to lower yields earned on assets offset partially by lower cost of funds.
➢ Provision for credit losses were $57,000 compared to a recovery of credit losses in the amount of $208,000.

Items of note

Q1 2021

➢ On January 4, 2021, the Bank announced the appointment of Peter Irwin to the Bank’s Board of Directors, filling the vacant position left by the sudden passing of Colin E. Litton in December 2020. Mr. Irwin brings to the VersaBank Board more than 30 years of leadership experience in the Canadian financial services industry. His extensive background includes investment banking, capital markets, corporate development, merchant banking and private equity.
➢ On November 30, 2020, the Bank’s wholly owned subsidiary DRT Cyber Inc. (“DRTC”) acquired 100% of the shares of 2021945 Ontario Inc., operating as Digital Boundary Group (“DBG”), in exchange for $8.5 million in cash and a deferred payment obligation of $1.4 million, for total consideration of $9.9 million. See Acquisition of DBG in the Financial Review – Balance Sheet section below for details.
➢ The Bank re-organized its broad lending asset categories to more effectively catalogue it’s lending assets as a function of the underlying key risk drivers and collateral as well as the applicable market segment. These changes have no impact on our reported aggregated results. See Loans in the Financial Review – Balance Sheet section below for details.

Q4 2020

➢ The Bank recognized a recovery of credit losses in the amount of $582,000 attributable primarily to the partial early repayment and restructuring of multiple commercial real estate loans with exposure to the travel and tourism industry and improved key macroeconomic indicator trends included in the macroeconomic scenario data used as forward-looking information in the Bank’s credit risk models.

Q1 2020

➢ No items of note.

VersaBank – Q1 2021 MD&A

Selected Financial Highlights

(unaudited)		As at or for the three months	As at or for the three months	As at or for the three months	As at or for the three months	ended
	January 31		October 31		January 31
(thousands of Canadian dollars exceptper share amounts)		2021		2020		2020
Results of operations
Interest income	$	21,515	$	21,068	$	22,166
Net interest income		14,374		13,708		13,557
Non-interest income (loss)		1,048		18		25
Total revenue		15,422		13,726		13,582
Provision (recovery) for credit losses		57		(582)		(208)
Non-interest expenses		8,087		7,763		6,705
Core cash earnings*		7,278		6,545		7,085
Core cash earnings per common share*	$	0.34	$	0.31	$	0.34
Net income		5,290		4,746		5,141
Income per common share:
Basic	$	0.22	$	0.20	$	0.22
Diluted	$	0.22	$	0.20	$	0.22
Dividends paid on preferred shares	$	542	$	542	$	542
Dividendspaid on common shares	$	528	$	528	$	528
Yield*		4.28%		4.33%		4.84%
Cost of funds*		1.42%		1.51%		1.88%
Net interest margin*		2.86%		2.82%		2.96%
Return on average common equity*		8.26%		7.46%		8.60%
Core cash return on average common equity*		11.72%		10.66%		12.23%
Book value per common share*	$	10.90	$	10.70	$	10.17
Efficiency ratio*		52%		57%		49%
Return on average total assets*		0.94%		0.86%		1.01%
Gross impaired loans to total loans*		0.00%		0.00%		0.38%
Provision(recovery)for credit losses as a % of average loans*		0.01%		(0.14%)		(0.01%)

Balance Sheet Summary
Cash and securities	$	212,016	$	257,644	$	134,253
Loans, net of allowance for credit losses		1,793,724		1,654,910		1,668,720
Average loans*		1,724,317		1,601,336		1,631,504
Total assets		2,044,976		1,943,885		1,854,765
Average assets*		1,994,431		1,937,071		1,820,073
Deposits		1,664,694		1,567,570		1,454,979
Subordinated notes payable		4,891		4,889		4,883
Shareholders' equity		259,508		255,288		244,234
Capital ratios*
Risk-weighted assets	$	1,721,935	$	1,580,939	$	1,558,070
Common Equity Tier 1 capital		214,851		219,359		203,399
Total regulatory capital		251,020		255,471		237,736
Common Equity Tier 1 (CET1) capital ratio		12.48%		13.88%		13.05%
Tier 1 capital ratio		14.18%		15.73%		14.94%
Total capital ratio		14.58%		16.16%		15.26%
Leverage ratio		11.40%		12.19%		11.86%

This is a non-GAAP measure. See definition in "Non-GAAP and Additional GAAP Measures" in the Basis of Presentation section below.

VersaBank – Q1 2021 MD&A

Business Outlook

The Bank remains active in niche markets that support modestly better pricing for its lending products, and further, continues to develop and expand its diverse deposit gathering network which provides efficient access to a range of low-cost deposit sources. In addition, the Bank 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 the Bank’s chosen niche lending and deposit markets, but also delivers superior financial products and better customer service to its clients.

Despite the challenges brought upon by COVID-19, the Bank continues to operate efficiently and effectively, and further, has remained focused on the safety and wellness of both its employees and clients as well as on continuously evaluating and, where opportunity exists enhancing its prudent risk management processes and activities. Having said this, we are pleased to report that currently we have no loans on our balance sheet that are subject to payment deferrals, and further, that the vast majority of our clients are reporting that they are currently in good financial health. Our staff continues to work remotely leveraging our fully functional Work-From-Home solution which was a natural and seamless evolution of the Bank’s branchless, technology-driven model.

While the Bank does not provide guidance on specific performance metrics we provide commentary below related to aspects of our business and certain expected trends related to same that could potentially impact future performance.

Lending Assets

➢ The Bank expects to continue to see strong, high quality deal flow in the commercial mortgage space over the course of fiscal 2021 due to a number of factors including its strong relationships with numerous originators and brokers in the multi-unit residential rental sector and the attractive mortgage rates that are and will remain available to firms who are in a position to deploy capital into commercial real estate assets. Management anticipates that the Bank will continue to see a high volume of opportunities in the multi-unit residential rental sector, which is considered one of the most stable and low-risk sectors in the real estate market.
➢ Recent elevated savings rates resulting from consumers general inability to spend and the impact of the various federal fiscal stimulus programs, combined with a low, stable interest rate environment, are expected to support robust consumer spending in the short to medium term on home improvements, as well as home purchases for which the Bank’s point of sale loan and lease origination partners provide financing. This, combined with the anticipated addition of new origination partners, is expected to drive higher purchase volumes in the coming quarters.

Credit Quality

➢ The Bank lends to niche markets that support modestly better pricing for its lending products but typically exhibit a lower than average risk profile as a function of the lower inherent risk associated with the underlying collateral assets and/or the structure of the Bank’s offered financing arrangements.

