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Own This Bank Stock for a Change of Pace

When most investors consider investing in Canadian banks, they usually go for one of the Big Six. National Bank of Canada (TSX:NA) is often on the outside looking in. So, imagine the chances of tiny VersaBank (TSX:VB) enticing investors to buy its stock when there are bigger, better dividend-paying options available; they’re slim to none.

Or at least that’s the commonly held perception. However, you don’t necessarily have to be big to be an attractive bank stock. Regionals in the U.S. prove this every day; VersaBank is no different.

Not sure you want to invest in a Canadian bank stock whose market cap is barely over $100 million? I’ve got three pretty compelling reasons why investors might want to own this small-cap bank stock, and none of them have to do with a big, fat, juicy yield.

A value play

VersaBank earned $0.33 per share in fiscal 2015, four cents higher than in the previous quarter. That’s a nice 13.8% increase year over year. In the first quarter ended January 31, 2016, it delivered a 28.6% increase in earnings per share to $0.09. Second-quarter earnings come out June 1, and they should deliver another healthy double-digit increase in earnings per share.

So, here’s the thing.

VersaBank went public in August 2013 at $7.25. It currently trades in the mid-$5 range, or 25% lower than its IPO price. Yet its earnings are significantly higher than they were almost three years ago. Using an apple-to-apples comparison, VersaBank had a net interest margin in fiscal 2012 of 1.30% on net interest income of $19.6 million. Fast forward to fiscal 2015, and its net interest margin was 2.21% on $34.0 million in net interest income.

VersaBank went public with a price-to-earnings ratio of 26.9; today, it’s trading at 12 times earnings. Its business has gotten bigger and better, and yet investors are holding it to the same multiple as the Big Six. That might make sense, if not for my next reason for owning VersaBank stock.

Credit quality is top notch

You’ve probably noticed with all the problems in the energy sector here in Canada that the big Canadian banks have been mentioning gross impaired loans with greater regularity in recent quarters as many of their oil and gas clients struggle to stay afloat.

While it doesn’t appear to be a problem for the big banks, yet, who collectively have something in the order of $50 billion in loans outstanding in the oil and gas industry and another $50 billion in undrawn commitments, a sudden reversal of fortune could signal renewed concerns from bank executives.

VersaBank, on the other hand, doesn’t have any gross impaired loans and hasn’t since fiscal 2012. Its common equity tier 1 (CET1) ratio in its most recent quarter was 10.11%, which is right in line with the Big Six.

Shouldn’t a bank with a risk profile that’s much less aggressive than its bigger peers be given a higher P/E ratio? One would think so. Sure, by not taking the same kind of risks, it’s got less growth potential ahead of it, but I look at VersaBank’s business as a case of the glass being half full. Avoiding risk is what you want from a bank, especially one smaller in stature and less able to spread the loan risk around.

VersaBank: FinTech original

VersaBank, which changed its name in mid-May from Pacific & Western Bank of Canada, is a branchless bank. It gathers assets through deposit brokers, financial advisors, and other financial services professionals. Recently, it opened up a new revenue stream by providing bankruptcy trustees with software to be able to efficiently operate chequing accounts for their clients. It’s a niche business that’s seen deposits grow by 43% over the past year to $119.8 million.

It might not seem like much, but when you don’t have any branches and you’re not owned by a big bank, it’s these types of initiatives that can make a big difference over time. Being a FinTech original definitely has its benefits.

Within three to five years, I could easily see its stock price go over $10.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Will Ashworth has no position in any stocks mentioned.

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