message to shareholders
President's Message
In 2002, our wholly owned subsidiary became a Canadian bank with a unique model. Rather than having an expensive branch network, it would gather deposits exclusively from a nationwide network of deposit brokers and lend those funds to low risk markets. These markets would be primarily public sector entities and high quality corporate and commercial entities. In order to attract these high quality assets, it would lend with low margins, but make up this reduction in revenue with lower loan losses and higher efficiencies. This new bank was designed to mitigate the principal risks facing banks, which include: credit risk; liquidity risk; interest rate risk and; operational risk.
However, with the onset of the liquidity crisis, this model proved vulnerable to changes in accounting principles, regulation and a departure from GIC’s historic relationship with Government of Canada Bond yields. The advent of mark to market accounting caused a rapid depletion of the bank’s capital that we were forced to replace with expensive debt and the spread we were formally able to earn on loans to public sector entities evaporated. Thankfully, the Bank’s low risk lending strategy insulated it from significant loan losses and its expansive deposit gathering network provided ample liquidity.
Clearly, we had to re-invent our Bank to capitalize on its strengths and eliminate the vulnerabilities that the liquidity crisis had revealed. Key elements of this strategy were: to find new revenue sources (bulk leasing and the Home Hardware card are primary examples of this); to lower cost sources of deposits (Trustee deposits are an example of this) and; to reduce our capital’s vulnerability to mark to market accounting (reducing our holdings in preference shares is an example of this).
In 2011, we made significant progress with this re-invention strategy.
During 2011, our loan and lease portfolio grew by 13% from $965 million to $1.1 billion. About half of this growth can be attributed to our new bulk lease financing program. During 2011, we also established relationships with six large lease vendors and began receiving leases from them electronically. We are continuing to expand this network of lease vendors and expect that most of the growth in our commercial lending business will be from this area.
Net revenue from lending operations again set a record increasing by 15% to $21.9 million. Although we are pleased with this significant increase in net revenue, our Bank’s net interest income figures were depressed by two large hospital construction loans that we priced prior to the liquidity crisis with thin spreads. The first hospital loan repaid during the last few weeks of fiscal 2011 and the second is due to repay at the end of 2012’s second quarter. We expect net interest income to improve significantly in 2012 as we are able to redeploy the proceeds of the hospital loans’ repayments into higher spread loans and leases.
The quality of our loans and leases throughout the year has remained outstanding with not a single loan being in arrears for most of the year. Gross impaired loans at the end of the year were a mere $923,000 or just 6 basis points of total assets.
We estimate that our loan and lease balances will grow by about 13% per year; however, as mentioned above, due to the repayment of the thinly priced hospital loans, net interest income from our commercial lending operations should grow more significantly.
On January 2, 2012 we launched a new credit card for Home Hardware’s customers and received a tremendous response from Home Hardware’s dealer network. Home Hardware has approximately 1,075 dealers that operate throughout Canada and we are very pleased to be working with these dealers to provide them with a high quality credit card financing service. This opportunity of course did not come without the requirement for a significant investment, most of which was made during 2011. The Bank absorbed some of these costs; however, the majority of the costs were borne by the Bank’s sister company, Versabanq. We are excited not only by the tremendous potential for profitable growth that this card brings, but also by the diversity that it adds to our revenue streams, which since the liquidity crisis have been primarily reliant upon our commercial lending business.
The other project that we have invested considerable time and money in 2011 is also near completion. Once operational, it should result in a significant reduction to our cost of funds and greatly increase the diversity of our deposit gathering network. We have been working with two of Canada’s largest trustees in bankruptcy, their administrative software provider and a large Canadian bank to develop custom banking software for this industry. There are approximately 900 trustees in bankruptcy operating throughout Canada with about $2 billion in deposits. We believe our custom banking software will prove to be an attractive alternative to the trustees’ present banking arrangements and we are hopeful that this will result in a new source of low cost deposits for our Bank.
In total during 2011, we invested approximately $3.1 million to bring these projects to successful launches. The cost of these investments served to depress our Bank’s earnings to little more than breakeven and increase the loss for the corporate group. As a large majority of these costs are now behind us, we expect our Bank’s profitability to increase significantly, which I expect to have a very positive effect on the consolidated groups’ earnings.
During the year we completed a public offering and private placement of units, which resulted in additional capital of $23million. Some of this capital was utilized to repay expensive debt and the rest to increase our Bank’s regulatory capital. The Bank’s regulatory capital increased to $149 million, a 16% increase over the previous year. Additionally in this coming November we have 6,200,000 warrants maturing. If these warrants are exercised, it will result in additional capital of approximately $17 million, which together with other initiatives will allow us to further reduce expensive debt and de-lever our corporate group. Prior to the liquidity crisis, our overall corporate group leverage was approximately the same as the Bank’s, but through the issuance of public debt and preference share liabilities, the overall group leverage now significantly exceeds the Bank’s leverage. It is our goal to once again align the overall group’s leverage with that of our Bank’s.
We obviously incurred considerable expenses in 2011 to diversify our lending and deposit gathering activities and to provide for significant profitable growth, we think these investments will prove to be well justified as we begin to receive the dividends this year and in the years to come. We know we are living in an unstable world that will no doubt deliver more challenges; however, our company is stronger than ever and unlike our much larger colleagues, has the luxury of exclusively betting on Canadians and the Canadian economy. We think that is the best bet a banker can make.