VersaBank – Q1 2021 MD&A

➢ We currently have no loans on our balance sheet that are subject to payment deferrals, but we continue to monitor our lending portfolio, as well as the underlying borrowers and our origination partners closely to ensure that we have good visibility on any credit trends that could provide an early warning indication of the emergence of any elevated risk in our lending portfolio.
➢ Forward-looking macroeconomic and industry data continues to change at a reasonably high frequency and as a result, management anticipates that estimated ECL amounts will continue to exhibit volatility well into the current year. Notwithstanding the above, the Bank also expects that the magnitude of the volatility exhibited in its forward ECL amounts will continue to be mitigated by the lower risk profile of the Bank’s lending portfolio that remains a function of the Bank’s prudent underwriting practices and its focus on niche financing markets within which it has a wealth of experience.
➢ The Bank has sourced credit risk modeling systems and forecast macroeconomic scenario data from Moody’s Analytics 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 credit risk modeling systems are integrated with the Bank’s internally developed ECL models. Currently we are seeing improving trends in the macroeconomic data used as forward-looking information for use in estimating our ECL, which could potentially result in the Bank recognizing lower provisions for credit losses or potentially even recognizing recoveries in the coming quarters, depending on the growth trajectory and composition of our lending portfolio. However, if the performance of the Canadian economy is not aligned with the current macroeconomic forecast trends, and further, begins to deteriorate more rapidly and deeply, our borrowers could be exposed to additional credit risk that could have an unfavourable impact on the Bank’s loan deferral trends, loan default trends and in the estimation of ECL.

Funding and Liquidity

➢ Funding costs have declined year over year and are expected to continue to decline over the course of fiscal 2021 as a function of anticipated growth in our commercial deposits and the expectation of a sustained low interest rate environment for at least the medium term. Government of Canada Bond yield trends, which effect loan yields, are expected to remain compressed over the course of fiscal 2021 which may result in some modest yield compression for the Bank; however, management does not anticipate that this will translate into NIM compression due to the expectation of lower, incremental cost of funds.
➢ The Bank continues to maintain liquidity levels that are higher than normal, or more specifically higher than pre-pandemic levels; however, management expects that the Bank’s liquidity levels will normalize prior to the end of the first half of fiscal 2021 and will continue to positively influence NIM.
➢ The Bank continues to develop and expand its diverse deposit gathering network that provides efficient access to a range of low-cost deposit sources that drives its low cost of funds. Management expects that the impact of COVID-19 on household finances has the potential to increase the rate at which it is able to grow its commercial deposit base as a function of an anticipated increase in the volume of

VersaBank – Q1 2021 MD&A

consumer bankruptcy and proposal restructuring proceedings that will be administered by Canadian insolvency professionals over the course of fiscal 2021.

Earnings and Capital

➢ Management expects earnings to grow in fiscal 2021 as a function primarily of anticipated balance sheet growth and incremental earnings contributions from the Bank’s technology and cybersecurity operations.
➢ Net interest income is expected to be up year over year attributable to the expansion of both of our core business lines across key existing as well as new asset categories, the redeployment of excess liquidity into higher yielding lending assets and the expectation of cost of funds continuing to trend lower over the course of the year.
➢ Non-interest expense is expected to grow year over year as a function of the consolidation of the operating expenses of Digital Boundary Group, which was acquired by the Bank’s wholly owned subsidiary DRT Cyber Inc. on November 30, 2020, as well as some additional investment in support of expanding the Bank’s technology and cybersecurity operations.
➢ The Bank’s capital ratios are currently comfortably in excess of regulatory minimums but are anticipated to decline marginally over the course of the year as a result of risk weighted asset growth from new loan fundings, the impact of which will be offset partially by earnings growth. Management is of the view that the Bank’s capital levels are sufficient to accommodate expected short term balance sheet growth; however, management continues to closely monitor the capital markets to identify opportunities for the Bank to raise additional capital on attractive terms in order to position the Bank to support balance sheet growth in the medium to long term.
➢ The Bank does not anticipate that it will increase its dividend rate until, at the earliest, OSFI has lifted its current restriction on increasing distributions to shareholders that was originally announced on March 13, 2020 as one of the measures OSFI was undertaking to mitigate the various financial stresses imposed on Federally Regulated Deposit-Taking Institutions derived from the onset of COVID-19.

There is potential that the Bank may not realize or achieve the expected or anticipated performance trends set out above as a function of a number of factors and variables including, but not limited to, the strength of the Canadian economy in general and the strength of the local economies within Canada in which the Bank conducts operations; the effects of changes in monetary and fiscal policy, including changes in interest rate policies of the Bank of Canada; global commodity prices; the effects of competition in the markets in which the Bank 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 regulating financial services; and the impact of COVID-19 on the Canadian economy. Please see “Cautionary Note Regarding Forward-Looking Statements” on page 2 of this MD&A.

VersaBank – Q1 2021 MD&A

Financial Review - Earnings

Total Revenue

Total revenue, which consists of net interest income and non-interest income, for the quarter was up 12% to $15.4 million compared to last quarter and was up 14% compared to the same period a year ago attributable to higher net interest income and non-interest income.

Net Interest Income

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(thousands of Canadian dollars)
January 31 October 31 January 31
For the three months ended: 2021 2020 Change 2020 Change
Interest income
Commercial real estate mortgages $ 9,110 $ 9,024 1% $ 8,387 9%
Commercial real estate loans 342 269 27% 358 (4%)
Point of sale loans and leases 11,501 11,107 4% 12,239 (6%)
Public sector and other financing 133 136 (2%) 290 (54%)
Other 429 532 (19%) 892 (52%)
Interest income $ 21,515 $ 21,068 2% $ 22,166 (3%)
Interest expense
Deposit and other $ 7,014 $ 7,233 (3%) $ 8,482 (17%)
Subordinated notes 127 127 0% 127 0%
Interest expense $ 7,141 $ 7,360 (3%) $ 8,609 (17%)
Net interest income $ 14,374 $ 13,708 5% $ 13,557 6%
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Q1 2021 v Q4 2020

Net interest income was up 5% to $14.4 million attributable primarily to:

➢ Higher interest income earned as a function primarily of growth in the Bank’s commercial real estate mortgages and loans and point of sale loans and leases portfolios.
➢ Redeployment of cash into higher yielding lending assets in the current quarter; and,
➢ Lower interest expense.

Offset partially by:

➢ Higher fees recognized in the comparative quarter attributable primarily to the partial, early repayment of multiple commercial real estate loans with exposure to the travel and tourism industry.

VersaBank – Q1 2021 MD&A

Q1 2021 v Q1 2020

Net interest income was up 6% attributable primarily to:

➢ Higher interest income driven by growth in the Bank’s commercial real estate mortgages and loans portfolios.
➢ Lower interest expense attributable largely to growth in the operating accounts that the Bank makes available to Canadian insolvency professionals.

Offset partially by:

➢ Lower interest income from point of sale loans and leases
➢ Lower yields earned on higher cash balances.
➢ Lower yields earned on floating rate lending assets attributable primarily to the accommodative monetary policy established by the Bank of Canada early in the spring of 2020.

Net Interest Margin

(thousands of Canadian dollars)
	January 31		October 31			January 31
Forthe threemonths ended:		2021		2020	Change		2020	Change
Interest income	$	21,515	$	21,068	2%	$	22,166	(3%)
Interest expense		7,141		7,360	(3%)		8,609	(17%)
Net interest income		14,374		13,708	5%		13,557	6%
Average assets	$	1,994,431	$	1,937,071	3%	$	1,820,073	10%
Yield		4.28%		4.33%	(1%)		4.84%	(12%)
Cost of funds		1.42%		1.51%	(6%)		1.88%	(24%)
Net interest margin		2.86%		2.82%	1%		2.96%	(3%)

Q1 2021 v Q4 2020

Net interest margin was up 4 bps attributable primarily to:

➢ Redeployment of cash into higher yielding lending assets over the course of the current quarter; and, ➢ Lower cost of funds.

Offset partially by:

➢ Lower yields earned in the current quarter attributable to a high volume of commercial real estate loan fundings occurring late in the period.

VersaBank – Q1 2021 MD&A

Q1 2021 v Q1 2020

Net interest margin was down 10 bps attributable primarily to:

➢ Lower yields earned on floating rate lending assets attributable primarily to the accommodative monetary policy established by the Bank of Canada early in the spring of 2020.
➢ Lower yields earned on higher cash balances.

Offset partially by:

➢ Lower cost of funds attributable largely to growth in the operating accounts that the Bank makes available to Canadian insolvency professionals.

Non-Interest Income

Non-interest income for the quarter was $1.0 million compared to $18,000 last quarter and $25,000 for the same period a year ago. Non-interest income recognized in the current quarter reflects the consolidation of the gross profit of DBG in the amount of $1.1 million earned in the last two months of the current quarter realized on sales of $1.7 million over the same period. Non-interest income from prior periods relates to income derived from miscellaneous transaction fees not directly attributable to lending assets. For further details on the Bank’s acquisition of DBG see Acquisition of DBG in the Financial Review – Balance Sheet section below.

Provision for Credit Losses

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(thousands of Canadian dollars)
January 31 October 31 January 31
For the three months ended: 2021 2020 Change 2020 Change
Provision for (recovery of) credit losses by lending asset:
Commercial real estate mortgages $ 147 $ (500) (129%) $ (247) (160%)
Commercial real estate loans (65) (36) 81% (9) 622%
Point of sale loans and leases (8) (5) 60% 47 (117%)
Public sector and other financing (17) (41) (59%) 1 (1800%)
Total provision for (recovery of) credit losses $ 57 $ (582) (110%) $ (208) (127%)
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Provision for credit losses represent the change in the Bank’s estimated ECL, net of any recoveries, relative to the comparative periods. ECL is the allowance or reserve that management has estimated and set aside on the Bank’s balance sheet to absorb all future credit related losses in the Bank’s lending and treasury portfolios. ECL is discussed in detail in the Credit Quality and Allowance for Credit Losses section below.

VersaBank – Q1 2021 MD&A

The Bank recorded a provision for credit losses in the amount of $57,000 for the current quarter compared to a recovery of credit losses in the amount $582,000 last quarter and a recovery of credit losses in the amount of $208,000 for the same period a year ago. The quarter over quarter trend was a function primarily of higher lending asset balances and net remeasurements of expected credit losses attributable to changes in the forward-looking information used by the Bank in its credit risk models in the current quarter as well as the impact of the partial, early repayment and restructuring of multiple commercial real estate loans with exposure to the travel and tourism industry last quarter. The year over year trend was a function of higher lending asset balances, net remeasurements of expected credit losses attributable to changes in the forward-looking information used by the Bank in the current quarter as well as net remeasurements of expected credit losses attributable to the impact of planned refinements to specific real estate asset loan and credit data inputs introduced in the third quarter of fiscal 2020.

Non-Interest Expenses

(thousands of Canadian dollars)

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January 31 October 31 January 31
For the three months ended: 2021 2020 Change 2020 Change
Salaries and benefits $ 5,030 $ 5,168 (3%) $ 3,939 28%
General and administrative 2,339 1,965 19% 2,171 8%
Premises and equipment 718 630 14% 595 21%
Total non-interest expenses $ 8,087 $ 7,763 4% $ 6,705 21%
Efficiency Ratio 52.44% 56.56% (7%) 49.37% 6%
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Q1 2021 v Q4 2020

Non-interest expenses were up 4% to $8.1 million attributable primarily to:

➢ The consolidation of the operating expenses of Digital Boundary Group which was acquired by the Bank’s wholly owned subsidiary DRT Cyber Inc. on November 30, 2020, (See Acquisition of DBG in the Financial Review – Balance Sheet section below for details) in the amount of $594,000;
➢ Increased salary and benefits attributable to staffing levels to support expanded business activity across the Bank.

Offset partially by:

➢ Lower salary and benefits expense in the current period as a result of higher staff related costs recognized in the comparative period that included higher vacation expense accruals resulting principally from employees taking less vacation time as a result of COVID-19 limiting travel and tourism opportunities.

VersaBank – Q1 2021 MD&A

Q1 2021 v Q1 2020

Non-interest expenses were up 21% attributable primarily to:

➢ Consolidation of the operating expenses of DBG in the amount of $594,000;
➢ Increased salary and benefits attributable to increased staff levels to support expanded business activity across the Bank; and,
➢ Investments in the Bank’s corporate development initiatives.

Tax Provision

The Bank’s tax rate is approximately 27%, similar to that of previous periods. The tax rate is impacted by certain items not being taxable or deductible for income tax purposes. Provision for income taxes for the current quarter was $2.0 million compared to $1.8 million last quarter and $1.9 million for the same period a year ago.

VersaBank – Q1 2021 MD&A

Financial Review - Balance Sheet

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(thousands of Canadian dollars)
January 31 October 31 January 31
2021 2020 Change 2020 Change
Total assets $ 2,044,976 $ 1,943,885 5% $ 1,854,765 10%
Cash and securities 212,016 257,644 (18%) 134,253 58%
Loans, net of allowance for credit losses 1,793,724 1,654,910 8% 1,668,720 7%
Deposits 1,664,694 1,567,570 6% 1,454,979 14%
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Total Assets

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Total assets at January 31, 2021 were $2.04 billion compared to $1.94 billion last quarter and $1.85 billion a year ago. The quarter over quarter and year over year trends were a function of lending asset growth as well as the consolidation of the assets of Digital Boundary Group which was acquired by the Bank’s wholly owned subsidiary DRT Cyber Inc. on November 30, 2020, (see Acquisition of DBG in the Financial Review – Balance Sheet section below for details).

VersaBank – Q1 2021 MD&A

Acquisition of DBG

On November 30, 2020, the Bank through its wholly owned subsidiary DRT Cyber Inc. (“DRTC”), acquired 100% of the shares of 2021945 Ontario Inc., operating as Digital Boundary Group (“DBG”), in exchange for $8.5 million in cash and a deferred payment obligation in the amount of $1.4 million, for total consideration of $9.9 million. The acquisition was accounted for in accordance with IFRS 3 Business Combinations and DBG’s financial results, since closing, have been included in the Bank’s interim consolidated financial statements.

DBG is one of North America’s premier information technology (IT) security assurance services firms with offices in London, Ontario and Dallas, Texas. DBG provides corporate and government clients with a suite of IT security assurance services, that range from external network, web and mobile application penetration testing through to physical social engineering engagements along with supervisory control and data acquisition (SCADA) system assessments, as well as various aspects of training.

The following table summarizes the preliminary fair value of the assets acquired and liabilities assumed on acquisition:

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(thousands of Canadian dollars)
November 30
Assets and liabilities acquired at fair value 2020
Cash $ 1,057
Accounts recievable 1,451
Right-of-use assets 2,473
Other assets 1,194
Intangible assets 3,940
Goodwill 5,754
Deferred income tax liability (898)
Lease obligations (2,650)
Other liabilities (2,381)
$ 9,940
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Intangible assets include customer relationships, brands, non-compete agreements and operational software. Goodwill primarily reflects the value of an assembled workforce and the value of future growth prospects and expected business synergies realized as a result of combining the acquired business with the Bank’s existing technology and cybersecurity operations. The goodwill as well as portions of the intangible assets are not deductible for income tax purposes. See Note 4 to the unaudited interim consolidated financial statements for additional information relating to the acquisition of DBG.

Cash and Securities

Cash and securities, which are held primarily for liquidity purposes, were $212.0 million or 10.4% of total assets at January 31, 2021 compared to $257.6 million or 13.3% of total assets last quarter and $134.3 million or 7.2% of total assets a year ago. The quarter over quarter trend was a function primarily of the

VersaBank – Q1 2021 MD&A

Bank redeploying cash into higher yielding lending assets in an effort to reduce the Bank’s liquidity levels to be more in line with normal operating levels. The year over year trend was a function primarily of the Bank strengthening its liquidity position over the course of the second quarter of fiscal 2020 as a prudent liquidity practice in response to the economic uncertainty resulting from the onset of the COVID-19.

Loans

(thousands of Canadian dollars)

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January 31 October 31 January 31
2021 2020 Change 2020 Change
Commercial real estate mortgages $ 712,256 $ 606,299 17% $ 539,977 32%
Commercial real estate loans 31,663 25,574 24% 22,830 39%
Point of sale loans and leases 1,008,029 980,677 3% 1,061,207 (5%)
Public sector and other financing 36,612 37,596 (3%) 39,894 (8%)
$ 1,788,560 $ 1,650,146 8% $ 1,663,908 7%
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Commencing fiscal 2021, the Bank re-organized its lending portfolio into the following four broad asset categories; Commercial Real Estate Mortgages, Commercial Real Estate Loans, Point of Sale Loans & Leases, 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 Commercial Real Estate Mortgages (“CRE Mortgages”) asset category is comprised of Commercial and Residential Construction Mortgages, Commercial Term Mortgages, Commercial Insured Mortgages and Land Mortgages. While all of these loans would be considered commercial loans or business-tobusiness loans, the underlying credit risk exposure is diversified across both the commercial and retail market segments, and further, the portfolio benefits from diversity in its underlying security in the form of a broad range of collateral properties.

The Commercial Real Estate Loans (“CRE Loans”) asset category is comprised primarily of Condominium Corporation Financing loans and loans to Mortgage Investment companies.

The Point of Sale Loans and Leases (“Point of Sale”) asset category is comprised of point of sale loan and lease receivables acquired from the Bank’s broad 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 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. The Bank has de-emphasized Corporate lending and continues to monitor the public sector space in anticipation of more robust demand for Federal, Provincial and Municipal infrastructure and other project financings, partially in response to additional Government policy measures that may be established to support the recovery of the Canadian economy.

VersaBank – Q1 2021 MD&A

Q1 2021 v Q4 2020

Loans were up 8% to $1.79 billion attributable primarily to:

➢ Higher CRE Mortgage balances derived from increased origination activity in our land and construction loan portfolios, term mortgage portfolios and loans to mortgage investment companies.
➢ Higher Point-of-Sale receivable balances due primarily to higher auto as well as home improvement/HVAC loan and lease receivable purchases.

Q1 2021 v Q1 2020

Loans were up 7% attributable primarily to:

➢ Higher CRE Mortgage balances derived from increased origination activity in our land and construction loan portfolios as well as loans to mortgage investment companies.

Offset partially by:

➢ Lower Point-of-Sale receivable balances as a function primarily of the negotiated, early repurchase of three portfolios of loan and lease receivables by the Bank’s point of sale origination partners over the course of the second and third quarter of fiscal 2020.

Residential Mortgage Exposures

In accordance with the Office of the Superintendent of Financial Institutions (“OSFI”) Guideline B-20 – Residential Mortgage Underwriting Practices and Procedures, additional information is provided regarding the Bank’s residential mortgage exposure. For the purposes of the Guideline, a residential mortgage is defined as a loan to an individual that is secured by residential property (one to four unit dwellings) and includes home equity lines of credit (HELOCs). This differs from the classification of residential mortgages used by the Bank which also includes multi-family residential mortgages.

Under OSFI’s definition, the Bank’s exposure to residential mortgages at January 31, 2021 was $4.1 million compared to $4.1 million last quarter and $1.7 million a year ago. The Bank did not have any HELOC’s outstanding at January 31, 2021, last quarter or a year ago.

Credit Quality and Allowance for Credit Losses

As discussed previously, we currently have no loans on our balance sheet that are subject to payment deferrals, but we continue to monitor our lending portfolio, as well as the underlying borrowers and our origination partners very closely to ensure that we have good visibility on any credit trends that could provide an early warning indication of the emergence of any elevated risk in our lending portfolio.

VersaBank – Q1 2021 MD&A

Allowance for Credit Losses

The Bank must maintain an allowance for expected credit losses or ECL allowance 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 ECL allowance 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.

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(thousands of Canadian dollars)
January 31 October 31 January 31
2021 2020 Change 2020 Change
ECL allowance by lending asset:
Commercial real estate mortgages $ 1,513 $ 1,366 11% $ 1,525 (1%)
Commercial real estate loans 72 137 (47%) 69 4%
Point of sale loans and leases 207 215 (4%) 276 (25%)
Public sector and other financing 40 57 (30%) 41 (2%)
Total ECL allowance $ 1,832 $ 1,775 3% $ 1,911 (4%)
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(thousands of Canadian dollars)

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January 31 October 31 January 31
2021 2020 Change 2020 Change
ECL allowance by stage:
ECL allowance stage 1 $ 1,665 $ 1,583 5% $ 1,675 (1%)
ECL allowance stage 2 167 192 (13%) 236 (29%)
- - -
ECL allowance stage 3
Total ECL allowance $ 1,832 $ 1,775 3% $ 1,911 (4%)
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The Bank’s ECL allowance at January 31, 2021 was $1.8 million compared to $1.8 million last quarter and $1.9 million a year ago. The quarter over quarter trend was a function primarily of higher lending asset balances and net remeasurements of expected credit losses attributable to changes in the forward-looking information used by the Bank in its credit risk models in the current quarter as well as the impact of the partial, early repayment and restructuring of multiple commercial real estate loans with exposure to the travel and tourism industry last quarter. The year over year trend was a function of lending asset growth, net remeasurements of expected credit losses attributable to changes in the forward-looking information used by the Bank in the current quarter as well as net remeasurements of expected credit losses attributable to the impact of planned refinements to specific real estate asset loan and credit data inputs introduced in the third quarter of fiscal 2020.

The Bank’s gross impaired loans at January 31, 2021 were $nil compared to $nil last quarter and $6.4 million a year ago. The year over year trend was a function of the repayment in full of an impaired commercial real estate loan in the fourth quarter of fiscal 2020.

VersaBank – Q1 2021 MD&A

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.

Since the onset of COVID-19 management undertook to continuously review and assess the Bank’s SICR methodology in the context of the material deterioration in macroeconomic conditions precipitated by COVID-19 with specific focus on the potential impact of deferrals, concessions or restructuring of principal and interest payments and has determined that such arrangements on their own do not qualify as a SICR. Further, and as a result of its review and assessment process, management has concluded that the determination of a SICR remains 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, and more specifically changes attributable to the continued impact of COVID-19 on the Canadian economy and the Bank’s business such as more restrictive measures imposed by the government related to public activity and the timeline associated with the roll out of the vaccines.

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 probability of default (“PD”) and loss given default (“LGD”) term structure forecasts for its loans. The Bank has sourced credit risk modeling systems and forecast macroeconomic scenario data from Moody’s Analytics 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 credit risk modeling systems are integrated 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 integration of unbiased, third party forward-looking 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

VersaBank – Q1 2021 MD&A

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 experienced credit judgment, where appropriate, to reflect the impact of the highly uncertain environment on the economy as a result of COVID-19 .

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.

The forecast macroeconomic scenario data utilized by the Bank in the current quarter consistently demonstrate generally more favourable trends relative to the forecast macroeconomic scenario data utilized in the previous quarter. Key assumptions driving the forecast macroeconomic trends this quarter include the efficacy of the vaccines and the timeline for the distribution of same, the timing associated with the peaking of COVID-19 cases, the timing and nature of small and medium sized businesses reopening, national and regional unemployment levels, the nature of the Bank of Canada’s continued monetary policy response and the scope, and continued availability of the federal government’s various, existing stimulus programs. Although the current forecast data suggests that the economy will generally improve more rapidly over the course of the next 12 months relative to the forecast data last quarter, the majority of the current macroeconomic trends continue to exhibit volatility to various degrees over the course of the next 18 – 24 months.

Further, management developed ECL estimates using credit risk parameter term structure forecasts sensitized to individual baseline, upside, downside, and severe downside forecast macroeconomic scenarios, each weighted at 100%, and subsequently computed the variance of each to the Bank’s reported ECL as at January 31, 2021 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).

VersaBank – Q1 2021 MD&A

A summary of the key forecast macroeconomic indicator data trends utilized by the Bank for the purpose of sensitizing lending asset credit risk parameter term structure forecasts to forward looking information, which in turn are used in the estimation of the Bank’s reported ECL, as well as in the assessment of same are presented in charts below.

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Expected Credit Loss Sensitivity:

The following table presents the sensitivity of the Bank’s estimated ECL to a range of individual forecast 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 January 31, 2021:

(thousands of Canadian dollars)
		Reported 100% ECL Upside	100% 100% 100% Severe Baseline Downside Downside
Allowance for credit losses	$	1,832 979 $	1,267 $ 2,054 $ 2,121 $
Variance from reported ECL Variance from reported ECL (%)		(853) (47%)	(565) 222 289 (31%) 12% 16%

Management anticipates that forward-looking macroeconomic and industry data will continue to change, specifically related to the economy’s anticipated recovery trajectory and as a result, expects that the Bank’s estimated ECL amounts will continue to exhibit some volatility over the course of fiscal 2021.

VersaBank – Q1 2021 MD&A

Considering the analysis set out above and based on management’s review of the loan and credit data comprising the Bank’s lending portfolio, combined with our interpretation of the available forecast macroeconomic and industry data, management is of the view that its reported ECL allowance is a reasonable proxy for potential, future losses.

Deposits

The Bank has established three core funding channels, those being personal deposits, commercial deposits, and cash holdbacks retained from the Bank’s point of sale loans and leases origination partners that are classified as other liabilities, which are discussed in the Other Assets and Liabilities section below.

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(thousands of Canadian dollars)
January 31 October 31 January 31
2021 2020 Change 2020 Change
Commercial deposits $ 523,471 $ 508,370 3% $ 440,903 19%
Personal deposits 1,141,223 1,059,200 8% 1,014,076 13%
Total deposits $ 1,664,694 $ 1,567,570 6% $ 1,454,979 14%
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Personal deposits, consisting principally of guaranteed investment certificates, are sourced primarily through a well-established and well-diversified deposit broker network that the Bank continues to grow and expand across Canada.

Commercial deposits are sourced primarily via specialized operating accounts made available to insolvency professionals (“Trustees”) in the Canadian insolvency industry. The Bank developed customized banking software for use by Trustees that integrates banking services with the market-leading software platform used in the administration of consumer bankruptcy and proposal restructuring proceedings.

Q1 2021 v Q4 2020

Deposits were up 6% to $1.7 billion attributable primarily to:

➢ The Bank raising additional broker deposits to fund loan growth and manage liquidity targets; and
➢ Higher commercial deposits resulting from continued organic growth and growth in the number of Trustees that have established operating accounts with the Bank.

Q1 2021 v Q1 2020

Deposits were up 14% attributable primarily to:

➢ The Bank raising additional broker deposits to fund loan growth and manage its liquidity levels; and,
➢ Higher commercial deposit balances resulting from continued organic growth and growth in the number of Trustees that have established operating accounts with the Bank.

VersaBank – Q1 2021 MD&A

Other Assets and Liabilities

Other Assets

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(thousands of Canadian dollars)
January 31 October 31 January 31
2021 2020 Change 2020 Change
Accounts receivable $ 2,605 $ 268 872% $ 1,443 81%
Funds held for securitization liabilities - 8,629 (100%) 22,309 (100%)
Prepaid expenses and other 9,726 6,843 42% 7,226 35%
Deferred income tax asset 4,286 5,145 (17%) 9,899 (57%)
Property and equipment 7,643 7,431 3% 7,765 (2%)
Right-of-use assets 5,337 3,015 77% 3,150 69%
Goodwill 5,753 - -
Intangible assets 3,886 - -
Total other assets $ 39,236 $ 31,331 25% $ 51,792 (24%)
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Q1 2021 v Q4 2020

Other assets were up 25% to $39.2 million attributable primarily to:

➢ The consolidation of the assets of DBG which was acquired by the Bank’s wholly owned subsidiary DRT Cyber Inc. on November 30, 2020 comprised of $5.1 million of tangible assets as well as $3.9 million of intangible assets and $5.8 million of goodwill.

Offset partially by:

➢ Funds paid to offset the redemption of maturing securitization liabilities; and
➢ Draw downs on the deferred income tax asset derived from taxable income generated by the Bank over the course of the respective period.

Q1 2021 v Q1 2020

Other assets were down 24% attributable primarily to:

➢ Funds paid to offset the redemption of maturing securitization liabilities; and
➢ Draw downs on the deferred income tax asset derived from taxable income generated by the Bank over the course of the respective periods.

Offset partially by:

➢ The consolidation of the assets of DBG which was acquired by the Bank’s wholly owned subsidiary DRT Cyber Inc. on November 30, 2020.

VersaBank – Q1 2021 MD&A

Other Liabilities

(thousands of Canadian dollars)

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January 31 October 31 January 31
2021 2020 Change 2020 Change
Accounts payable and other $ 6,411 $ 4,233 52% $ 2,570 150%
Deferred income tax liability 898 - -
Lease obligations 5,598 3,084 82% 3,164 77%
Cash collateral and amounts held in escrow 3,379 4,012 (16%) 6,291 (46%)
Holdbacks payable on loan and lease receivables 99,597 96,064 4% 105,256 (5%)
Total other liabilities $ 115,883 $ 107,393 8% $ 117,281 (1%)
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Q1 2021 v Q4 2020

Other liabilities were up 8% to $115.9 million attributable primarily to:

➢ The consolidation of the assumed liabilities of DBG which was acquired by the Bank’s wholly owned subsidiary DRT Cyber Inc. on November 30, 2020 in the amount of $5.9 million; and
➢ Higher holdbacks payable balances attributable to higher Point of Sale receivable balances.

Offset partially by:

➢ Lower cash collateral balances held in escrow.

Q1 2021 v Q1 2020

Other liabilities were down 1% attributable primarily to:

➢ Lower holdbacks payable balances attributable to lower Point of Sale loan and lease receivable balances; and
➢ Lower cash collateral balances held in escrow.

Offset partially by:

➢ The assumption of liabilities totaling $5.9 million associated with the acquisition of DBG.

Shareholders’ Equity

Shareholders’ equity was $259.5 million at January 31, 2021 compared to $255.3 million last quarter and $244.2 million a year ago. The quarter over quarter and year over year trends were a function primarily of net income earned offset partially by the payment of dividends.

The Bank’s book value per common share at January 31, 2021 was $10.90 compared to $10.70 last quarter and $10.17 a year ago with the increase being a function primarily of net income earned offset partially by the payment of dividends over the respective periods.

VersaBank – Q1 2021 MD&A

See Note 10 to the unaudited interim consolidated financial statements for additional information relating to share capital.

Updated Share Information

As at February 22, 2021, there were no changes since January 31, 2021 in the number of common shares, Series 1 and Series 3 preferred shares, and common share options outstanding.

Off-Balance Sheet Arrangements

As at January 31, 2021, the Bank did not have any significant off-balance sheet arrangements other than loan commitments and letters of credit resulting from normal course business activities. See Note 13 to the unaudited interim consolidated financial statements for more information.

Related Party Transactions

The Bank’s Board of Directors and senior executive officers represent key management personnel. See Note 14 to the unaudited interim consolidated financial statements for additional information on related party transactions and balances.

Capital Management and Capital Resources

The table below presents the Bank’s regulatory capital position, risk-weighted assets and regulatory capital and leverage ratios for the current and comparative periods.

(thousands of Canadian dollars)
		January 31		October 31			January 31
		2021		2020	Change		2020	Change
Common EquityTier 1capital	$	214,851	$	219,359	(2%)	$	203,399	6%

Total Tier 1capital	$	244,188	$	248,696	(2%)	$	232,736	5%

Total Tier 2capital	$	6,832	$	6,775	1%	$	5,000	37%

Total regulatory capital	$	251,020	$	255,471	(2%)	$	237,736	6%

Total risk-weighted assets	$	1,721,935	$	1,580,939	9%	$	1,558,070	11%
Capital ratios
CET1 capital ratio		12.48%		13.88%	(10%)		13.05%	(4%)
Tier 1 capital ratio		14.18%		15.73%	(10%)		14.94%	(5%)
Total capital ratio		14.58%		16.16%	(10%)		15.26%	(4%)
Leverage ratio		11.40%		12.19%	(6%)		11.86%	(4%)

VersaBank – Q1 2021 MD&A

The Bank reports its regulatory capital ratios using the Standardized approach for calculating risk-weighted assets, as defined under Basel III, which may require the Bank to carry more capital for certain credit exposures compared to requirements under the Advanced Internal Ratings Based (“AIRB”) methodology. As a result, regulatory capital ratios of banks that utilize the Standardized approach are not directly comparable with the large Canadian banks that employ the AIRB methodology.

OSFI requires that all Canadian banks must comply with the Basel III standards on an “all-in” basis for purposes of determining their risk-based capital ratios. Required minimum regulatory capital ratios are a 7.0% Common Equity Tier 1 (“CET1”) capital ratio, an 8.5% Tier 1 capital ratio and a 10.5% total capital ratio, all of which include a 2.5% capital conservation buffer.

The quarter over quarter trends exhibited by the Bank’s reported regulatory capital levels, regulatory capital ratios and leverage ratios were a function of retained earnings growth, tax provision recoveries related to the Bank’s deferred tax asset, the addition of goodwill and intangible assets from the acquisition of DBG and changes to the Bank’s risk-weighted asset balances and composition. The year over year trends exhibited by the Bank’s reported regulatory capital levels, regulatory capital ratios and leverage ratios were a function of retained earnings growth, tax provision recoveries related to the Bank’s deferred tax asset, the inclusion of eligible ECL allowance amounts related to the transitional arrangements pertaining to the capital treatment of expected loss provisioning as set out by OSFI and changes to the Bank’s risk-weighted asset balances and composition.

For more information regarding capital management, please see Note 15 to the Bank’s January 31, 2021 interim Consolidated Financial Statements as well as the Capital Management and Capital Resources section of the Bank’s MD&A for the year ended October 31, 2020.

Liquidity

The unaudited Consolidated Statement of Cash Flows for the three months ended January 31, 2021 shows cash used by operations in the amount of $26.5 million compared to cash used by operations in the amount of $13.1 million for the same period last year. The net use of cash by operations for the current and the comparative period were a function primarily of cash outflows to fund loans exceeding cash inflows from deposits raised and use of existing liquidity to fund loans. Based on factors such as liquidity requirements and opportunities for investment in loans and securities, the Bank may manage the amount of deposits it raises and loans it funds in ways that result in the balances of these items giving rise to either negative or positive cash flow from operations. The Bank will continue to fund its operations and meet contractual obligations as they become due using cash on hand and by closely managing its flow of deposits.

Interest Rate Sensitivity

The table below presents the duration difference between the Bank’s assets and liabilities and the potential after-tax impact of a 100 basis point shift in interest rates on the Bank’s earnings during a 12 month period and the potential after-tax impact of a 100 basis point shift in interest rates on the Bank’s shareholders’ equity over a 60 month period if no remedial actions are taken. At January 31, 2021, the duration difference between assets and liabilities was 1.3 months compared to 0.6 months at October 31, 2020, which indicates

VersaBank – Q1 2021 MD&A

that the Bank’s assets and liabilities would reprice at approximately the same time in the event of a future change in interest rates.

change in interest rates.
(thousands ofCanadiandollars)
		January	31, 2021			October	31, 2020
		Increase		Decrease		Increase	Decrease
		100 bps		100 bps		100 bps		100 bps
Increase (decrease):
Impact on projected net interest
income during a 12 month period	$	3,419	$	(3,061)	$	2,569	$	(2,099)
Impact on reported equity
during a 60 month period	$	400	$	(662)	$	(2,527)	$	1,604
Duration difference between assets and
liabilities (months)		1.3				0.6

Contractual Obligations

Contractual obligations as disclosed in the Bank’s MD&A and Audited Consolidated Financial Statements for the year ended October 31, 2020, have not changed significantly as at January 31, 2021

Summary of Quarterly Results

(thousands of Canadian dollars except pershare amounts) 2021			2020	2020							2019
Q1	Q4		Q3		Q2		Q1		Q4		Q3		Q2
Results of operations: Interest income 21,515 $ $	21,068	$	20,172	$	22,688	$	22,166	$	22,263	$	22,958	$	21,125
Yield on assets (%) 4.28%	4.33%		4.12%		4.83%		4.84%		4.96%		5.10%		4.89%
Interest expense 7,141	7,360		7,788		8,212		8,609		8,608		8,899		8,382
Cost of funds (%) 1.42%	1.51%		1.59%		1.75%		1.88%		1.92%		1.98%		1.94%
Net interest income 14,374	13,708		12,384		14,476		13,557		13,655		14,059		12,743
Net interest margin (%) 2.86%	2.82%		2.53%		3.08%		2.96%		3.04%		3.12%		2.95%
Non-interest income 1,048	18		8		9		25		(20)		19		4
Total revenue 15,422	13,726		12,392		14,485		13,582		13,635		14,078		12,747
Provision for (recovery of) credit losses 57	(582)		(44)		490		(208)		21		381		(411)
Non-interest expenses 8,087	7,763		6,410		6,899		6,705		6,171		6,860		6,411
Efficiency ratio 52%	57%		52%		48%		49%		45%		49%		50%
Core cash earnings 7,278	6,545		6,026		7,096		7,085		7,443		6,837		6,747
Core cash earnings per common share 0.34 $ $	0.31	$	0.29	$	0.34	$	0.34	$	0.36	$	0.32	$	0.32
Income before income taxes 7,278	6,545		6,026		7,096		7,085		7,443		6,837		6,747
Tax provision 1,988	1,799		1,657		1,947		1,944		2,038		1,874		1,851
Net income 5,290 $ $	4,746	$	4,369	$	5,149	$	5,141	$	5,405	$	4,963	$	4,896
Income per share Basic 0.22 $ $	0.20	$	0.18	$	0.22	$	0.22	$	0.23	$	0.21	$	0.21
Diluted 0.22 $ $	0.20	$	0.18	$	0.22	$	0.22	$	0.23	$	0.21	$	0.21
Return on average common equity 8.26%	7.46%		6.90%		8.64%		8.60%		9.23%		8.56%		8.89%
Core cash return on average common equity 11.72%	10.66%		9.89%		12.29%		12.23%		13.11%		12.20%		12.68%
Return on average total assets 0.94%	0.86%		0.78%		0.98%		1.01%		1.08%		0.98%		1.01%
Gross impaired loans to total loans 0.00%	0.00%		0.43%		0.41%		0.38%		0.39%		1.58%		1.57%

VersaBank – Q1 2021 MD&A

The financial results for each of the last eight quarters are summarized above. Key drivers of the quarter over quarter performance trends for the current reporting period were: lending asset growth, increased NIM attributable primarily to lower cost of funds, ECL volatility attributable primarily to changes in the forwardlooking information used by the Bank in its credit risk models, and higher non-interest expenses attributable to both organic and acquisitive business growth. Results for the current quarter reflect the consolidation of the balance sheet and the associated financial performance of Digital Boundary Group which was acquired by the Bank’s wholly owned subsidiary DRT Cyber Inc. on November 30, 2020.

Basis of Presentation

Non-GAAP and Additional GAAP Measures

Core Cash Earnings reflects the Bank’s core operational performance and earnings capacity, is calculated as net income (as presented in the Consolidated Statements of Comprehensive Income) adjusted for income taxes, restructuring charges, corporate projects and other non-core operational expenses. Core cash earnings does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions.

Core Cash Earnings per Common Share is defined as core cash earnings divided by the number of common shares outstanding.

Yield is calculated as interest income (as presented in the Consolidated Statements of Comprehensive Income) divided by average total assets. Yield does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions.

Cost of Funds is calculated as interest expense (as presented in the Consolidated Statements of Comprehensive Income) divided by average total assets. Cost of funds does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions.

Net Interest Income and Net Interest Margin or Spread is calculated as net interest income divided by average total assets. Net interest margin or spread does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions.

Return on Average Common Equity is defined as annualized net income less amounts relating to preferred share dividends, divided by average common shareholders’ equity which is average shareholders’ equity less amounts relating to preferred shares recorded in equity.

Core Cash Return on Average Common Equity is defined as annualized core cash earnings less amounts relating to preferred share dividends, divided by average common shareholders’ equity which is average shareholders’ equity less amounts relating to preferred shares recorded in equity.

VersaBank – Q1 2021 MD&A

Book Value per Common Share is defined as Shareholders’ Equity less amounts relating to preferred shares recorded in equity, divided by the number of common shares outstanding.

Efficiency Ratio is calculated as non-interest expenses as a percentage of total revenue (as presented in the interim Consolidated Statements of Comprehensive Income). This ratio does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions.

Return on Average Total Assets is defined as annualized net income less amounts relating to preferred share dividends, divided by average total assets.

Gross Impaired Loans to Total Loans captures gross impaired loan balances as a percentage of the Bank’s loans, net of allowance for credit losses. This percentage does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions.

Provision for (Recovery of) Credit Losses as a Percentage of Average Total Loans captures the provision for (recovery of) credit losses (as presented in the interim Consolidated Statements of Comprehensive Income) as a percentage of the Bank’s average loans, net of allowance for credit losses. This percentage does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions.

Basel III Common Equity Tier 1, Tier 1, Total Capital Adequacy and Leverage Ratios are determined in accordance with guidelines issued by the Office of the Superintendent of Financial Institutions ( Canada ) (OSFI).

Significant Accounting Policies and Use of Estimates and Judgments

Significant accounting policies and use of estimates and judgements are detailed in Note 2 and Note 3 of the Bank’s 2020 Audited Consolidated Financial Statements. There have been no material changes in accounting policies since October 31, 2020 except as noted below.

During the current quarter the Bank updated or incorporated the following significant accounting policies:

Principles of consolidation

The Bank holds 100% of the common shares of DRT Cyber Inc., VersaVault Inc., 11409891 Canada Inc. and VersaJet Inc. DRT Cyber Inc. holds 100% of the common shares of 2021945 Ontario Inc. (see note 4– Acquisition). The Consolidated Financial Statements include the accounts of these subsidiaries. All significant intercompany accounts and transactions have been eliminated.

VersaBank – Q1 2021 MD&A

Business Combinations

The Bank applied IFRS 3 Business Combinations in accounting for an acquisition as described in note 4 – Acquisition using the acquisition method. The cost of an acquisition is measured at the fair value of the consideration, including contingent consideration if applicable, given 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. 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 their fair values 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.

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 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 income 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 stated 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 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 (CGU). 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 value in use, 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. 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.

VersaBank – Q1 2021 MD&A

Revenue recognition

The acquisition of 2021945 Ontario Inc. and its wholly owned subsidiary, operating as Digital Boundary Group (see note 4 – Acquisition), generates a new non-interest revenue stream for the Bank. Digital Boundary Group generates professional services revenue primarily from fees charged for IT security assurance services, data acquisition (SCADA) 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.

Other accounting standard pronouncements adopted in fiscal 2020

The following accounting standard amendments issued by the IASB became effective for the Bank’s fiscal year beginning on November 1, 2020:

i) Changes to the Conceptual Framework, seeking to provide improvements to concepts surrounding various financial reporting considerations and existing IFRS standards.

ii) Amendments to IAS 1, Presentation of Financial Statements and IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, clarifying the definition of “material”.

iii) Amendments to IFRS 9, Financial Instruments and IFRS 7, Financial Instruments: Disclosures, Interest Rate Benchmark Reform, detailing the fundamental reform of major interest rate benchmarks being undertaken globally to replace or redefine Inter-Bank Offered Rates (“IBORS”) with alternative nearly riskfree benchmark rates (referred to as “IBOR reform”).

In preparing the consolidated financial statements, management has exercised judgment and developed estimates in applying accounting policies and generating reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting periods. An area where significant judgment and related developed estimates were applied was in the assessments of impairment of financial instruments and detailed in Note 7 of the Bank’s 2020 Audited Consolidated Financial Statements.

Future Changes in Accounting Policies

The Bank monitors the potential changes proposed by the IASB and assesses the impact that change in accounting standards may have on the Bank’s financial reporting and accounting policies. Future accounting policies that may impact the Bank can be found on page 33 of the Bank’s 2020 annual MD&A and note 4 of the Bank’s 2020 annual consolidated financial statements.

VersaBank – Q1 2021 MD&A

Controls and Procedures

During the quarter ended January 31, 2021, there were no changes in the Bank’s internal controls over financial reporting, that have materially affected, or are reasonably likely to materially affect, the Bank’s internal controls over financial reporting.

FOR FURTHER INFORMATION PLEASE CONTACT:

VersaBank Investor Relations: Wade MacBain (800) 244-1509, [email protected]

LodeRock Advisors: Lawrence Chamberlain (416) 519-4196, [email protected]

Visit our website at: www.versabank.com

VersaBank – Q1 2021 MD&A

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VersaBank — Interim / Quarterly Report 2021

47151_rns_2021-02-24_9fe7ceaf-29ea-486a-81f7-80651c92a89b.pdf

Management’s Discussion and Analysis

Cautionary Note Regarding Forward-Looking Statements

Overview

Update on impact of COVID-19 pandemic

Overview of Performance

Q1 2021 vs Q4 2020

Q1 2021 vs Q1 2020

Items of note

Q1 2021

Q4 2020

Q1 2020

Selected Financial Highlights

Business Outlook

Lending Assets

Credit Quality

Funding and Liquidity

Earnings and Capital

Financial Review - Earnings

Total Revenue

Net Interest Income

Q1 2021 v Q4 2020

Q1 2021 v Q1 2020

Net Interest Margin

Q1 2021 v Q4 2020

Q1 2021 v Q1 2020

Non-Interest Income

Provision for Credit Losses

Non-Interest Expenses

Q1 2021 v Q4 2020

Offset partially by:

Q1 2021 v Q1 2020

Tax Provision

Financial Review - Balance Sheet

Total Assets

Acquisition of DBG

Cash and Securities

Loans

Q1 2021 v Q4 2020

Q1 2021 v Q1 2020

Residential Mortgage Exposures

Credit Quality and Allowance for Credit Losses

Allowance for Credit Losses

Assessment of significant increase in credit risk (“SICR”)

Forward-Looking Information

Expected Credit Loss Sensitivity:

Deposits

Q1 2021 v Q4 2020

Q1 2021 v Q1 2020

Other Assets and Liabilities

Other Assets

Q1 2021 v Q4 2020

Offset partially by:

Q1 2021 v Q1 2020

Offset partially by:

Other Liabilities

Q1 2021 v Q4 2020

Q1 2021 v Q1 2020

Shareholders’ Equity

Updated Share Information

Off-Balance Sheet Arrangements

Related Party Transactions

Capital Management and Capital Resources

Liquidity

Interest Rate Sensitivity

Contractual Obligations

Summary of Quarterly Results

Basis of Presentation

Non-GAAP and Additional GAAP Measures

Significant Accounting Policies and Use of Estimates and Judgments

Principles of consolidation

Business Combinations

Goodwill and Intangible Assets

Revenue recognition

Other accounting standard pronouncements adopted in fiscal 2020

Future Changes in Accounting Policies

Controls and Procedures

FOR FURTHER INFORMATION PLEASE CONTACT:

VersaBank Interim / Quarterly Report 2021